Tenants, landlords, and soil conservation.

When both landlord and tenant are risk averse, one would expect to find share rental contracts. As in the case of a risk-neutral landlord, the tenant's incentive compatibility and participation constraints are given by conditions (19) and (20). The landlord chooses the fixed payment [t.sup.ra], the rental share [s.sup.ra], and the level of conservation investment [k.sup.ra] to maximize [E.sub.[epsilon]]{W((1 - s)[R(e, k, [x.sub.0]) + [epsilon]] + t - 1(k))} + [beta][E.sub.[eta]]{W(V([x.sub.0] - h(e, k)) + [eta])} subject to conditions (19) and (20). As before, the landlord chooses the fixed payment so that the participation constraint binds. The respective conditions characterizing the landlord's optimal choices of the tenant's share and conservation investment can be shown to be

(32) [E.sub.[epsilon]]{W'} ([R.sub.e] - [C.sub.e]) - [beta] [E.sub.[eta]] {W'} V' [h.sub.e]] [R.sub.e] / [C.sub.ee] - s [R.sub.ee] + [E.sub.[epsilon]]{W'} ([tau] + [rho]) = 0

(33) [E.sub.[epsilon]]{W'} ([R.sub.k] - [I.sub.k]) - [beta] [E.sub.[eta]] {W'} V' [h.sub.k]] - [E.sub.[epsilon]]{W'} ([tau] + [rho]) s [R.sub.ek]/[R.sub.e] = 0

where [tau] = [E.sub.[epsilon]] {W' [epsilon]}/[E.sub.[epsilon]] {W'} is the correlation between the random factor [epsilon] and the landlord's marginal utility of income.

It is clear that equations (32) and (33) are not equivalent to equations (26) and (27), hence:

PROPOSITION 7. When the landlords and tenants are both risk averse, share rental contracts combined with investment in durable conservation measures are not capable of achieving first-best levels of effort and conservation.

The intuition here is the same as in the risk-neutral landlord case. The three instruments available to the landlord are not sufficient to meet the four objectives of optimal risk sharing, effort, conservation, and ensuring that the tenant receives her reservation utility.

The optimal share allocated to the tenant in this case is

(34) [s.sup.ra] = 1 - [beta] [E.sub.[eta]] {W'} V' [h.sub.e]/[E.sub.[epsilon]] {W'} [R.sub.e] + ([tau] + [rho]) ([C.sub.ee] - [s.sup.ra][R.sub.ee])/[R.sup.2.sub.e].

As in the case of a risk-averse tenant and risk-neutral landlord, the tenant's share is adjusted downward to make the tenant face the marginal cost of land degradation and to mitigate the disincentive effect of risk on effort. In this case, though, the latter adjustment takes into account the landlord's risk aversion as well as the tenant's.

Finally, the close similarity of equations (32) and (33) to equations (21) and (23) suggests that, as in the case of a risk-neutral landlord and risk- averse tenant, effort under the share rental contract is less than the first best for a risk- averse landlord while conservation effort may be greater or smaller than the first best and that figures 3 and 4 illustrate the possible equilibrium outcomes in this case.

Implications for Empirical Work

Propositions 1-7 indicate that landlords' choices of rental contract form and investment in durable conservation measures are more complex than those predicted on the basis of tenants' incentives alone. When landlords and tenants are both risk neutral, the analysis suggests that there should be no difference in conservation investments made by owner-operators and those made under share rental contracts, while those made under cash rental contracts should be higher than those made under share rental contracts or under owner operation. The same patterns apply when both landlords are risk averse and tenants are risk neutral--except that the level of conservation investment is likely to be lower than under risk neutrality, for reasons of risk bearing alone. And when tenants are risk averse, conservation investment under rental contracts may be higher or lower than under owner operation.

These differences in performance suggest that rental contract choice and conservation investment are more appropriately treated as simultaneous choices, that is, the choice of whether to rent as well as the form of rental contract should be treated as endogenous rather than exogenous. To see why, consider the case where both landlord and tenant are risk neutral. (The analysis is easily extended to cases involving risk aversion.) Let [W.sup.f] and [W.sup.c] be the landlord's expected present value of income under share and cash rental contracts, respectively, with optimal conservation investment and contract terms and [W.sup.s] be the landlord's maximized expected present value of income under a share with no conservation investment. Let [m.sup.f], [m.sup.c], and [m.sup.s] be the respective transaction costs associated with these contract specifications; they cover such items as the costs of verifying output (in the case of share contracts) and collecting rent, differences in the tax treatment of income and property, etc. For simplicity, assume they are independent of the maximized value of income, so that the present value of expected net income under contract type j = f, c, s is [W.sup.j] = [m.sup.j]

The landlord selects the contract that generates the highest present value of expected net income. Suppose, for example, that conservation investment is contractible and not prohibitively costly, so that [W.sup.f] - [m.sup.f] > [W.sup.s] - [m.sup.s]. In this case the landlord chooses a cash rental contract when [W.sup.c] - [m.sup.c] > [W.sup.f] - [m.sup.f]. Since [W.sup.f] > [W.sup.c] by propositions (1) and (3), the landlord will choose a cash rental contract only when [m.sup.f] - [m.sup.c] > [W.sup.f] - [W.sup.c] > 0, share rental contracts have higher transaction costs than cash rental contracts and the difference in transaction costs between the share and cash rental contracts with optimal conservation investment exceeds the difference in the present value of expected income.

One implication of this analysis is that correlations between rental status and conservation investment observed in empirical studies may be biased by endogenous matching, as has been shown to occur in empirical studies of agency and risk (see, for example, Prendergast 2002 or Ackerberg and Botticini 2002). (1) The empirical findings of Allen and Lueck (1992) and Dubois (2002) provide support for treating contract choice as endogenous. Both studies found that share rental contracts are more prevalent than cash rental contracts or owner operation in situations where land is highly vulnerable to degradation. Future studies of the impacts of tenure on conservation practice adoption should thus at least test for the endogeneity of contract choice.

The conditions for landlords to prefer cash to share rental contracts are more likely to be met when the tenant's optimal share under a share rental contract, [s.sup.f] = [s.sup.s], is close to 1, so that the share rental contract closely resembles a cash rental contract. By equation (16), the tenant's optimal share is close to 1 when [beta] V'[h.sub.e]/[R.sub.e] is close to zero. This analysis suggests certain hypothesis about likely correlations between contract terms and conservation investment. Landlords are more likely to offer cash rental contracts with investments in durable conservation measures in areas where land is less sensitive to soil degradation (V' is small), soils are less vulnerable to degradation ([h.sub.e] is small), and conservation measures are relatively cheap (I(k) is small for all k). Conversely, they are more likely to offer share rental contracts combined with investments in durable conservation measures in areas where the value of land is highly sensitive to soil degradation (V' is large) and soils are highly vulnerable to degradation ([h.sub.e] is large). They are more likely to offer share rental contracts without investments in durable conservation measures or operate land themselves in areas where the value of land is highly sensitive to soil degradation and soils are highly vulnerable to degradation but where durable conservation measures are either physically inappropriate ([h.sub.k] is small in magnitude for all k) or excessively costly (I(k) is large for all k), so that [W.sup.s] - [m.sup.s] > max{[W.sup.f] - [m.sup.f], [W.sup.c] - [m.sup.c]}.

Conclusion

The impact of tenancy on investment in soils has concerned economists from earliest days of the discipline. It has long been argued that tenants tend to overexploit land, but that conventional wisdom has been derived largely without consideration of landlords' actions, which are the focus of this article. Previous studies have shown that share contracts can mitigate tenants' overexploitation of soil and provide empirical evidence indicating that landlords prefer share contracts on land at greater risk of degradation (Allen and Lueck 1992; Dubois 2002). We examine what happens when landlords can invest in durable conservation measures (or enforceably stipulate that tenants do so) in addition to choosing between cash rentals, share rentals, and owner operation. We show that when tenants are risk neutral, landlords overinvest in conservation under cash rental contracts but can achieve first-best levels of output and protection against land degradation when conservation investment is combined with share rental. When tenants are risk averse, however, the first best is unattainable. Conservation investment combined with share rental results in output levels below the first best, while equilibrium conservation investment may be greater or less than the first best.