Agriculture Reference
In-Depth Information
Chapter 7: Ratchet Effects in Agricultural Contracts
1. The analysis in this chapter draws on Allen and Lueck (1999b).
2. See Berliner (1957) for a Soviet application, and Weitzman (1980), and Baron and Besanko (1984) for early
formal analyses.
3. Methods of commitment may take different forms, including long-term agreements, reputation, and specific
investments. Kanemoto and MacLeod (1992) show how competition from older workers can ameliorate the ratchet
effect under some circumstances.
4. The landowner is made better off from the new knowledge; hence, the fixed side payment made by the farmer
to the landowner must also increase with the incentives in the contract.
5. Refutable implications arising from dynamic models, like the ratchet effect, are rare. This may explain the
common use of adjectives like “celebrated” (Salanie 1997, 158) in discussions of the ratchet effect.
6. In a standard principal-agent model, lower standards over time are not possible. This is because the informed
farmer would never accept the initial contract if it contained performance standards that were too high and violated
his individual rationality constraint.
7. Much of the ratchet literature still examines Soviet-style organizations. More recently, however, the applications
have expanded to include the U.S. military (Ickes and Samuelson 1987), private ownership (Olsen and Torsvik
1993), and labor markets (Kanemoto and MacLeod 1992). The analysis of ratchet effects is now found in theoretical
texts like Milgrom and Roberts (1992), Laffont and Tirole (1993), and Salanie (1997).
8. This model is similar to the one in Milgrom and Roberts (1992).
9. Although the ratchet effect is often discussed in the context of risk-averse farmers, it does not depend on any of
the classical principal-agent assumptions. In particular, risk aversion is not necessary. A ratchet effect can exist in
more complicated multiple moral hazard models and models of adverse selection without the assumption of risk
aversion. For an example of a ratchet effect model with moral hazard and no risk aversion, see Meyer and Vickers
(1997).
10. This is a reasonable assumption in our context, given the demographical similarity of farmers and landowners
on the Great Plains (see chapters 2 and 6). Also, the use of tractors and other types of farm machinery tends to
equalize the ability to farm, since sheer physical strength is less of a factor. We recognize that farmers are not truly
identical and that the landowner will learn about specific farmers.
11. The ratchet effect appears to grind against the old ladder hypothesis (Spillman 1919) that implies young farmers
start with cropshare contracts, move on to cash rent contracts, and eventually have sole ownership of the farm.
However, they are not necessarily at odds. With models that incorporate the ratchet effect, a new tenant farmer is
not the same as a young tenant farmer.
12. This simple production function allows us to focus on the ratchet effect. See Meyer and Vickers (1997) for a
similar setup.
13. This simple specification of the correlation in random inputs can easily apply to agriculture where the effect
of nature is often relatively straightforward. For example, a particular hay field may have poor drainage or slope,
which leads to poor drying conditions and reduced hay output. Knowledge of this learned in the first period helps
the landowner better estimate the drying contribution of nature in the second period.
14. In order for there to be a ratchet effect,
γ>
0 because otherwise the landowner would be ignoring the first-period
information.
15. Because we focus on gross income, the
C(e)
term is gone. This simplifies the analysis without altering the
predictions.
16. The benefit of the acquired information is the reduction in the variance in the landowner's estimate of the value
of random input; that is,
Var(θ
2
−
θ
2
)<Var(θ
2
)
. When the landowner has a better measure of the random input,
he has a more accurate picture of the farmer's contribution as well and can better alter the contract to increase his
returns. Although the share to the farmer increases, the side payment to the landowner also increases, making the
landowner better off.
