Introduction - The Nature of the Farm - page 5

to enforce or maintain them, is for a confusion to exist over the effects of nature and the
actions of people. The more uncertainty there is in nature and the more individuals are able
to influence final outcomes, the larger the transaction costs. What makes farming such a
rich field for a transaction cost approach is the obvious impact of Mother Nature, and the
equally important impact of farming decisions on crop output.
Our approach to farming contracts and organization is a transaction cost approach because
we develop a set of specific models that depend on the ability of contracting parties to police
their interactions with each other. Although farmers enter into contracts with various parties
(for example, custom combiners, laborers, landowners, pesticide applicators, storage firms),
these contracts are never complete and problems arise in their enforcement due to nature's
uncertainty and the complexity of the assets involved in production. Farmers can hide bales
of hay that were intended to be shared with landowners, harvest crews can arrive late causing
a reduction in crop value, and, of course, hired workers can generally shirk their duties.
Transaction costs are the costs of engaging in and preventing these activities, along with
any lost gains from trade that result. Both landowners and farmers seek to mitigate these
costs. A theme throughout the topic is that contracts have incentives that often substitute for
direct monitoring. As a result, contracting problems are often solved by altering incentives
given the constraints imposed by the particular farming technology, the role of nature, and
the potential gains from specialization. 10
Our transaction cost approach is in the tradition begun by Coase and Cheung, Alchion
and Demsetz (1972), and most recently exposited by Barzel (1997). It is similar to
Williamson's (2000) discussion of the New Institutional Economics, but differs from his
(1979) view of transaction costs that emphasize the role of specific assets in determining
organizational forms. Recently Hart (1995, chap. 2) developed what he calls a “property
rights approach” to firm ownership. Our topic has a similar spirit to that of Hart, but its
method is broader. Hart's framework stresses the investments individuals make under dif-
ferent ownership structures. He notes that investments may become sunk, raising the costs
of negotiating over the gains from trade in future periods, and that different asset ownership
structures will influence investment and total value. Our model is more general and more
relevant to farming where investment in such assets tends to play a minor role.
Five Important Ideas
Five important ideas define our framework and require discussion. First, we assume that all
parties (farmers, landowners, other input owners) choose contracts and organizational forms
because they maximize the expected value of the relationship , given the characteristics of
all parties, the desired output, and the attributes of assets such as land and equipment. By
focusing on joint wealth maximizing allocations, we ignore issues of bargaining and surplus
division. In addition, the empirical implementation of bargaining strength seems impractical