Political economy of regulation of broiler contracts.

In this paper we present a brief history of regulation of broiler contracts whose main characteristic has been that virtually all regulatory attempts on either federal or state levels have failed. We identify two possible sources of market failure that may justify regulation: asymmetric bargaining power between integrators and contract growers and imperfect information. We search for the explanation for this outcome by comparing the public interest theory of regulation with the interest group theory (Posner 1974).

Based on the existing literature on possible market failures in broiler contracts, we found that empirical evidence in support of those is rather weak. This may or may not explain the existing lax regulatory environment in which poultry processors operate from the public interest theory's point of view. However, we can build a more compelling case for the lack of regulation resorting to the interest group theory's main arguments as formulated by Becker (1983).

Broiler Industry Organization

Modern broiler industry is a vertically integrated system of production, processing, and distribution. Broiler companies (called integrators) control all stages of production ranging from breeding flocks and hatcheries to broiler grow-out and processing. Over the past 40 years, the industry has become increasingly concentrated such that in 2002 the industry's five-firm concentration ratio based on the volume of production was 55.41. The largest five firms in the industry are Tyson Foods, Goldkist, Pilgrim's Pride, ConAgra Poultry, and Perdue Farms (see table 1). The industry is mainly concentrated in the Southeastern region of the United States. This region produces more than 85% of U.S. broiler meat. The Southeastern region has a comparative advantage in raising chickens due to the warm climate and inexpensive farm labor. In 2002, Georgia was the leading state in broiler production with 15% of U.S. production, followed by Arkansas, Alabama, Mississippi, and North Carolina (see table 2).

The finishing stage of broiler production (the final stage of the production process where one-day-old chicks are brought to the farm and grown to market weight) is organized almost entirely through contracts between processors and independent growers. As seen from table 2, in 2002 there were over twenty thousand farms with broiler contracts, the majority of them concentrated in the top five broiler producing states.

Modern broiler contracts are written by the integrator and offered to prospective growers on a take-it-or-leave-it basis. Contracts typically cover only one flock of birds at a time and generally do not guarantee any specific number of flocks per year. In order to obtain a contract, prospective broiler growers are responsible for constructing broiler facilities according to integrator's specifications. Growers are also responsible for labor, utility costs (electricity and water), clean-up costs, and dead birds disposal. The integrator provides baby chicks, feed, medication, and the services of field personnel and decides on the volume of production (the rotation of flocks on a given farm and the density of birds in a given house). The distribution of production inputs (feed and chicks) and the requests for the facilities and equipment upgrades and replacements are also under the discretion of the integrator.

The majority of contracts are settled via tournament-based schemes, consisting of a base payment per pound of live meat and the bonus payment. The bonus payment is tied to the grower's performance relative to other growers. Generally, the relative performance is measured by the difference between a grower's individual settlement costs (the costs of integrator supplied inputs) and group average settlement costs. For below average settlement costs the grower receives a bonus and for the higher-than-average settlement costs he receives the penalty (for details see Vukina, 2001).

Production contracts have played a decisive role in the broiler industry's remarkable growth but the integrator-grower relations have gradually worsened. Starting in the mid 1990s the tensions have received increasing attention nationwide. The National Contract Poultry Grower Association (NCPGA), state and federal legislators, and the USDA have started to systematically seek information about the impact of integrators practices and contractual arrangements on contract growers. According to Ilvento and Watson (1998) and the FLAG (1) (2001) survey, the issues of major concern to growers are: (a) use of tournament schemes to determine payments, (b) concerns about quality of inputs (chicks and feed), (c) high number of birds condemned at the plants with unsatisfactory explanation, (d) pressure to adopt housing improvements and equipment upgrades, (e) questionable accuracy of weighing chicks and feed, (f) timing and frequency of flock placements, (g) inadequate contract dispute resolution procedures, and (h) retaliation for joining grower associations.

Regulation of Contracts

The main federal legislation concerning contracts in agriculture is the Packers and Stockyard Act (P & S Act), originally enacted in 1921 and enforced by the Grain Inspection, Packers and Stockyards Administration (GIPSA) of USDA. Its role is to prohibit activities that might adversely affect fair competition. Originally, the P & S Act did not directly consider contracts between poultry processors and contract growers. However, in 1987, the definition of "a live poultry dealer" in the P & S Act was changed to include the company who owns the birds and arranges for growers to raise and care for live poultry. This change brought broiler contracts under the P & S Act. From that time on, the USDA has passed regulations providing more detailed requirements covering contractual relationships in the statutory provisions.

Another federal law affecting integrator-grower relations is the Agricultural Fair Practice Act (AFPA) of 1967. Under this law, the right of contract poultry growers to decide freely whether or not to join the associations of growers is protected from interference by poultry companies. In general, attempts to persuade growers to join or dissuade growers from joining producer associations are unlawful if they involve coercion, discrimination, or intimidation of any kind. However, the AFPA does not require that a poultry company deal with growers who are members of an association as long as this decision is not based on membership in the association. This means that a poultry company could defend itself against the claim of violating the AFPA by showing that it had another lawful reason for the decision not to deal with the grower (FLAG 2001).

Due to many existing loopholes in the current regulation, there were several attempts at the federal level to regulate broiler contracts in recent years. In 1997, in an advanced notice of proposed rulemaking, GIPSA announced that it is considering "the need for issuing substantive regulations to address concerns in the poultry industry with respect to contract payment provisions tied to the performance of other growers" (Federal Register, p, 5935). In 1998, the National Commission on Small Farms recommended that the Secretary of Agriculture evaluate the need for federal legislation to provide uniform contract regulations for all growers engaged in agricultural production contracts. In reference to poultry contracts, the recommendation specifically focused on the factors used in ranking growers and determining performance payments (USDA, 1998). No concrete regulatory actions were taken as the result, but the pressure from the growers' circles to do something continued.

In 1999, Representative Marcy Kaptur (Ohio) introduced in the House of Representatives two bills. Bill H.R. 2829 ("Poultry Farm Protection Act of 1999") sought to amend the P & S Act to provide the Secretary of Agriculture with administrative authority to investigate live poultry dealers. H.R. 2830 ("Family Farmer Cooperative Marketing Amendments Act of 1999") would amend the AFPA to provide for the accreditation of associations of agricultural producers, promote good faith bargaining between such associations and the poultry companies, and strengthen the enforcement authorities to respond to violations of the AFPA. Both of those attempts were stalled in various subcommittees in the House Committee on Agriculture.

In 2000, Senator Tom Harkin (Iowa) introduced bill S. 3243 ("Agricultural Producer Protection Act of 2000." The bill would set minimum standards for agricultural contracts, requiring good-faith negotiation between integrators and grower associations. In 2001, Tom Daschle (South Dakota) proposed the same kind of legislation called "Securing a Future for Independent Agriculture Act of 2001," (S. 20). Both bills were read twice and referred to the Committee on Agriculture, Nutrition, and Forestry, with no further action taken. (2)