Farm bankruptcy risk as a link between direct payments and agricultural investment

The European Union is increasingly relying on direct paymentsto support farm incomes. Recent research has shown that a directpayment may increase production and investment by risk-aversefarmers via a link between wealth, risk aversion and decisionmaking. This paper shows that, even in the absence of risk aversion,a direct payment may stimulate farm investment. With lendersusing a standard insolvency rule for determining bankruptcy,the direct payment raises the expected value of marginal investmentbecause it reduces the risk of bankruptcy over the farmer'soperating time horizon. The investment response to the directpayment is larger for a farmer with an intermediate versus lowor high level of equity, and for a farmer with a long versusshort-time horizon.