A Financial Contracting Approach to the Role of Supermarkets in
Farmers’ Credit Access
Philippe Marcoul∗and Luc Veyssiere†
September 7, 2007
Over the last decade, supermarkets have spread to developing countries and have become major actors
in the food marketing system in these countries. Their involvement in farmer’s production is wellkown.
In this paper, we construct a simple financial contracting model to analyze this activity and especially
its impact on farmers’ credit access.
In our framework, the supermarket is modeled as a procurement organization, not only able to
advise contracting farmers on their production practices, but also to partly finance their activity; i.e. to
substitute for conventional lenders. We show that by bundling advising and moneylending activities the
supermarket reduces the agency cost incurred to insure proper incentives in the procurement process.
This reduction in agency costs can extend financing to smaller farmers who would otherwise remain
credit constrained. We also point out to reasons as to why supermarket sometimes prefer small farmers.
Finally, supermarkets usually set higher food standards. By examining the impact of the introduction
of higher food standards, the paper shows that the coexistence of the market for domestic retailers and
supermarket products may broaden the credit access of farmers.
Keywords: Financial Contracting, Development, Financial Intermediation, Food Standards, Organiza-
tion of Production, Supermarket
JEL classification: O17, O33, O50, Q12, Q13
∗Corresponding author: Philippe Marcoul, Department of Economics, Iowa State University, Ames, IA 50011-1070. Phone:
(515) 294-6311, Fax: (515) 294-0221; E-mail: email@example.com.
†Veyssiere Luc, Department of Economics, Iowa State University, Ames, IA 50011-1070. Phone: (515) 294-4611, Fax: (515)
294-0221; E-mail: firstname.lastname@example.org.
In the last two decades, we have witnessed an impressive development of supermarket chains in developing
countries. Saturation and intense competition in retail markets of developed countries, together with sub-
stantial margins offered by investing in developing markets, have largely contributed to the emergence of
supermarket chains.1In countries where a substantial portion of the population lives in rural areas, the rise
of supermarkets, that arguably affect the livelihood of farmers, is a sensitive issue. Although they represent
a source of investment in local economies, their real welfare impacts are hard to assess and remain contro-
versial. On the one hand, many empirical studies have found that supermarkets tend to leave behind or
exploit small growers, preferring to concentrate their procurement of fresh agricultural products on larger
scale operations (Dolan and Humphrey 2000; Dolan, Humphrey and Harris-Pascal 2001, Trail 2006).2On
the other hand, although many growers successfully work with supermarkets, it is not clear whether growers
who fail to enter a business relationship with them are worse off relative to the period preceding their entry.
In addition, other recent case studies have somewhat challenged the view that supermarkets have only a
negative impact on small growers. In particular, these studies show that in niche markets small growers per-
form remarkably well and remain an attractive supply source for supermarket chains (Boselie, Henson and
Weatherspoon 2003, Henson, Masakure and Boselie 2005 and Minten, Randrianarison and Swinnen 2007).
However, while arguments on both sides are compelling, it is somewhat difficult, in light of these (rather)
contradictory observations, to forge a clear understanding of the impact of supermarkets on grower activity.
The objective of this paper is to contribute to this debate by providing a theoretical framework to analyze
the impact that supermarkets have on growers’ credit access.
There exists an important descriptive literature on supermarkets in developing countries. This literature
describes and discusses what these retail chains are trying to accomplish and how they achieve their goals.
First, it must be noted that besides the growing (local) demand for fresh food products that they try to meet,
supermarkets or their affiliated grocers demand a substantially higher quality in the products they procure.
Thus, supermarkets not only need to sell more in local markets, but they need to offer safer and higher quality
products, as well. Therefore, the natural response of supermarkets has been to develop their own standards in
countries where public food quality standards are often inadequate and lack proper enforcement. However,
the quest for higher quality and safer food products cannot be achieved without innovative procurement
practices. These practices revolve around the creation of vertical relationships with growers through the
1For instance, Carrefour, a French-based supermarket chain, earned on average three times higher margins in its Argentine
operations than in those located France (Reardon et al., 2003).
2While the local demand for food is globally increasing, supermarket chains established in developing countries also export
a substantial portion of their production to developed countries (Dolan and Humphrey 2000). Thus, supermarket production
will only exclude a portion of the growers that remain uninvolved with the supermarket.
establishment of tighter procurement contracts. Although the specific form of the contractual relationship
between the grower and the supermarket can vary greatly depending on the context, there is arguably a
Typically, supermarkets require their growers to make a substantial up-front investment into their oper-
ations. This investment ranges from new equipment purchases to the establishment of quality control and
coordination systems. The literature analyzing supermarket procurement practices also reports that super-
markets are playing new roles in the production process. These roles essentially consist of a combination of
intense production monitoring and advising, sometimes using the support of public partners (Boselie, Henson
and Weatherspoon 2003). In practice, the advising is performed on the spot, when supermarket employees
visit producers and discuss with them problems encountered during the growing cycle. The typical advice
ranges from the proper way to apply fertilizers to the safe handling of pesticides. In addition, supermarkets
also take on a monitoring role that essentially protects their investment in the growers’ operations. Indeed,
the relationship between farmers and supermarkets features a strong moral hazard component. For instance,
to certify that product standards are met, but also that procured quantities are sufficient, supermarkets must
make sure growers follow specific procedures and do not cheat or misrepresent their efforts and/or actions.3
Finally, although supermarkets rarely provide cash credit to farmers, they extend loans in the form of
input advances that are reimbursed later when the crop is sold.4These input loans, which range from seeds
to fertilizers and pesticides, cover most of the necessary inputs and their amount can be substantial relative
to expected crop payments.5Supermarkets also attempt to absorb some of the growers’ risks related to
market conditions. This is usually achieved by committing to input and output prices prior to planting.
Such commitments arguably result in lower liquidity needs for growers and are, in that sense, equivalent
to additional loans. Overall, supermarkets’ objectives seem to ensure that the financial and production
risks faced by their grower base are sustainable and compatible with a long-term dedication to safe and
high-quality products (Henson, Masakure and Boselie 2005).
The organization of production by supermarkets, nevertheless, raises several questions. For instance, it
is not clear from a theoretical standpoint why supermarkets should provide such a bundle of services. It is
conceivable that advising services could be provided independently of input loans. Farmers could finance,
possibly using moneylending services, the purchase of the inputs necessary to carry over the production
Supermarkets would then purchase the crop, provided that it met a certain quality threshold.
3The most common form of cheating faced by supermarkets is one in which farmers sell part of their crop (for a higher
price) to other grocers or local markets and, therefore, do not deliver the quantity that was agreed upon (Gow and Swinnen
2001 and Minten, Randrianarison, and Swinnen 2007).
4Cash advances are, in fact, widespread in transition countries (Gow and Swinnen 2001).
5For instance, Boselie, Henson and Weatherspoon (2003) reports that it takes a number of plantings for producers to achieve
a net overall profit.
6In developing countries, credit loans extended by traditional moneylenders use growers’ crops as collateral. To make sure
The mere fact that such organization of production does not prevail in practice suggests that substantial
benefits exist in bundling these tasks. In particular, to the extent that supermarkets are keen to have a large
grower base, it is possible that this organization of production will allow more farmers to access credit. More
generally, we wonder how the emergence of supermarkets will modify credit access for small growers.
In this paper, we analyze the market for growers’ loans using a simple model of financial intermediation.
In our framework, growers need to make a financial investment before they can produce for the supermarket.
An organization in which supermarkets advise, extend a loan and monitor growers is preferred by the
supermarket. In other words, bundling these tasks in the financial contract results in an organization in
which motivation costs or agency rents are reduced. Allocating the two tasks to the supermarket implies
that, as a monitor, the value of a high quality crop is increased when the probability of success increases as
well; thus the supermarket also has an incentive to advise diligently. We show that rent contraction results
in more poor growers obtaining loans.
Our definition of the supermarket procurement process is very much similar to that of contract farming.
Production finance by contract farming usually involve technical advising and monitoring. As described
by Conning (2000), contract farming, apart from the advising part, is not different from traditional money
lending. In particular, it possesses all the informal aspects of moneylending. However, this type of lending
has become prevalent in many developing countries. For instance, Conning (2000) reports that, during the
last 20 years, that production finance has become dominant in Chile. Our multitask approach to this type of
contract can explain their relative superiority with respect to banking finance or traditional moneylending.
We also analyze the implications of our model for the grower’s effort. We show that the organization
of the production by the supermarket has some motivational consequences for growers. In particular, in
our framework, poorer farmers tend to exert higher levels of effort and consequently produce higher quality
products. Many recent empirical contributions tend to echoe our finding that smaller farmers maybe prefered
by supermarkets (Boselie, Henson and Weatherspoon 2003, Henson, Masakure and Boselie 2005 and Minten,
Randrianarison and Swinnen 2007).
Finally, we explore the implication of higher standards set by supermarkets on the final market. In this
variant of our model, loan access is endogenized and ultimately determined by the competitive outcome on
the final market. We show that stronger standards can benefit growers, as they obtain loans more often.
In what follows, we briefly present the existing literature on lending in developing countries that is relevant
to our work. We also relate our paper to the corporate finance literature on advising and venture capital.
that the grower repays his loan, the moneylenders closely monitor him during the crop cycle to make sure that he does not
secretly side-sell and then default on their loan by pretending to have a bad harvest (See Aleem 1990 and Hoff and Stiglitz
1998). Unlike the advising part, the monitoring exerted by the supermarket is very similar to that of traditional moneylending
(See Conning 2000 and Minten, Randrianarison and Swinnen 2007 for the case of supermarket monitoring.)
The model developed in the main section formalizes the basic idea of bundling advising and monitoring
tasks in the same financial contract. We then study growers’ incentives in this setup. Finally, we study how
standards affect competition in the final market, and thereby influence growers’ access to loans.
2 Relation to the literature
The literature on moneylending in developing countries starts from the premise that borrowers in developing
countries usually have weak balance sheets, and therefore have difficulty accessing financing. Most of the
contributions in this field describe mechanisms by which borrowers are able to commit to repay their loans.7
One of the main mechanisms to facilitate access to financing in the absence of adequate collateral is group
lending. In Beasley and Coate (1995), a lender extends a loan to a group of persons jointly responsible for
its repayment. Each borrower can be diligent and decide to repay his loan. When he or she is tempted
to default, the rest of the group will subject him to intense social pressure, so that shirking incentives are
weakened. Thus, this mechanism essentially makes use of the ability of the agents to monitor each other’s
actions (Barnerjee, Besley, and Guinnane 1994).
Group lending also uses the fact that members of the group are well-informed agents. Ghatak (1999)
shows that a group that is jointly liable can act as a screening device when agents have superior information
about each other’s project profitability.8
As investigated by Aleem (1990) and Hoff and Stiglitz (1998),
the informal lending activity in developing countries is usually performed by local agents who can easily
monitor borrowers. Hoff and Stiglitz (1998), especially emphasize the fact that the moneylending activity is
an informationally intensive activity characterized by monopolistic competition.
Similarly, our work assumes that supermarkets are especially well-informed local agents as, in practice,
they employ well-informed local agents to perform the monitoring activity.9In addition, the monitoring
activity of supermarket employees is very close in nature to that of moneylenders.10
7A comprehensive review of this literature is out of the scope of this paper and we only allude to key contributions. For a
good review of this literature, we refer the reader to Armendáriz de Aghion and Morduch (2005).
8Interestingly, without appealing to adverse selection, Armendariz de Aghion and Gollier (2000) show that group joint
liability also has the property of making cross pledging possible and therefore can enhance lending activity. The idea is to
mutualize risks in such a way that a person’s loan success can serve to repay another person’s loan failure.
9For instance, Minten, Randrianarison and Swinnen (2007) describe the organization of the procurement activity by retail
chains in Madagascar. They write (p. 11):
Every extension agent, the chef de culture, is responsible for about thirty farmers. To supervise these, (s)he
coordinates five or six extension assistants (assistant de culture) that live in the village itself. The chef de culture
has a permanent salary paid by the firm.
10Minten, Randrianarison and Swinnen (2007) also describes the frequency and the purpose of the monitoring (p 12):
During the cultivation period of the vegetables under contract, the contractor is visited on average more than
once (1.3 times) a week. This intensive monitoring is to ensure correct production management as well as to avoid
Our work also shares common features with the literature on venture capital. Casamatta (2003) studies
under which conditions an entrepreneur (in fact, a borrower) should hire an advisor. This article provides a
rationale for the existence of venture capitalists by showing that these advisors have to provide funds as well.
In Casamatta (2003), when the venture capitalist advices diligently, the probability of a successful project
Although the investment scale of the project is quite different, the supermarket plays a role that is,
arguably, qualitatively identical to that played by venture capitalists. Indeed, supermarket employees do not
their activity to growers’ monitoring ; they continuously advise them on best production practices. Moreover,
it is well documented that supermarket agents have substantial knowledge in horticulture and, in that sense,
are valuable advisors.11
Overall, allocating these two tasks to a single agent (i.e., the supermarket) helps to reduce the agency
rents that would have to be distributed to several agents had the supermarket contracted at arm’s length
with the growers. In the spirit of the literature on micro-finance described earlier, our main result is to show
that, by combining these two tasks, the supermarket allows poorly collateralized growers to obtain a loan; a
loan that they would otherwise not obtain. This result is, to the best of our knowledge, novel.
From a purely theoretical standpoint, our contribution also relates to recent work on the design of con-
tracts involving multitasking agents. Laux (2001) shows how, in a limited-liability contracting environment,
wage cost can be reduced by assigning several independent projects to a single agent rather than several
agents. By paying the agent only when all projects succeed, the principal can relax the agent’s limited
liability constraint by punishing the agent for a given project by taking away payment on another.
More recently, Hueth and Marcoul (2007) model producer cooperatives by assuming that members provide
not only work (as input providers) but also monitoring of managerial activity (as directors). The resulting
multitasking structure is shown to strictly lower motivation costs.
3 Supermarket procurement organization
In developing countries, the supermarket not only behaves as an external consultant (that provides pro-
duction advice), but also endorses the role of conventional moneylenders. The literature on micro-credit in
developing countries has emphasized the role of moneylenders as important actors in farming areas. Tra-
11Again, Minten, Randrianarison and Swinnen (2007) write:
The second constraint is human capital and long duration required for training of the assistants de culture which
organize and supervise the contracting farmers in the field. It is estimated that it takes on average two or three
years until the firm will be able to give him/her full responsibility in the field. This slows down growth and
ditionally, growers have relied on moneylenders, as the latter have an informational advantage and excel in
curbing farmers’ incentives not to reimburse loans (see, for instance, Armendáriz de Aghion and Morduch,
2005). The purpose of this section is to understand the economic rationale beyond the supermarket procure-
ment system and its implication on credit access by farmers. In particular we seek to understand why the
supermarket does not confine its activity to advising farmers on production, but rather, also gets involved
in some lending activity.
The contractual relationship between farmers and the supermarket is modeled via a framework similar
in spirit to Holmstrom and Tirole (1997).12
However, unlike the conventional financial intermediary of
Holmstrom and Tirole (1997), we characterize a contractual framework in which the supermarket not only
monitors borrowers, but also provides advice that enhances the value of their projects.
3.1Presentation of the model
Consider a project that returns R, but requires a fixed investment I. Farmers would like to implement this
project, but unfortunately are financially constrained; farmers have finance A with I > A. We assume that
there is a moral hazard component in the farmer’s behavior; he can either choose to be diligent, in that case,
he is successful with probability pH(and fail with probability 1 − pH), or he might shirk and, in that case,
will always fail.13In addition, when unsupervised by a monitor, we assume that the farmer enjoys a private
benefit B. Based on a survey of Ivory Coast agricultural producers, Biais, Azam, Dia and Maurel (2001)
estimate that this opportunity cost of effort is important. Specifically, they report a value for B as large as
40 percent of the investment.
Farmers are assumed to be protected by limited liability, i.e. investors can at most seize the realized
outcome. This assumption is in line with Innes (1990) and all the following literature on financial contracting.
Finally, shirking is assumed not to be socially optimal (i.e. B < I), while the net value of the project under
diligence by farmers is strictly positive (i.e., pHR − I > 0).
The external finance necessary to the development of the project can be provided by three distinct
• The local bank can provide I − A to farmers at a gross rate normalized to 1. The bank is a passive
but rational investor; it extends a loan as long as it can recoup it in expectation. Banks are passive
investors in the sense that they do not supervise borrowing farmers. As a result, banks rely primarily
on collateral-based enforcement of their loans.
12For applications of this framework to developing countries, see, for instance, Straub (2005) that explores informal credit
markets and Conning (1999), Conning and Kevane (2003) and Conning and Udry (2006) on micro finance.
13In practice, shirking farmers may be successful, although at a lower rate. This assumption simplify the analytical results
obtained, it does not affect their qualitative nature.
• Moneylenders play are financial intermediary. Their function is to monitor farmers and thereby alleviate
the moral hazard problem. In fact, by monitoring, moneylenders reduce the farmers’ opportunity cost
of being diligent by reducing the benefit of shirking to b, with B > b. Finally, they lend capital to
farmers at a gross rate γ > 1.
• The supermarket, like the moneylenders, plays the role of financial intermediary. Unlike the "conven-
tional" moneylenders, it will not only monitor farmers, but also advise them on production. Advising
raises the probability of success of the project to pH+pAwith pH+pA< 1.14Note that a supermarket
whose advice is worthless (i.e. pA= 0) is equivalent to a moneylender.
The proper implementation of the project requires that all agents be provided with adequate incentives.
In particular, the contract design problem consists in optimally sharing the project return, R, among the
contracting parties. The optimal sharing rule is such that it guarantees the participation of all agents without
destroying incentives for diligent behavior.
To understand the rationale behind the bundling of monitoring and advising by the supermarket, two
differing organizations of production are considered: an organization where the supermarket acts as an
external consultant, restricting its action to advising farmers, and an organization where the supermarket
not only advises, but also acts as a moneylender.
It is important to understand that whether the supermarket takes on a monitoring role or not, farmers
always have the choice between two sources of financing: direct financing by the bank and indirect financing
via a financial intermediary (either the supermarket or a moneylender).
3.2Monitoring and advising as separate tasks
We consider a first organization of production, where the supermarket limits its role to advising and where
financing remains in the hands of the moneylender and the bank. In this case, there are four parties involved
in the financial contract: the farmer, the moneylender, the bank and the supermarket. Thus, the project
return R is divided up, so that
R = Rf+ Rm+ Rl+ Rs,(1)
where Rf, Rm, Rland Rsdenote the success-contingent stakes of the project obtained by the farmer,
the moneylender, the bank and the supermarket, respectively.15
14This additive specification implies that effort by the farmers and advising by the supermarket are not complementary. Their
joint realization is not required to implement the project. Instead, each contributes separately to improve the profitability of
the project. This may seem a very strong assumption, but it is done on purpose as assuming synergies would simply reinforce
our main results.
15In case of failure, the project yields no return. This implies, together with limited liability, that each contracting party
receives no payment.
3.2.1 Direct financing
In the absence of moneylenders, the project return is only divided between the bank, the farmer and the
supermarket (i.e. Rm= 0). As previously mentioned, in this financial contract, the share received by each
party should be such that it does not destroy each agent’s incentive.
Farmers. For a farmer to be diligent, he should receive at least
(pH+ pA)Rf− A ≥ pARf+ B − A,
This incentive compatibility constraint requires that the farmer earns at least as much from being diligent
as from shirking. Note that as a direct consequence of the substitutability of effort exerted by the supermarket
and the farmer, this constraint holds whether the supermarket is properly advising or not.
The supermarket. Advising by the supermarket is also subject to moral hazard. The opportunity
cost of advising for the supermarket is c > 0. To guarantee proper incentives, the supermarket should
receive at least as much when being diligent as while shirking. The incentive compatibility constraint of the
supermarket is thus written as
(pA+ pH)Rs− c ≥ pHRs,
Bank. The banking sector is assumed perfectly competitive, and in order to accept a loan application
the bank should at least break-even. The break-even condition is expressed as
(pA+ pH)Rl≥ I − A.(4)
The left-hand side of (4) is referred to as the expected pledgeable income, while the right-hand side is the
market value of the fund supplied by the local bank. The pledgeable income is the maximum amount that
can be promised to investors without destroying the incentives of the agents involved in the financial contract
(here, the farmer and the supermarket). Given that Rm= 0 and according to the sharing rule (equation
(1)), it is straightforward that the maximum expected pledgeable income is (pA+ pH)(R − Rs− Rf). This
(pA+ pH)(R − Rs− Rf) ≥ I − A. (5)
Furthermore, to make the analysis non-trivial, the following assumption is made regarding advising.
pA(R − Rf− Rs) ≥ pHRs
This assumption guarantees that the maximum pledgeable income for farmers is increased with advising
by the supermarket. This assumption implies that pAR ≥
present value of the project is superior to the minimum stake necessary to insure proper incentives from
c, which means that the rise in the net
the supermarket. In other words, the net present value of the project is increased by advising from the
supermarket. This assumption is necessary in order for farmers to be willing to participate.
Let us now consider the case where farmers borrow from an intermediate moneylender (i.e., Rm≥ 0). The
moneylender is an active investor, in the sense that she visits and monitors farms to guarantee that farmers
exert sufficient effort.
The moneylender. As in Holmstrom and Tirole (1997), the monitoring activity is subject to moral
hazard. The opportunity cost of monitoring for the moneylender is m, and the incentive compatibility
constraint of the moneylender requires that
(pH+ pA)Rm− m ≥ pARm,
Farmers. By monitoring farmers, the moneylender reduces the farmers’ benefits of shirking to b, with
B > b. Hence, assuming proper monitoring by the moneylender, the incentive compatibility constraint of
the farmer can be rewritten as
Bank. In the presence of intermediation via a moneylender, the break-even condition can be expressed
(pA+ pH)(R − Rs− Rf− Rm) ≥ I − Im− A. (8)
Here, Imdenotes the amount of capital invested by the moneylender in the farm project that she monitors.
Finally, we make the following assumption.
B − b ≥ m
This assumption is necessary in order for intermediation by a moneylender to be a viable option. It
simply states that the reduction in the private benefit of the farmers, B − b, is greater than the cost of
monitoring, m. It is intuitive that under these conditions monitoring is socially desirable, since it increases
the number of financed farmers. If this assumption does not hold, then moneylending will not be profitable.
Proposition 1 In the money lending case, there exists two thresholds of liquid assets given by Aa= I −
(pA+ pH)R −
as an external consultant (i.e. limits its activity to advising), the optimal contract between the farmer, the
and Aam= I − Im− (pA+ pH)
. When the supermarket behaves
bank, the moneylender and the supermarket has the following features:
• when A ≥ Aa, farmers borrow solely from the bank.
• when Aa≥ A ≥ Aam, farmers borrow from banks and the moneylender.
• when A < Aam, farmers do not have access to credit.
Moreover, as an external consultant, the advising rent of the supermarket is given by
Proof. Farmers can either be directly financed by the bank or indirectly via a moneylender.
Let us first consider the case where farmers are directly financed. Substituting back (2) and (3) into (5)
A ≥ Aa= I − (pA+ pH)
In other words, to obtain a loan with direct financing, farmers should justify a minimum level of assets,
at least equal to Aa, to the bank.
Farmers not directly financed by the bank (i.e., such that A ≤ Aa) can turn to a moneylender to obtain
a loan. By the same reasoning, substituting back (7), (6) and (3) into (8) implies that
A ≥ Aam= I − Im− (pA+ pH)
−b + m
Verifying that Aa≥ Aamfor any Im≥ 0, it follows that farmers with finance A, such that Aa≥ A ≥ Aam,
are financed via a moneylender. Finally, farmers with finance such as A ≤ Aam do not offer a sufficient
guarantee to receive a loan either from the bank or the moneylender. Furthermore, note that to guarantee
the participation of the moneylender, it is necessary that (pA+ pH)m
pH≥ m+Im; i.e. its expected rent from
moneylending is at least as high as its cost. Because a positive share of the project has to be forfeited to a
moneylender, when given the choice, farmers will seek to avoid borrowing from a moneylender.
Supermarket advising rent:
The rent of the supermarket is given by Φa= (pA+ pH)Rs− c =pH
It is important to understand that the lower the level of collateral necessary in order to be financed (i.e.,
the lower Aam), the greater the number of farmers financed. For the sake of comparison, the financial contract
in absence of a supermarket has been reported in the appendix. It is straightforward that given Assumption
2, more farmers get financing when advised by the supermarket (i.e. the level of finance necessary to access
credit is reduced when advising is part of the contract).
3.3Bundling monitoring and advising
We now explore the possibility that the supermarket decides to take on two missions; namely, moneylending
and advising farmers. In practice, the financing part often takes the form of an input advance on seeds,
pesticides or fertilizers.16Unlike the previous case, the multitasking nature of the supermarket now generates
several incentive constraints. First, the supermarket must be given reward Rs, such that it does not want
to shirk on the advising task alone:
(pA+ pH)Rs− ms− c ≥ pHRs− ms,
16The fact that the supermarket offers inputs rather than cash has several rationales. First, there are economies of scale in
procurement; supermarkets or grossists often serve several thousands of small growers. Second, there is arguably less scope for
diversion of physical inputs, although it is still possible that farmers may try to resell them in a secondary market.
Note that we assume that the supermarket is as efficient as the moneylenders in the monitoring activity, and
we let ms= m. The supermarket must also monitor the farmer. Such monitoring includes, among other
things, making sure that the farmer does not divert the inputs, and following the farmer closely at harvest
time to make sure he does not resell his harvest to other retailers.17The incentive constraint is written as
(pA+ pH)Rs− m − c ≥ pARs− c
Finally, the supermarket can decide to shirk on both tasks, in which case the incentive constraint is
(pA+ pH)Rs− m − c ≥ 0
m + c
pA+ pH. (12)
Overall, the supermarket will be diligent in both tasks if constraints (10), (11), and (12) hold true. Thus,
the minimum stake consistent with supermarket diligence is
m + c
If we denote by Isthe amount of capital invested by the supermarket in every farm that it monitors, we can
state the following result:
Proposition 2 When the supermarket not only advises, but also acts as a moneylender, there exists a
threshold of farmers’ asset, defined by AS
am= I − (pA+ pH)
− Is, such
that the optimal contract passed between the farmer, the bank and the supermarket has the following regimes:
• when A ≥ Aa, farmers borrow solely from the bank.
• when Aa≥ A ≥ AS
am, farmers borrow from banks and the supermarket.
• when A < AS
17More generally, the cost of monitoring the borrower in developing countries can represent up to 39% of the amount lended.
See Aleem (1990) for a description of monitoring practices.
am, farmers do not get funded.
Proof. Here, the financial contract involves three parties: the farmer, the bank and the supermarket.
Therefore, the return R is shared among them:
R = Rf+ Rs+ Rl.
As in proposition 1, the farmer will not require a loan from the supermarket if A ≥ Aa and prefers
direct financing with the bank. However, when the farmer has insufficient wealth (i.e., when A < Aa), the
supermarket substitutes for the moneylender and offers credit and advising. The project is then funded if
(pA+ pH)[R − Rs− Rf] ≥ I − A − Is
A ≥ AS
am= I − (pA+ pH)
m + c
− Is. (14)
Yet, to understand the behavior of the supermarket, it is critical to derive the rent associated with
moneylending for both the moneylender and the supermarket.
This section examines financial intermediation by the moneylender and the supermarket. In particular, it
determines the amount of capital invested, as well as the gross rate charged by these two financial interme-
Moneylender. By definition,
(pH+ pA)Rm= γIm.(15)
Here, γ denotes the gross rate charged by the moneylender. Together with equation (6), this implies that
the amount of capital borrowed via intermediation by the moneylender should be at least
In fact, all farms monitored will demand precisely this minimum level of capital. More would be exces-
sively costly and less would be inconsistent with proper incentives from the moneylender. Furthermore, the
moneylender rent can be expressed as
Γml= Download full-text
∙(γ − 1)(pA+ pH)
As a result, in its most general form, the gross rate charged by the moneylender can be expressed as
pAm − pHΓmlm. (18)
This gross rate captures different forms of the moneylending market structure. For instance, Hoff and
Stiglitz (1998) argue that there is monopolistic competition in moneylending. This case is captured by
Γml= 0 and γ =pA+pH
; price competition between moneylenders is such that the gross rate is set to cover
exactly the cost of moneylending (i.e., m + Im). However, it can also be argued that due to the scarcity
of moneylenders and the high transaction cost that plagues developing countries, moneylenders may enjoy
a niche market in financial intermediation. Because it may be too costly for borrowers to seek another
moneylender, moneylenders enjoy a positive rent Γml> 0. In that case, the gross rate charged is given by
Supermarket gross rate. Similarly,
(pH+ pA)Rs= δIs.(19)
Here, δ denotes the gross rate charged by the supermarket. Using logic similar to the moneylender case,
the incentive constraint of the supermarket implies that
m + c
Therefore, the rent of the supermarket when advising and lending money can be expressed as
Φs= (pH+ pA)δ − 1
m + c
− (m + c).(21)
The next Lemma, which will be needed later, clarifies when the supermarket behaves as a multitask
Lemma 3 The supermarket provides both advising and moneylending services if
m + c
Proof. The participation of the supermarket is warranted if Φs≥ 0. Assuming that max