Risk Sharing and the Choice of Contract - The Nature of the Farm - page 119

is heterogeneity in both the leased asset (land, in our case) and the risk preferences of the
agent. Landowners and risk-averse farmers compete for one another and match in ways that
either create a positive relationship between risk and incentives, or other nonmonotonic re-
lationships, depending on various assumptions. It is certainly possible that risk preference
matching and other new ideas may indeed be able to resurrect risk sharing as a basis for
understanding contracting. The idea of matching is worthy of further exploration, but there
are two problems. First, empirically identifying differences in risk preferences is likely im-
possible. Second, there is no reason that the effects of matching should be restricted to risk
preferences. Matching might take place in terms of land types, reputations, asset types, and
so on. Still what we have shown here is that the classic risk-sharing model is not a useful
empirical paradigm and that transaction cost economics offers an empirically supported
alternative. 40
In the next chapter we analyze a relatively new development in the theoretical analysis of
contracts—the possibility of so-called ratchet effects. This phenomenon is also developed
from a principal-agent model with risk averse agents to be consistent with the literature that
gave birth to it. As with this chapter, we find no evidence for complicated ratchet effects
existing in modern agriculture.