Quality Measurement and Contract Design: Lessons from the North American Sugarbeet Industry

This paper examines contracts used in the North American sugarbeet industry. Though quite similar in many respects, the contracts we study vary across processing firms in the set of quality measures used to condition contract payments to growers. This is somewhat surprising, given the homogeneous nature of the processors' finished product (refined sugar). It seems unlikely that processors differ significantly in how they value the various attributes of a sugarbeet, and such a difference is perhaps the most natural reason to expect variation in the structure of quality incentives across processors. Previous attempts to explain the observed variation in sugarbeet contracts have focused on differences in organizational form across firms. In this paper, we provide an alternative explanation that relies on variation across production regions in growers' ability to control the relevant measures of sugarbeet quality.     

Microeconometric analysis of wine grape supply contracts in Australia*

This paper examines wine grape supply contracts used in the main grape growing regions of Australia. An empirical analysis provides insight into specific aspects of contract design and implementation. Statistical analyses of sample data reveal differences between regions in contract specifications. Lower quality grape growing regions place a greater reliance on grape quality assessment to determine bonus/penalty payments compared to higher quality regions. Contracts in higher quality regions place greater emphasis on explicit winery involvement and direction in vineyard management. Results indicate that longer duration contracts are more inclusive in terms of the number of clauses included. Evidence of risk shifting (i.e., winery to grower) for high quality grapes is reported, where the price received by growers is determined by the bottle price of the wine produced.     

How much do farmers value their independence?

A farmer's decision to contract or produce independently depends on the distribution of income and the nonpecuniary attributes associated with both business arrangements. The benefits to growers from contracting (such as risk reduction) may be overestimated if the nonpecuniary benefits enjoyed by independent producers (such as the right to make management decisions and own the commodity produced) are not accounted for. This study uses data from a U.S. national survey of hog producers to estimate (1) the difference in expected net returns between contracting and independent production, (2) the premium a representative farmer would pay for the risk reduction provided by a contract, and (3) the premium a farmer would pay for the nonpecuniary benefits associated with independent production. Results indicate that growers have a strong preference for autonomy—with moderately risk‐averse growers being willing to pay more for the attributes of independent production than they would for the risk‐reducing benefits of a contract.     

Distress rentals and the land rental market as a safety net: contract choice evidence from Tigray,Ethiopia

Rural households in the semiarid Northern Ethiopian highlands are net buyers of food. Crop failure due to erratic and unpredictable rainfall occurs frequently and leads to food shortages and income shocks. The renting out of land may be one of the coping responses of households exposed to shocks. We developed a theoretical household model for poor landlord households capturing their contract choice response to downside production shocks. We tested econometrically whether contract choice may depend on poverty, capital constraints, production risk and random shocks. The multinomial logit model estimates show that poor households experiencing random shocks are more likely to choose fixed‐rent contracts as a distress response to shocks, suggesting that fixed‐rent contracts may be used to meet immediate needs, but at the expense of future incomes. We also found that fixed‐rent contracts are preferred when ex ante production risk is low, while sharecropping is more likely where production risk is high. Finally, we found an indication that the choice of a fixed‐rent contract as a coping response to shocks comes as a last resort after all other means of coping are exhausted.     

The impact of geographic reputation on the value created in Champagne

With asymmetric information, consumers need to rely on the reputation of wine to define quality before the purchasing. Amongst the tools available for underlining reputation, geographic location is considered to offer high potential. Today, some wines benefit from a country's reputation, some from the renown of a region and some from the local reputation of one specific vineyard, whilst conversely some providers suffer from a weak geographic reputation. There can be a split between producers within one vineyard or region based on varying geographic reputation. This kind of split appears in Champagne, with a range of well‐known and less well‐known brands and is particularly significant to the small growers who sell wine. This study used a representative sample of these growers to examine how their location impacts on their reputation. The results show that their selling price is influenced by the local system of grading vineyard quality, their distance from traditional regional centres and the presence in their village of growers cited in a national guide.     

Agricultural Producer Price Expectations

Producer price expectations underlie much of agricultural supply analysis. While producer price expectations would ideally be discovered experimentally, this is too costly. Instead, producer price expectations are usually represented in agricultural supply analysis by easily obtained hypothesized expectation formulations. In most cases, the hypothesized expectation formulations are functions of past prices. However, other formulations are sometimes used, such as current cash and futures prices, or initial payments in the case of grains marketed by the Canadian Wheat Board. This paper compares actual producer price expectations with a variety of hypothesized expectation formulations for wheat and canola in Saskatchewan. A test developed by Granger is used to determine the proxy models that are significantly dominant. The model that dominates as a proxy in the case of wheat price expectations is the two-year declining-weight moving average. The two models that dominate as a proxy in the case of canola price expectations are the first-order autoregressive and, as well, the two-year declining-weight moving average. There is no significant difference between the two models. Somewhat surprising is the performance of formulations based on futures prices. These formulations perform very poorly in representing producers' price expectations, even though they are found to be among the most accurate predictors of actual commodity prices. An even more interesting observation is the performance of the futures price model in the canola market. Even though the November contract in January explains very little of the variation in the actual commodity prices for that year, its error in predicting canola prices is not significantly greater than that of the best performing, the four-year declining-weight moving average, based upon the root mean squared error criterion.     

Optimal Protein Segregation Strategies for Wheat Growers

A technology that can measure wheat grain protein concentration and then segregate grain based on measurements during harvesting is on the horizon. This new technology provides wheat growers with opportunities to segregate grain that can be directed to premium markets. In this article, we identify an individual grower's optimal segregation and blending strategies under non‐uniformly curved price schedules. When price schedules are three‐step shaped, we show that the optimal segregation and blending strategies can be obtained by solving a specified non‐linear programming problem. Based on cash price and protein distribution data for wheat in the U.S. Pacific Northwest region over 1991–2011, an application of our theoretical model shows that on average a Hard Red Winter (respectively, Hard Red Spring) wheat grower should be willing to pay about 17.7 (respectively, 30.8) cents for segregating one bushel of wheat. We also study how growers’ net returns would be affected were the technology to be adopted.     

On the co-existence of spot and contract markets: the delivery requirement as contract externality

A contract between an upstream and a downstream party consistsof a contract price and a delivery requirement. Contract formationentails an externality. It changes the probability distributionof the spot market price by removing high reservation pricebuyers and various sellers from the spot market. The first effectdecreases the expected spot market price when the number ofcontracts is small, whereas the decrease in the number of sellersand additional residual contract demand increase the expectedspot market price beyond a certain number of contracts. It impliesan endogenous upper bound on the number of contracts. Contractprices are positively related to the number of contracts. Finally,additional contract formation reduces the variance of the spotmarket price when the number of contracts is sufficiently large.     

Finding optimal price risk management instruments: the case of the Spanish potato sector

This article offers a comprehensive analysis of the problem of choosing between alternative market risk management instruments. We model farmers' behavior to optimize the certainty equivalent, formulated by a mean–variance model, by combining instruments with and without basis risk. Results are expressed as the demands for hedging with futures, forward contracts and insurance. Theoretical results are applied to a selection of Spanish producers of fresh potatoes, a sector that is exposed to significant market risks. Amsterdam's Euronext provides potato futures prices, and the recently launched revenue insurance in Spain provides the example for price insurance. Three conclusions summarize the article's main findings. First, we show that Spanish potato revenue insurance subsidies are a factor that determines the instrument rankings and choice. Second, the efficiency of insurance subsidies is generally low. Finally, the Amsterdam potato futures market does not provide a cost‐effective means to manage price risks for Spanish fresh potato growers.     

An Evaluation of the Compensation Required by European Union Cereal Growers to Accept the Removal of Price Support

Motivated by the policy trend of exposing European Union farmers to more market risk by reducing price support, this paper evaluates the compensation required by EU cereal growers to accept the complete removal of price support. Additional considerations are whether this policy change also includes the removal of set‐aside, or features only a partial removal of price support. A model is developed which captures the main on‐ and off‐farm factors influencing grower perceptions of the impact of this policy change. This model is subjected to a numerical analysis which shows that divergent assessments of the expected profitability of releasing to production land previously set‐aside mean growers are unlikely to agree whether compensation is even required. It is concluded that the retention of set‐aside for environmental purposes is likely to mean growers are more united in their perception of the need for, and amount of, compensation to accept the removal of price support.     

UNDERWRITING ASSISTANCE TO THE AUSTRALIAN WHEAT INDUSTRY — AN APPLICATION OF OPTION PRICING THEORY

For the ten crop seasons 1979-80 to 1988-89, returns to producers in the Australian wheat industry were underwritten by a government-guaranteed price floor. Similar schemes operate in other rural industries (dairy, apples and pears, dried fruits). Although the underwriting provisions have only been triggered once (in the 1986-87 season), the provision of this scheme has acted to reduce the risk normally associated with returns to producers of wheat in all years of its operation. This reduction in risk has been granted free-of-charge by the Commonwealth Government. The guaranteed price can be viewed as a put option taken out by the Government on behalf of growers — it gives growers the option to sell to the Australian Wheat Board at this floor price. The aim of this paper is to apply to this underwriting arrangement the Black-Scholes formula for valuing options, in order to estimate the cost that growers would otherwise have had to pay to obtain cover (through put options) equivalent to the guaranteed price. We also estimate the magnitude of this form of assistance to the industry, which (until now) has not been taken into account unless the returns to growers fell below the guaranteed price.     

Factors influencing hedging decision: evidence from Brazilian citrus growers

The purpose of this study was to analyse the hedging behaviour of 98 citrus growers from the State of Sao Paulo, Brazil. Marketing behaviour was modelled as a choice between spot market, short and long‐term forward contracts. A multinomial logistic regression model was used to evaluate the role of behavioural, personal and managerial variables in the choice. Results indicated that the factors which explain the use of forward contracts by citrus growers are the following: risk propensity; trade with juice processing companies; farming diversification; overconfidence in management; participation in pools; use of management tools; and technical assistance. The results can be useful for farmers, policymakers, government agencies, traders and extension agents.     

Quality control in nonstaple food markets: evidence from India

Using original survey data collected on growers, traders, processors, markets, and village communities, we will compare the situation in four states: Tamil Nadu, Uttar Pradesh, Maharashtra, and Orissa. We examine the way that information about crop attributes is conveyed (or not) along the value chain. We find that little information circulates about unobservable crop characteristics. Growers receive a price premium when they dry, grade, and pack their produce, but we find no evidence that information about crop salubrity or agricultural practices circulates through the value chain or that growers are encouraged to follow specific agricultural practices for quality purposes. Market infrastructure is deficient regarding sanitation, with few public toilets, inadequate drainage, and no coordinated pest control.     

Auctions for conservation contracts: an empirical examination of Victoria's BushTender trial

The present paper proposes that markets for nature conservation on private land are missing because of the problem of asymmetric information. An auction of conservation contracts was designed to reveal hidden information needed to facilitate meaningful transactions between landholders and government. The present paper describes the key elements of auction and contract design employed and the results obtained from a pilot auction of conservation contracts run in two regions of Victoria. The pilot demonstrated that it was possible to create at least the supply side of a market for nature conservation and in conjunction with a defined budget, prices were discovered and resources allocated through contracts with landholders. The present paper compares a discriminative price auction with a hypothetical fixed-price scheme showing that an auction could offer large cost savings to governments interested in nature conservation on private land. The paper identifies some important design problems that would need to be solved before auctions could be applied more broadly including: multiple complementary outcomes, reserve prices, sequential auction design and contract design. Nevertheless, the paper does show that auctioning conservation contracts for environmental outcomes is an important new policy mechanism that deserves closer examination.     

Regulating Broiler Contracts: Tournaments versus Fixed Performance Standards

Grower discontent with tournaments as mechanisms for settling poultry contracts can largely be attributed to the group composition risk that tournaments impose on growers. This article focuses on the welfare effects of a widely advocated regulatory proposal to prevent integrator companies from using tournaments and replace them with schemes that compare performance to a fixed standard. The analysis shows that the mandatory replacement of tournaments with fixed performance standards, absent any rules that regulate the magnitude of the piece rate, can decrease grower income insurance without raising welfare. However, replacing tournaments with fixed performance standards can simultaneously increase income insurance and welfare, provided that the magnitude of the piece rate is also regulated.     

Contract farming,contract design and smallholder livelihoods*

Contract farming has gained in importance in many developing countries. Previous studies analysed effects of contracts on smallholder farmers’ welfare, yet mostly without considering that different types of contractual relationships exist. Here, we examine associations between contract farming and farm household income in the oil palm sector of Ghana, explicitly differentiating between two types of contracts, namely simple marketing contracts and more comprehensive resource-providing contracts. Moreover, we look at different income sources to better understand how both contracts are linked to farmers’ livelihood strategies. We use cross-sectional survey data and regression models. Issues of endogeneity are addressed through measuring farmers' willingness-to-participate in contracts and using this indicator as an additional covariate. Farmers with both types of contracts have significantly higher household incomes than farmers without a contract, yet with notable differences in terms of the income sources. Farmers with a marketing contract allocate more household labour to off-farm activities and thus have higher off-farm income. In contrast, farmers with a resource-providing contract have larger oil palm plantations and thus higher farm incomes. The findings suggest that the two contract types are associated with different livelihood strategies and that disaggregated analysis of different income sources is important to better understand possible underlying mechanisms.     

Contract farming and smallholder incentives to produce high quality: experimental evidence from the Vietnamese dairy sector

In emerging markets for high‐value food products in developing countries, processing companies search for efficient ways to source raw material of high quality. One widely embraced approach is contract farming. But relatively little is known about the appropriate design of financial incentives in a small farm context. We use the example of the Vietnamese dairy sector to analyze the effectiveness of existing contracts between a processor and smallholder farmers in terms of incentivizing the production of high quality milk. A framed field experiment is conducted to evaluate the impact of two incentive instruments, a price penalty for low quality and a bonus for consistent high quality milk, on farmers’ investment in quality‐improving inputs. Statistical analysis suggests that the penalty drives farmers into higher input use, resulting in better output quality. The bonus payment generates even higher quality milk. We also find that input choice levels depend on farmers’ socio‐economic characteristics such as wealth, while individual risk preferences seem to be less important. Implications for the design of contracts with smallholders are discussed.     

Contracting and Farmers’ Perception of Unfair Trading Practices in the EU Dairy Sector

It is commonly asserted that unfair trading practices (UTPs) emerge largely as a result of contract incompleteness. In line with this view it is claimed that making contracts more complete will represent an antidote to UTPs. In this paper we argue that this does not need to be the case. This is because contracts, except for their potential to increase the surplus generated in the transaction, determine how this surplus will be divided. This, in turn, makes it possible for both trading partners to use contractual terms to turn the distributional conflict to their advantage. In the presence of unequal distribution of bargaining power this may lead to a situation in which the stronger party may succeed in tilting the contract in its favour by including UTPs in the contract content. Drawing insights from data collected in 2017 through a field survey among dairy farmers in France, Germany, Poland and Spain, we find support for this argument. Our estimation results show that contract completeness increases the likelihood of farmers reporting that their contracts with processors include the practices that may be considered as UTPs. Further, and also in line with this argument, contract completeness does not seem to affect UTPs during the contract execution or its termination.     

ECONOMIC ISSUES FROM THE BROADS GRAZING MARSHES CONSERVATION SCHEME

The paper examines two key issues relating to the use of fixed-price conservational contracts of the type embodied in the new Environmentally Sensitive Area policy in the UK. It uses data for the Broads Grazing Marshes Conservation Scheme (BGMCS). The budgetary costs of the fixed-price contract are compared to those of (i) public purchase of land with leaseback for grazing, and (ii) of individual management agreements. Using a net present value criterion, public purchase emerges as the cheapest option, and management agreements as a superior option in defined circumstances. The paper also explores equity and efficiency issues arising from fixed price contracts. It is concluded that for many farmers and landlords in the BGMCS the fixed payment exceeded what was necessary to achieve the conservational objectives, while at the same time it was less than the profit foregone by farmers who might possibly have switched to arable farming.     

Yield quality and irrigation with saline water under environmental limitations: the case of processing tomatoes in California

Irrigation with saline water has a positive impact on some quality indices of processing tomatoes, but with concomitant reductions in output quantity. This article studies the impact of the trade‐off between these two factors on optimal water management under waterlogging and costly drainage‐disposal conditions. The focus is on the content of total soluble solids as a quality measure affecting prices paid by California processors to tomato growers. A function relating quality to water and salinity applications and a quality hedonic‐price function are estimated and introduced into a static, field‐level mathematical programming model. The model calculates optimal water management under environmental regulations associated with drainage disposal in California. Findings indicate that only when the quality effect is taken into account does blending fresh surface‐water with saline drain‐water become an optimal strategy. Management and policy implications on the regional scale are discussed.