Agriculture Reference
In-Depth Information
first-order conditions imply that the farmer uses less effort and fewer units of the asset when
the asset is financed through a loan. In effect, the limited liability faced by the farmer means
that he farms in a way that lowers the value of the farm in all states of the world. One can
imagine a farmer reducing the amount of effort in timing planting and harvesting carefully,
for example.
Facing higher costs of ownership from a combination of forgone specialization gains and
lower marginal products from the neglect of assets works to lower the value of the ownership
governance structure. These results are also shown in the top panel of figure 8.1, where it
is clear that input levels are lower than without borrowing:
e
o
l
o
<e
o
<e
∗
,
<l
o
<l
∗
, and
k
o
V(e
o
,
l
o
,
k
o
<k
∗
=
k
o
. The value of this governance structure will be
.
15
)
Contracting for Assets
With contracting the farmer exchanges greater specialization (in effort and asset use) and
fewer capital constraints, for the costs of moral hazard (in effort and asset use) and timeliness
in the coordination of all inputs. The magnitude of these costs depends on whether the
contract is simple or custom, and whether the contract is short- or long-term. In a simple
contract, there will be asset moral hazard. In a custom contract there will be no asset moral
hazard but there will be effort moral hazard; that is, the operator will shirk. In a short-term
contract timeliness costs will be present, but they are absent in long-term contracts. Long-
term contracts do not necessarily mean multiple-year contracts because long-term simply
means the contract period extends beyond the dates of the relevant season.
Simple Long-Term Contracts (Case 5).
With long-term contracts the most efficient size
of asset is used and the rental rate falls from
r
l
. Still the asset is available for a period
at least as long as the season it is required, so there will be periods of unemployment for the
asset, and this prevents the marginal cost from equaling the first-best rental rate,
r
o
to
r
∗
. Without
a specialized operator for the asset the marginal costs of effort are not minimized, so that
w
o
=
w
l
>w
∗
.
Figure 8.1, bottom panel, shows the input choices for this contract. Because the farmer
does not own the asset, he faces a lower cost of using the unpriced attribute (
v
l
<v
∗
), which
k
l
>k
∗
). This causes a deadweight loss per unit of the unpriced
leads to overuse of the asset (
.
16
With competitive markets for assets, this cost is incorporated in
the cost (price) of the priced attribute and drives a wedge of vertical distance
attribute equal to area
D
r
l
D
between
r
l
+
D
and
and a total deadweight cost equal to the hatched
area (rectangle plus triangle). The value of this governance structure will be
h
l
, and it creates a full price of
V
l
(e
l
,
l
l
,
k
l
)
.
Simple Short-Term Contract (Case 4).
The advantage of a short-term contract is that an
asset may be rented only for the stage(s) it is required, and need not be unemployed on the
farm. Since a short-term contract can fully exploit asset specialization and avoid downtime,
