Agricultural contracts: data and research needs.

Cross-sectional observation of discrete contract characteristics represents a third form of data. For example, one might have a set of hypotheses regarding how a particular contractual provision or attribute should vary across different contracting environments, and then set about testing each hypothesis by collecting data on variation of the relevant characteristic in a cross section together with exogenous conditioning variables. This approach has been commonly employed in the empirical literature on franchise contracting. One might start with some hypothesis regarding how royalty rates should be high or low, depending on the degree of moral hazard present, and then relate observable variation in characteristics of the firms studied to differences in the degree of moral hazard. The benefit of this empirical approach is being able to collect enough contract data to perform statistical inference. However, surprisingly few researchers have used this approach to study agricultural contracts (see Goodhue et al. 2003 for an exception).

Future Data Collection Possibilities

Should there be a collective effort among agricultural economists to support systematic data collection on agricultural contracting, and, if so, what form should this effort take? Our view is that collecting contracts by itself is unlikely to lead to a useful research resource. Collecting individual contracts without knowing something about the relevant contracting parties and relevant economic environment leaves one with little information to explain or answer questions about any given contract. Collecting data on contractual outcomes is not likely feasible across an entire industrial sector. Absent collection of individual contracts or of outcomes under specific contract relationships, the only remaining option of the three discussed in the previous section is collection of information on contract characteristics from a cross section of commodities. We believe that some version of this approach is both feasible and potentially useful. There are a number of ways to go about collecting and making accessible such data, but the task will inevitably be somewhat different than what is done with regard to other sorts of data.

First, contracts are high-dimensional objects, and the relevant dimensions vary across commodities. Unlike collection and dissemination of prices and quantities, some tailoring with regard to the specific data elements that are reported for each commodity will be required. Second, many of the terms and conditions that are used in contracts have special meaning to the given sector. Thus, collecting data will require effort to identify the relevant contracting terms and provisions, and then to focus a data collection and reporting effort based on some subset of these. Ultimately, some judgment will be needed to evaluate the right balance between simply "reporting the contracts" and reporting summary information about the contracts. For a given sector, reporting might involve definition of the relevant set of contracting terms and provisions, a few example contracts, and summary information about the use and relative incidence of different kinds of contracts. Third, evidence to date suggests that contracts evolve either very slowly over time or in large discrete jumps. Thus, much of the data that is collected will be static with very little change from year to year. Whatever data is collected, there will always be need for additional data to answer specific questions. The need, then, is for data that is potentially a good starting point for many questions.

We can think of two kinds of "data" that can serve this purpose. The first are case-study descriptions that document "typical" contracts and that describe the organizational and institutional setting for the relevant commodity sector. The second are survey data that document variation of contract characteristics across individuals and firms within the sector. At present, there are a few scattered sectoral studies that summarize generic contracting issues within particular sectors, but none that systematically document and describe specific contracts and contracting practices. The USDA ARMS (USDA 2006) survey includes questions on contracting that were designed to help track flows of revenues and expenses among farm businesses, landlords, contractors, and other service providers. (3) The survey distinguishes two contract types, "marketing" and "production" contracts, in an attempt to account for situations where contractors pay for a significant portion of farm expenses.

Guidance for making the distinction is provided by offering parenthetical definitions of each type of contract: "A production contract is a verbal or written agreement setting terms, conditions, and fees to be paid by the contractor to the operation for the production of crops, livestock, or poultry. The contractor usually owns the commodity and often provides inputs; A marketing contract is a verbal or written agreement setting a price and market before harvest for a crop or before removal from the operation for livestock or poultry. The operation usually owns the commodity prior to delivery, and provides most or all inputs. (4) Two key distinctions are made here: (1) a production contract pays "fees," while a marketing contract sets a price and market before harvest or animal removal, and (2) under a production contract, the contractor usually owns the commodity and often provides the inputs, while the reverse is usually the case in a marketing contract. It is easy to imagine respondents having difficulty parsing these definitions. What is the difference between a "fee" and a "price," and how should the "usually" and "often" qualifiers be interpreted?

There do seem to be two qualitatively distinctive motivations for contracting. Some contracts are used to coordinate delivery of specific quantities and qualities of agricultural goods while others are offered as a marketing service to farmers. A tomato processor or poultry integrator operates a manufacturing plant where there is a need to plan the flow of farm deliveries. Some form of ex ante contract is a natural response to the need for this kind of planning. In contrast, dairy processors or grain handlers act as intermediaries between farmers and futures markets by offering forward price contracts. Their "plants" are more flexible and allow for storage and diversion of goods to neighbor facilities if necessary. Contracts do indeed look different across these two sets of environments. The trouble, however, is that there are many intermediate cases where the distinction becomes blurred. An example: A fresh-fruit packer intermediates between a handful of growers and downstream retail markets. The grower--packer relationships are informal (no written contract), but there is significant planning regarding deliveries as harvest time approaches. The packer has field representatives who communicate regularly with each grower and who may have some influence over growers' cultivation and varietal choices. Should a single bilateral grower-packer relationship in this setting be classified as a production or a marketing contract?

Some amount of further data collection will inevitably take place in response to specific policy needs and the curiosity of researchers. There is value, however, in systematically collecting publicly accessible data that summarizes the incidence and nature of agricultural contracting. We do not think that the distinction between "production" and "marketing" contracts serves this purpose well. The meaning of the distinction varies across commodity sectors, and creates confusion when discussing agricultural contracts in general. Moreover, it seems unlikely that any sort of classification scheme will adequately capture variation in the characteristics that are relevant for research and policy uses. Instead, we need better information on the specific characteristics that contracts have and how these characteristics vary across time, space, and across individual contracting parties. Collecting information on just one or a small number of characteristics (e.g., ownership or provision of inputs, provision of finance, contract duration, and formality) across a large number of commodity sectors would generate vastly greater information than what is currently available. (5)

Evidence from California and Future Research Needs

Hueth and Ligon (1999) report on results from a pilot survey of contractors in California fruit and vegetable markets. Results from the full survey suggest that it is not uncommon for contracting firms to also engage in farm-level production. Nearly half of all 385 responding firms grow produce in-house with firms reporting on average that 18% of farm inputs are obtained this way. Of the produce that is purchased from external growers, more than half was typically obtained via an informal relationship. It is not uncommon for firms to be highly involved in farm-level decision making, to provide inputs directly, to provide finance, or to exercise some control over harvest timing. Many firms specialize contracts to individual growers, and firms typically have long-term relationships (at least five years) with over half their growers. The survey and data are available for public use. For access instructions, see Hueth and Ligon (2007).

These observations suggest a number of potentially interesting research questions. For example:

1. The "make or buy" decision has probably received more attention than any other within the literature on contracting and firm boundaries. In agricultural markets, firms often are hybrid organizations that make and buy. What purpose does this hybrid form serve?