Agriculture Reference
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The farmer's two-period compensation without commitment is now
Q 2 q 2 k 2 ],
Y =
s 1 Q 1 q 1 k 1 ]
s 2
Q 1 = e 1 + k 1 +
replaces the side payment
. As above, a series of substitutions—
Q 2 = e 2 + k 2 + θ 2 θ 2 , and
θ 2 = γ(e 1 + k 1 ) + θ 1 —allow us to rewrite the compensation
θ 1 ,
function as
Y =
(s 1 γs 2 )(e 1 + k 1 + θ 1 ) q 1 k 1 ]
s 2 (e 2 + k 2 + θ 2 ) q 2 k 2 ].
Since the structure of this problem is identical to the contract choice problem, the structure
of the solution is also identical. As before, it is clear that the effective share coefficient on
first-period output is not the nominal contract amount
This implies that effort and the actual shares increase over time. This is the ratchet effect,
again. When there is no commitment, output shares (
(s 1 )
but a smaller amount
(s 1 γs 2 )
) will be higher for new farmers.
Notice that equation (7.7) also implies that the input cost shares remain constant over time.
In contrast, if a new landowner is involved in the contract, he has no knowledge of past
performance, and, consequently, he should not provide the farmer with higher powered
incentives. The ratchet effect therefore plays a similar role within share contracts in terms
of incentives increasing over time, which leads to the second set of predictions.
PREDICTION 7.3 New farmers should receive a higher output share than farmers with
ongoing contracts; however, input cost shares should remain constant.
PREDICTION 7.4 New landowners should not change the output shares to their farmers
compared to established landowners.
Empirical Analysis: Testing for Ratchet Effects
To test these predictions, we again use the contract data from the 1986 Nebraska and South
Dakota Leasing Survey. 18 Recall there are 3,432 contracts in total, of which 2,424 are
cropshare and 1,008 are cash rent. Of these, 264 cropshare contracts and 29 cash rent
contracts had new farmers within five years of the survey. In addition, 115 cropshare and
38 cash rent contracts had new landowners within five years of the survey. The data set
has information on whether input and output shares changed and on the direction of the
change for output shares. The definition of the variables used in this chapter are found in
table 7.2.
Ideally, to test the ratchet effect we would like a panel data set containing information
on contract terms as well as farmers and landowners. However, because our cross-section
data includes retroactive information, they are still well suited to test the predictions from
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