Agricultural contracts: data and research needs.

Though the use of contracts in the U.S. agriculture is not a new phenomenon, there is new interest in both the extent and consequences of their use. Some useful data regarding the extent of contracts in agriculture, which we review briefly below, do exist, but the more interesting questions for social scientists and policymakers have to do with the effects of the use or adoption of contracts on outcomes. Unfortunately, data tend to fail us when we attempt to address questions regarding the effects of contracts. Any changes induced by contracts necessarily depend on the specific provisions of actual contracts, and these can be difficult to summarize in a useful way. The actions and states of the world governed by contracts can be complicated and vary widely across environments.

This problem was recognized long ago by Mighell and Jones (1963), who sought to systematically organize contracts into different types, and who drew a distinction between "production" and "marketing" contracts that still guides some contemporary efforts to collect data on agricultural contracts. We argue that this distinction is of very little value for understanding the range of contemporary agricultural contracts. Not only does this typology obscure important differences in contracts by offering only two possible types, but (worse) contracts used by producers often do not clearly govern production or marketing singly, but rather touch upon aspects of both. In this article, we discuss possibilities for systematic data collection that we believe can aid in building further general knowledge regarding agricultural contracts, and that can support more specific research projects as need or interest arises.

The Extent of Agricultural Contracts

In research that was well ahead of its time, Mighell and Jones (1963) estimated that in 1960 U.S. farmers delivered about 19% of all crop production and 27% of all livestock production under some form of "production" contract. Moreover, they noted that for some commodities (e.g., processing vegetables and sugar beets), contracts have "long been significant" (Mighell and Jones 1963, p. 64). At the time the authors were reporting, there were no official statistics on the extent of contracting in agriculture, so the data were "based on the best judgments of a number of production and marketing specialists in the Department (USDA 2006)." More recently, MacDonald et al. (2004) use data from the U.S. Department of Agriculture's 2001 Agricultural Resource Management Survey (USDA ARMS) to report that some form of contract was used in the delivery of roughly 26.2% of the value of all crop production and 46.8% of the value of all livestock production (USDA 2006). Although these two sets of numbers are not directly comparable, (1) there does not appear to have been a large aggregate increase in the extent of crop contracting during the last forty years, though contracting in markets for livestock has nearly doubled. In more recent times, and using more comparable data, the MacDonald et al. (2004) report documents a modest 6% point increase between 1978 and 2001 in the share of all farm commodities delivered under a production contract. (2)

The research conducted by Mighell and Jones (1963) appears to have been a response to the dramatic transformation of the poultry sector during the 1950s from market-to contract-based procurement. Their report ends with a call to arms and a summary of research needs that at the time included studies of "measurement and description; performance and effects; social attitudes and educational methods; methods of improving vertical coordination; and supply management and vertical coordination." A number of researchers responded to this call. Cambell (1973) provides a bibliography on the topic as of the early 1970s that documents various efforts to describe and measure the extent and nature of contracting. However, the research appears not to have attracted much interest from academic journals at that time, and eventually research on the topic seems to have died down through the late 1970s and 1980s. This changed in the 1990s as advances in information and contract economics entered the mainstream, and agricultural economists were handed the tools needed to formalize hypotheses about the structure and performance of contracts. The papers by Knoeber and Thurman (1994, 1995) are among the earliest in this more recent literature (which we briefly synthesize below) on agricultural contracting.

Methodological tools continue to develop (see Bolton and Dewatripont 2005), but interest in the study of agricultural contracting is now motivated to a greater degree by what is happening in industry. Although the aggregate incidence of contracting has increased only modestly, farm-to-market contracting is implicated in a wide variety of current policy issues: The pork industry experienced a transformation during the 1980s and 1990s not unlike what happened in poultry during the 1950s; contracts between beef packers and feed lots are believed by some to offer opportunities for strategic anti-competitive manipulation of spot markets for live cattle; McDonald's and Burger King, among others, have demanded delivery of processed meat raised on the farm and brought to slaughter according to specific animal-welfare guidelines; and heightened concern about the environmental consequences of farming in poultry and pork production raise issues regarding the assignment of liability across contractor and contracted.

Informed debate, and ultimately policy guidance, with respect to these and other issues requires an understanding of the forces that shape contract design. Although there have been a number of recent research efforts, most have been theoretical or based on a proprietary data source that does not permit access by other researchers. Perhaps this is not surprising given the proprietary nature of most forms of contracting. In the end, the best we can do may be to exploit what access we do have to proprietary data to the fullest possible extent. Nevertheless, we believe that there is potentially an opportunity for, and value in, collecting publicly accessible data.

Empirical Approaches for Studying Contract Relationships

Space limitations preclude a complete literature review. In this section, we identify three types of empirical work that have been carried out, and briefly review select examples of each that are most familiar to us. For a detailed bibliography, see Dimitri et al. (2007).

Some authors have examined a single or small number of individual contracts (e.g., Hueth and Ligon 1999; Hueth and Melkonyan 2004). Viewing a contract as a "data point," empirical studies of this sort are based on a rather small number of observations. However, this criticism ignores the differential information content of a contract relative to, say, a single consumption or production decision. Contracts are negotiated by two or more parties so that an equilibrium contract depends on the preferences of more than a single agent. Second, based on the presumption that contracts are designed optimally, a single contract contains information not only about preferences, but also about the structure of production in the relevant environment. A contract maps production outcomes into compensation, which effectively means that compensation must be specified for all (or nearly all) possible production outcomes. Using the now familiar "first-order approach" for designing an efficient contract in an environment with moral hazard, this mapping is characterized by a relationship between marginal utilities (representing preferences), a likelihood ratio (reflecting production structure), and a pair of Lagrangian multipliers, one of which reflects the nature of the agent's outside options. If this approach is a reasonable way of modeling actual contracts, then observed contracts implicitly contain information about each of these objects. Empirically, the central challenge is identification. Contract structures within a given contract environment tend not to vary greatly. Absent frequent exogenous shocks of sufficient magnitude to induce changes to observed equilibrium contracts, it is generally not possible to disentangle preference and production structures from observation of a single contract.

Obtaining a rough description or the entire written version of one or a small number of contracts is generally feasible where there is interest in doing so. However, much can be gained by observation of contractual outcomes across time and space. For example, observing production levels and payments under a given contract repeatedly over time may allow for inference with respect to contractual dynamics. Contractual outcomes may be determined in part by implicit understandings held by the parties, or by unobserved renegotiation. To the extent that observed outcomes differ from what is prescribed in the written contract, it may be possible to infer something about the nature of implicit contracting and commitment. Alternatively, observing outcomes across multiple producing agents in a given time period may allow for inference with respect to the production structure with which agents operate. Research of this nature has accounted for the largest quantity of published research on agricultural contracts (e.g., Knoeber and Thurman 1994; Levy and Vukina 2004; Hueth and Ligon 2002).