Agricultural Contracts and Transaction Costs

Abstract

Agricultural contracts are agreements between the owners of various inputs over the biological stages of food production. Biological stages of production are often heavily influenced by nature both in terms of random shocks and seasonal constraints. Nature can create large opportunities for transaction costs, constrain production specialization, and impose risk on individuals. This chapter focuses on the two main types of land contracts: cropshares and cash rents. It identifies a number of characteristics of these contracts and their evolution over time. We argue that a transaction cost framework remains the most robust theory to understand the structure of contracts and note that evidence from the past 20 years confirms this. Indeed, the transaction cost model has shown its usefulness in the new environmental literature on soil conservation in light of climate change. Finally, we argue that when market selection effects are considered, the transaction cost model is also consistent with some of the new findings regarding risk aversion and contract choice.

Full text

Agricultural Contracts and Transaction
Costs 27
Douglas W. Allen and Dean Lueck
Contents
27.1 Introduction .............................................................................. 674
27.2 Basic Features of Agricultural Contracts ................................................ 677
27.2.1 Land Leases ..................................................................... 677
27.2.2 Equipment Contracts . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .. . . . . . . . . . . . . . . . . . . . . . . 679
27.2.3 Labor Contracts ................................................................. 681
27.3 Transaction Costs and Institutional Economics ......................................... 682
27.3.1 Transaction Costs and Property Rights . . . . .................................... 682
27.3.2 Transaction Costs and Agriculture . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 683
27.4 Transaction Cost Explanations of Agricultural Contracts ............................... 684
27.4.1 Simple Contracts for Land . . . .................................................. 684
27.4.2 Cropshare Versus Cash Rent ................................................... 685
27.4.3 Input Sharing in Share Contracts .............................................. 687
27.4.4 Equipment Contracting and Custom Operation . . . ............................ 687
27.4.5 The Role of Customs and Traditions in Contact Design . . .. . . . . . . . . . . . . . . . . . . 689
27.5 Transaction Costs and/or Risk Aversion ................................................ 689
27.6 Conservation and Contract Design ...................................................... 692
27.7 Conclusion ............................................................................... 693
References ....................................................................................... 694
Abstract
Agricultural contracts are agreements between the owners of various inputs over
the biological stages of food production. Biological stages of production are often
heavily influenced by nature both in terms of random shocks and seasonal
constraints. Nature can create large opportunities for transaction costs, constrain
production specialization, and impose risk on individuals. This chapter focuses
D. W. Allen (*)
Department of Economics, Simon Fraser University, Burnaby, BC, Canada
e-mail: doug_allen@sfu.ca
D. Lueck
Department of Economics, Indiana University, Bloomington, IN, USA
© The Author(s) 2025
C. Ménard, M. M. Shirley (eds.), Handbook of New Institutional Economics,
https://doi.org/10.1007/978-3-031-50810-3_27
673

on the two main types of land contracts: cropshares and cash rents. It identifies a
number of characteristics of these contracts and their evolution over time. We
argue that a transaction cost framework remains the most robust theory to
understand the structure of contracts and note that evidence from the past
20 years confirms this. Indeed, the transaction cost model has shown its useful-
ness in the new environmental literature on soil conservation in light of climate
change. Finally, we argue that when market selection effects are considered, the
transaction cost model is also consistent with some of the new findings regarding
risk aversion and contract choice.
Keywords
Contracts · Farming · Cropshares · Cash rents · Biological stages · Risk aversion ·
Soil conservation · Transaction costs · Seasonality
27.1 Introduction
The economic analysis of agricultural contracts has a long and storied history,
reflecting farming’s relatively simple setting, its amenability to abstract modeling,
and its familiar history, institutional, and empirical features. Furthermore, agriculture
remains a dominant industry in much of the world, and the role of contracts in the
management of soil and other land attributes have become even more important
within the context of changing climate.
Agriculture typically refers to a sequence of production stages, which typically
are thought to span the biological stages “controlled by the farm.”
1
Figure 27.1
presents various stages of production for a generic crop—animal or plant—and
draws attention to the arbitrariness of what is meant by “agriculture.”Figure 27.1
also shows that the range of farm production activities has narrowed over time. In
Typical Farm Sequence in 1800
Genetics Equipment Planning Preparing Planting Husbandry Harvest Storage Processing Marketing
Seedstock Inputs Site Breeding Maintenance Slaughter Retailing
Typical Farm Sequence in 2020
Fig. 27.1 The extent of agricultural production
1
Among agricultural economics, the term “production agriculture”is often used.
674 D. W. Allen and D. Lueck

1800 the typical North American farm would have broken land, produced seeds, and
carried production through to some form of processing and marketing. Today, what
we normally think of as “the farm”is a firm that essentially controls just the
narrowest growth-based biological stages of production.
In this chapter, we consider the contracts that exist over the biological stages.
Although we briefly discuss agricultural contracts over a broad number of stages,
and some attention is given to international contracts, the focus is on farming
contracts found in North America. This does not mean that agricultural contracts
are not an important issue in other parts of the world but instead reflects our own
expertise and knowledge.
Because agriculture is biological production, it is heavily affected by nature. The
effects of nature in turn shape the structure of agricultural contracts because these
effects influence the transaction costs involved. “Nature”refers to the aggregate of
natural forces that can influence the outcome of agricultural production and includes
the forces of climate and weather, pests, seasons, geology, and hydrology. In the
aggregate, nature not only generates random havoc and blessings on crops and
livestock, but nature also restricts the ability of farmers to specialize and exploit
the gains from specialization.
In many cases, the constraints of nature, coupled with social and economic
forces, lead to rather simple contracts. For example, contracts between farmers and
landowners tend to be enforced by reputation. When agriculture includes the
non-biological or non-growing stages of production, or when production is
designed in such a way that nature’s role during the growing stage is minimized,
contracts tend to become more complex, and the organization of the farm tends to
move from family farms using simple contracts, to corporate firms with compli-
cated contracts between relatively small, often family-based growers.
2
Contracting in agriculture is not, of course, limited to agreements between
farmers and landowners. There are contracts for equipment, labor, marketing,
production, and services.
3
These contracts can be simple and short term, or they
can be complicated and long term. Table 27.1 summarizes some of the features of
these contracts and shows where they are most found.
4
For example, marketing
2
For example, the introduction of antibiotics, which allowed for the intensive indoor husbandry of
cattle, hogs, and poultry, dramatically limited major natural inputs (e.g., disease) in the production
process. This allowed for corporate governance and complicated incentive contracts for the local
growers. For other examples of complex agricultural production, see Frank and Henderson (1992),
Fulton (1995), Knoeber (1989,2000), Kliebenstein and Lawrence (1995), Knoeber and Thurman
(1994), Lazzarini et al. (2001), Martinez and Reed (1996), Ménard (1996), Sauvee (2002), and
Ménard and Klein (2004).
3
These contracts use various methods of payment (e.g., hours for tractors, revenue share for
marketing) and impose various duties on both farmers and other contracting parties. These duties
include sharing input costs, using specified techniques, and performing tasks at specified times.
4
Roy (1963) gives an early account of contracting practices in agriculture. See Perry et al. (1997) for
a more recent account, which finds that such contracts cover almost one-third of the value of farm
production in the United States.
27 Agricultural Contracts and Transaction Costs 675

contracts for fruits, dairy, sugar, and many vegetables are often established between
the farmer and a processor. In these contracts, although the farmer (or “grower”)
typically controls production, he is partly integrated with the processing firm and
agrees to deliver a specific quantity and quality of crop, usually at a specific time. For
poultry, swine, and some vegetables, farmers enter production contracts where the
farmer agrees to produce a crop under the direction of another firm. In these
contracts, the farmer is often required to use certain inputs and techniques and
may share costs with the firm.
In this chapter, our focus is on contracts for land because this remains the area of
most interest to economists. We begin with some general descriptions of the struc-
ture and extent of contracts for land and equipment. Next, we describe the transac-
tion cost framework for examining such contracts. It is our contention that this
approach remains the best and most robust theory of agricultural contracts. We
follow this description with a series of contract observations that are best explained
by the mitigation of transaction costs.
Two main streams of literature in agricultural contracts have developed since our
original (Allen and Lueck 2005) chapter. First, several papers reexamined the role of
risk aversion in the context of endogenous matching between farmers and land-
owners. Second, the literature on soil conservation and environmental management
has been drawn to the transaction cost problem of a farmer exploiting the land
attributes of the landowner. Interestingly, evidence from this second literature has
findings relevant to the role of risk aversion in contract design.
Table 27.1 Features of typical agricultural contracts
Type Features (parties, payment, duties) Examples
Equipment Farmer rents equipment on a time basis (day,
month, year) or on an hourly rate of use
Field implements, tractors
Labor Farmer hires labor for skilled and unskilled work.
Payment can be hourly, monthly, or based on piece
rates
Equipment operation,
harvesting, field work
Land Farmer rent land in return for cash or share of the
crop. Input costs are sometimes shared
Small grains, pasture, hay,
row crops
Marketing Farmer agrees to deliver crops of a specific quantity
and quality to a processor. Farmer and marketing
firm share the revenues. Farmer control overall
production and owns the crop
Apples and other fruit,
dairy, sugar, cattle,
vegetables
Production Farmer (“grower”) agrees to produce a crop under
the direction of another firm. Farmer will be
required to use certain inputs and techniques and
may share costs. The contracting firm will
generally control production and own the crop
Seed, vegetables, poultry,
swine
Service Farmer hires firm to perform specific tasks.
Typically, the firm provides both the labor and the
specialized equipment required
Harvesting, pest control,
cattle feeding
676 D. W. Allen and D. Lueck

27.2 Basic Features of Agricultural Contracts
27.2.1 Land Leases
Farmland leases take two basic forms: cropshare and cash rent.
5
Acropshare
contract is so-called because the two parties share the harvested output, not the
crop revenue, and they tend to have no additional cash side payments.
The farmer may pay for all the inputs (e.g., seed, fertilizer, harvesting) or share
these input costs with the landowner. Sharing input costs is almost always done in a
dichotomous fashion, with the input share either equaling the output share or
equaling 100% for the farmer. This means that if the farmer and landowner are
sharing output 50/50, then when inputs are being shared, they are also shared 50/50.
If inputs are not shared, then the farmer almost always pays for them. When inputs
are not shared, then the share of output to the farmer is always higher.
The primary alternative form of land contract in agriculture is a cash rent contract.
In a cash rent contract, the farmer pays the landowner a fixed monetary sum for the
exclusive use of the land for a specific period. Usually, the payment is made before
the crop is harvested, but sometimes a series of payments is spread out over the year.
Unlike cropshare contracts, in cash rent contracts, farmers typically do not share
input costs with the landowner. Occasionally cash rent contracts will have an
“adjustment”clause in them, increasing the rent if there is an exceptionally good
or “bumper”crop.
6
Although cropshare contract shares are quite limited to a few discrete fractions
(0.5, 0.6, 0.75) and are usually no higher than s¼0.75 or s¼0.8, cash rents vary
almost continuously and are more sensitive than cropshare contracts to differences in
economic fundamentals, such as land quality, input prices, and land size. In this
respect, a cash rent contract is not just an extreme cropshare contract where the share
equals 1; a smooth continuum of share contracts does not exist.
In many non-agricultural settings, exchanges are governed by rather complicated
contracts.
7
Farmland contracts, on the other hand, are simple, often oral, and tend not
to stipulate in detail how the land will be farmed; rather, they require the farmer use
the land in a “good and husband-like”manner, a term used by lawyers and judges.
8
Furthermore, these contracts are most often annual agreements, subject to automatic
renewal, unless one party makes an early commitment not to renew. Sometimes the
agreements are for several years, but rarely are they longer than 5 years. They are,
however, typically renewed for extended periods, even up to 30 years. Most
5
In the law of property, a temporary agreement for the exclusive and possessory use of land is called
a“lease”; thus, we use the terms contract and lease synonymously for farmland.
6
Allen and Lueck (2002) found that such clauses accounted for about 10% of the cash contracts in
their data.
7
There are also simple contracts outside of agriculture, as Macauley (1963)first pointed out.
8
Goodhue et al. (2003) examine contracts for wine grape growers in California and find oral
agreements are common, but are replaced more often with written agreements for high-quality
grapes.
27 Agricultural Contracts and Transaction Costs 677

interesting is that these contracts tend not to contain detailed descriptions regarding
duties, techniques, or other farming practices.
9
Both cash rent and cropshare leases are very common in North America.
10
Table 27.2 shows some basic features of modern farmland contracts. The table
shows that farmland leasing accounts for about 40% of all acres farmed in both
Canada and the United States and a wide range across four European countries.
11
In
terms of number of leases, about 70% of leases in the United States are cash rent in
2014 and 15% are cropshares.
12
Cropshares vary, but most observed shares are from 50% to 75% and tend to be
simple fractions (e.g., 1/2, 2/3, 3/5, and 3/4). Worldwide, 50% appears to be the most
common output share, although in North America the three most common shares
(the share kept by the farmer) are 50%, 60%, and 67%, which are often called
“halves,”“fifths,”and “thirds”by farmers. Table 27.3 shows the discreteness and
frequency of the shares to farmers in cropshare contracts across several regions in
North America (Allen and Lueck 2009, Young & Burke, 2001).
Table 27.2 Some features of modern farmland contracts
United
States
2014
Canada
2011
Ireland
2010
England
2010
France
2010
Belgium
2010
General information,
Acres leased (%) 39 38.5 16 32 75 66
Average lease size
(acres)
60 236
Average land value
($/acre)
$4100 NA
Cash leases,
All leases (%) 70 91 57
Leased acreage (%) 69 23.8 59
Share leases,
All leases (%) 15 9 21
Leased acreage (%) 21 16.5 24
Source: Statistics Canada, Census of Agriculture, 1976–2011; (US Census of Agriculture 1999,
2014; Swinnen et al., 2016)
9
Agricultural land leases are often between family members. Onofri et al. (2023) report that across
Europe most of these features of American land leases carry over. Contracts tend to be informal,
normally renewed for long durations, and family farms dominate.
10
Gray et al. (1924) note that leasing was widespread in early twentieth-century America and that
cash rent and cropshare contracts were the dominant forms.
11
The wide variation in land leasing in Europe is mostly driven by different types of agriculture and
government regulations on land markets (Swinnen et al., 2016).
12
The remainder are divided between cash leases with adjustment clauses (just 5.6% of the cash
contracts), cash-share combination leases (about 10.5% of all leases), and “other”leases (about
10.5% of all leases). See 1999 Agricultural Economics and Landownership Survey, Table 98.
678 D. W. Allen and D. Lueck

Three important characteristics are shown in Table 27.3. First, shares below
50–50 for the farmer are less than 2%. Second, a variety of dominant share rates
exist across different regions. And finally, all shares are simple fractions (e.g., ratios
of small whole numbers). In each case, the shares are customary in that they are rigid
locally but vary across regions.
Over the past 30 years, the most significant change in land leases in North
America has been the rise of cash rent contracts. Figure 27.2 shows the growth of
cash rent contracts relative to cropshare contracts in the United States (Canada is
similar). The data for the figure includes all regions in the United States, nine
different crops (cotton, rice, soy duram/spring/winter wheat, barley, corn, and
sorghum), and runs between 1996 and 2011. The figure shows that the ratio of
cash rent contracts to cropshare contracts (by acres) increased from just above two to
around five—almost a doubling of the relative importance of cash rent contracts over
this period.
27.2.2 Equipment Contracts
Although farmland leases are the most common agricultural contract analyzed by
economists, farmers also contract for the use of equipment—both general (e.g.,
Table 27.3 Frequency (%) of farmer shares in cropshare contract terms across regions
Farmer
share (%)
British
Columbia
1979
British
Columbia
1992
Louisiana
1992
Nebraska
South Dakota
1992
Kansas
2000
Illinois
1995
9/10 (90) 5 4.4 0.3 0.12 0 0
17/20 (85) 7 20 0.6 0 0 0
5/6 (83) 0 0 12.6 0 0–0.6 0
4/5 (80) 21.9 8.9 38.6 0.12 0–1.2 0
3 / 4 (75) 26 15.6 23.1 1.40 0.4–1.2 0
2/3 (67) 19.8 22.2 0.9 32.8 68–79 9.7
3/5 (60) 1.2 13.3 6.8 30.16 11–15 6.7
1/2 (50) 11.2 6.7 2.2 30.92 9–15 82.3
2/5 (40) 0 0 0 1.32 0–2.1 2
Observations 242 45 324 2424 1449 935
Source: Allen and Lueck (2009)
Fig. 27.2 The growth of cash
renting in the United States.
(Source: Allen and Borchers
2016)
27 Agricultural Contracts and Transaction Costs 679

tractors) and specialized (e.g., swathers). The value of a major piece of equipment
relative to a typical plot of land on a farm varies by location and type of farming. In
some situations, farmers might have more wealth tied to their farm equipment than to
other assets. For example, a quarter section (160 acres) of dry wheat land in the
Canadian Prairies has an average worth of $2250 (US) per acre or $360,000 (Farm
Credit Canada, 2022). In 2022, US cropland values averaged over $5000 per acre
and ranges from $2000 to $6000 per acre on the Great Plains states of Kansas,
Nebraska, South Dakota, and North Dakota.
13
A large modern combine harvester
could be worth more than $400,000, and a farmer might own more than one. Thus,
equipment contracts are often as important as land contracts in terms of the value of
the contracted assets.
Although data are limited, equipment is much more likely to be owned than
rented and is much more likely to be owned compared to farmland. Farmers often
hold large inventories of infrequently used equipment like cultivators, harvesters,
and sprayers. In this sense, it is common to hear that farmers own “too much”capital.
Many of these expensive assets are used for surprisingly short periods and are simply
held in inventory for the remainder of the year.
When farmers rent equipment, such as combines and tractors, they are typically
charged by the hour or some other unit of time (e.g., day, week, and month).
14
The
firms that lease out equipment tend to be local farm implement dealers that deal
primarily in the sale of farm equipment. Equipment leases are usually written and
usually last less than a year.
15
In fact, equipment is seldom rented for an entire season
and is often rented for only a particular stage of production. This means that for
certain kinds of equipment, during crucial stages, farmers in a locale demand the
equipment at the same time.
Even though farmers have underutilized equipment, they often use multiple
pieces of the same or similar machines as well (e.g., combines, tractors, trucks).
Farmers who use more than one machine are much more likely to rent the secondary
machines than own them. Farmers often attempt to lower capital costs by sharing
equipment with neighbors. However, since farmers in a locale often need the
equipment at the same time, the types of shared equipment are limited to those
machines for which timeliness costs are small.
16
Equipment that is specialized to a
crop (e.g., cotton gin) or to a specific stage (e.g., planting, harvesting) is seldom
governed by contract.
Of particular interest among equipment contracts is the practice of custom
contracting. In agriculture, the term “custom”refers to contracting for equipment
13
See USDA Land Values Summary 2022 at https://www.nass.usda.gov/Publications/Todays_
Reports/reports/land0822.pdf).
14
Tractors prices vary with horsepower, so rates are often discussed in terms of “horsepower hours.”
See Edwards and Meyer (1986) and Pflueger (1994) for some details on modern farm equipment
leasing.
15
Most long-term (greater than 1 year) equipment leases have options to buy (Pflueger, 1994).
16
The contractual implications of timing are discussed in Sect. 27.3).
680 D. W. Allen and D. Lueck

and an operator (often the owner) at the same time. In a typical case, a farmer may
contract for a plane to do crop spraying and hire the pilot as well. Farmers also hire
custom firms for baling, cultivating, fertilizer and pesticide application, feed grind-
ing, fencing, hauling, land clearing, planting, plowing, and seed cleaning (Eaton &
Shepherd, 2001). By far, the most important custom contracting is for grain
harvesting. And by far the most important custom grain harvesting is the 1000-
mile south-to-north migration of harvesters that takes place in the wheat belt of the
Great Plains. A 1971 study by the USDA showed that nearly 3500 custom combiners
or “cutters”harvested 35% of the wheat on the Great Plains (Lagrone & Gavett,
1975). In 1997, roughly 2000 custom cutters harvested one-half of the United States’
wheat crop (DuBow, 1999). Overall, however, all custom work comprises just 2% of
all US farm expenses.
17
Although some cutters work only locally, more than 90%
make the long interstate journeys.
Contracts between custom combiners and farmers have a structure that originated
in the 1940s when the industry had its first major expansion. Since that time, cutters
have been paid according to a three-part formula that includes a per-acre fee for
cutting, a per-bushel fee for hauling grain to a local storage site, and a per-bushel fee
for high yield crops (usually over 20 bushels per acre).
18
In unusual cases—drought,
hail, long hauls, or wind—special harvest rates would be developed to suit both
parties. As with agricultural contracts in general, farmers and cutters rely heavily on
verbal agreements, enforced with handshakes and the possibility of renewal.
19
As
Isern (1981, p. 92) notes:
The unwritten code of custom combining was a flexible one, but the person who stretched it
beyond reason suffered the consequences. The custom cutter who failed to live up to his
obligations to a farmer found it hard to obtain work in the locality the next year. Likewise, if
a farmer reneged on an agreement, the word spread among custom cutters working the area,
and the farmer might be left with no harvesters at all.
27.2.3 Labor Contracts
Of all contracts related to agriculture, labor contracts seem to resemble contracts
outside agriculture the most. For land contracts, sharing is important, and for
equipment contracts, underutilization is obvious; yet nothing particularly striking
or unusual is apparent in agricultural labor contracts. No doubt, this results from the
17
This shows how distinctive the custom grain harvest is. See 1997 Census of Agriculture, Table 3
“Farm Production Expenses.”The census does not collect data on specific custom services. Custom
harvesters have a professional association, the US Custom Harvesters, which reports 649 operators
in 2023.
18
According to Isern (1981), this formula was typically 3/3/3 when it first emerged in the early
1940s. The high yield payment compensates the cutter for slower progress (in terms of acres) with
higher yields and greater wear and tear on the machines.
19
Our information on this is limited, but contracts for equipment rental from farm implement
dealers are more formal, written agreements, much like those used when renting a car.
27 Agricultural Contracts and Transaction Costs 681

limited role that hired labor plays in most farming contexts. Farming is dominated by
family farms where the farmer (or members of his family) provides most of the labor
services.
20
Allen and Lueck (2002) found a pattern familiar to most labor contracts. When
laborers engage in general farm duties, such as cleaning barns, mending fences, and
operating basic equipment, wages are the dominant form of compensation. When
workers assume supervisory or management roles, such as foreman, office worker,
or manager, they are often paid by monthly salary. Finally, when workers are hired
for harvest, both wage and piece rate contracts are used.
27.3 Transaction Costs and Institutional Economics
When transaction costs are zero, it does not matter how ownership of inputs and
outputs is distributed by the terms of a contract. Farmers can control land through
cash leases, share contracts, or ownership; farmers can own or rent their equipment
in any proportion; and labor produces an equal amount of output under any com-
pensation scheme. These applications of Coase (1960), of course, apply to other
aspects of agricultural organization. If transaction costs are zero, then a farm could
be a family-run sole proprietorship or a large-scale corporation. Farms could be
integrated completely or disintegrated to the point of owning a wheat field for 1 day.
Explanations of differences in how contracts assign property rights, therefore, must
include differences in transaction costs. Institutional economists not only recognize
the necessity of transaction costs, but their models also tend to treat transaction costs
as a sufficient explanation.
27.3.1 Transaction Costs and Property Rights
Transaction costs are the costs of enforcing and maintaining property rights and
include the deadweight losses that result from enforcing property rights (Allen,
1991,2000), and the fundamental transaction cost hypothesis is that institutions,
organizations, and contracts are designed to maximize wealth net of the relevant
transaction costs. Therefore, within the context of agricultural production, various
parts of the exchanges are managed in different ways. That is, various exchange
margins will involve reputations, the law, third-party agencies, and private contracts.
Farm contracts are designed to mitigate transaction costs given the constraints
imposed by the particular farming technology, the role of nature, and the potential
gains from specialization, as the parties attempt to police certain interactions with
20
The main exception to this would be migrant farm labor for the harvesting of fruits and
vegetables, especially along the Pacific Coast.
682 D. W. Allen and D. Lueck

each other.
21
Farmers can hide bales of hay that were intended to be shared with
landowners; harvest crews can arrive late, causing a reduction in crop value; farmers
can exploit landowner assets like land attributes and equipment; and of course,
workers can shirk. Efforts to engage and prevent these activities, along with any
lost gains from trade that result, are transaction costs.
27.3.2 Transaction Costs and Agriculture
Four transaction costs factors are important for the study of agricultural contracts.
First, agricultural inputs and outputs are complex, in the sense that they are
composed of many attributes. When goods are complex, they create an opportunity
for transaction costs to arise for every attribute. This subsequently allows for
ownership to be divided over the various attributes because multidimension goods
are costly to measure (Allen & Barzel, 2023). Land, for example, is comprised of
features that include terrain, nutrients, moisture, and soil type, but contracts for land
typically only specify the amount of land in terms of surface area. Many, if not most,
of the attributes of the land are not explicitly specified and can then be used by either
party. Different ownership and contract types affect the various attributes in different
ways, creating trade-offs.
Second, uncertainty is an input into production. The biological element of farm
production means that nature is always present. Nature causes uncertainty, and this is
the source of moral hazard on both sides of the contract. Nature allows one party to
exploit an exchange at the expense of the other party because it masks their actual
effort. This factor is important in agriculture because weather, pests, and other
natural phenomena contribute so much to the final output. In a land lease, for
example, uncertainty from weather and other natural forces means that the farmer
has the opportunity to “exploit”the landowner in several ways: under-supplying
effort; overusing soil quality attributes; and underreporting the shared crop, to name
a few.
Third, nature also has a systematic seasonality. Seasonality refers to crop cycles,
the number and length of stages, and timeliness costs. For any given crop or
livestock, there is a natural order of production: planting comes before cultivation,
which is always followed by harvest. For winter wheat in Texas, this means planting
in the fall and harvesting in late spring or early summer. The predictable aspect of
nature—its seasonality—limits the degree to which farmers can specialize in pro-
duction (Allen & Lueck, 1998,2002). Seldom is a farmer able to specialize in one
task, due to seasonality. A farmer, who only plowed or only planted, would be
unemployed for most of the year. Most types of farm output are greatly restricted by
21
This assumes that natural selection has resulted in the most valuable contract or organization
being chosen (Alchian, 1950; Coase, 1960). The contracts observed are not the result of inert culture
or custom, nor are they the result of one-sided bargaining. In the transaction cost approach,
competition is assumed to extend to the nature of the contract. Thus, only those contracts which
maximize the gains from trade will survive.
27 Agricultural Contracts and Transaction Costs 683

nature in terms of how they can be produced. Both plant and animal crops have
“growing seasons”that restrict the nature of farm production. As a result, farmers are
seldom able to realize potential forms of economies of size. And since individuals
are engaged in many tasks, monitoring costs are high. Seasonality also influences the
use and type of contracts because its presence makes the net gain from ownership
and integration larger than it would be, otherwise.
Fourth, farming involves timeliness costs: the forgone values from lower crop
yields or quality that result from not completing tasks (e.g., planting, cultivating,
spraying, harvesting) at the optimal time (Short & Gitu, 1991). In many types of
agriculture, these costs are substantial; waiting a day to harvest wheat might mean a
complete crop loss from a hail or windstorm. The structure of contracts and farm
organization is thus expected to create incentives to minimize these costs.
22
27.4 Transaction Cost Explanations of Agricultural Contracts
The transaction cost framework has been successful in explaining agricultural
contracts. We report some of the basic findings below and add case study and
historical data as well. In the process, we document the history of economic thought
on the various contract questions.
27.4.1 Simple Contracts for Land
Why are farmland contracts so simple, even though the value of the assets at stake is
quite large? Transaction cost features of agricultural contracts explain the seemingly
naive contracts. First, specific assets (Klein et al., 1978; Williamson, 1979) are often
relatively minor, so that long-term contracts are not needed to prevent holdup
problems.
23
Second, in close-knit farming communities, market enforcement of
contracts via reputation (Klein & Leffler, 1981) serves to reduce the need to use
detailed written contracts.
24
Third, in areas where farming has been long practiced,
22
Allen and Lueck (2002) discuss the implications of timeliness costs.
23
In cases where specific assets are important, long-term contracts and even vertical integration
dominate (Crocker and Masten, 1988; Joskow, 1987). In farming specific investments are often
made with irrigation. An important special case of specificity relates to “time specificity,”partic-
ularly in the harvest and delivery of perishable products. Specific investments may be more
important with industrial farming methods, and in these contexts, we do not expect simple contracts.
Again, these issues arise more in stages outside the biological stages we focus on. One area where
specific asset might be important is for orchards in rather uneven terrain (e.g., Columbia River
region in the Pacific Northwest). In this case, the subtleties of aspect (i.e., the land’s location with
respect to the sun), elevation, and slope may generate specific knowledge about a plot of land that
only a long-term farmer might have.
24
Ellickson (1991) studies enforcement in the shadow of the law among members of homogeneous
groups.
684 D. W. Allen and D. Lueck

the common law has developed default rules that define the behavior of farmers and
landowners, again rendering detailed contracts needless.
25
Even farmland contracts can be quite detailed when the conditions for simple
contracts are not met. Consider the case of land leases on the Great Plains during the
late 1800s and early 1900s. During this time, large so-called Bonanza farms arose in
the Red River Valley along the Minnesota–North Dakota border, and their owners
often leased out land in relatively small plots (e.g., 100–200 acres) (Drache, 1964).
In sharp contrast to the simple (annual and oral) contracts that dominate modern
farmland leases, these leases were remarkably detailed and always seem to have
been written. Typically, these contracts were several single-spaced typed pages
specifying the terms of payment; the method, depth, and time of plowing; the
amount of fallow land; and the time and type of seeding (Allen & Lueck, 2002).
The relative complexity of these contracts is consistent with the discussion above. In
this region, the common law was simply undeveloped and lacked default rules,
settlements were still being established and communities had not yet developed
enough to exploit reputations, and so parties needed to specify, in detail, the sorts of
things that would now simply fall under the category of good husbandry.
27.4.2 Cropshare Versus Cash Rent
Perhaps the oldest contractual question studied by economists has been: Under what
conditions would a farmer and landowner contract for land with a cash rent or
cropshare contract? From Adam Smith’s famous share-tax analogy, to Alfred Mar-
shall and other neoclassical economists, the dominant view came to be that cropshare
contracts were an inefficient choice compared to cash rent. Johnson (1950)
questioned this view: if cropsharing is so inefficient, then why were so many Iowa
farmers and landowners using it? Not until Cheung (1969) extended the Coase
Theorem (1960) into share cropping did the modern analysis begin. Cheung
(1969) and Stiglitz (1974) famously created the basic principal-agent framework
of contract choice which depended on a trade-off between incentives and risk
aversion.
A major shift came when Eswaran and Kotwal (1985) introduced a multiple
margins moral hazard model with risk-neutral contracting parties. Other similar risk
neutral models (Holmström & Milgrom, 1991; Allen & Lueck, 1992a,b; Luporini &
Parigi, 1996; Prendergast, 2002) showed the power and simplicity of transaction cost
models to explain contract choice.
Within this risk-neutral, multiple margins framework, the choice between cash
rent and cropshare contracts can be explained by focusing on simple production
25
Burkhart (1991) notes that farm leases contain an implied covenant to work the farm in a “farmer-
like manner”—meaning that if the tenant does not use good farming practices, the covenant is
breached and the landlord can recover damages. What constitutes a “farmer-like manner”can be
shown by custom, practices of area farmers, or county extension agents.
27 Agricultural Contracts and Transaction Costs 685

trade-offs. For example, Allen and Lueck (2002) show that cash rent contracts
provide perfect labor incentives for farmer effort, but because the farmer’s rent is
based on the amount of land farmed and not the amount of soil exploited, the cash
rent contract provides an incentive to overuse the land. In particular, farmers have an
incentive to exploit the valuable water and nutrient attributes, which will enhance
their crops. Cropshare contracts, on the other hand, generate moral hazard costs for
farmer effort, but this implies that the farmer has less incentive to overwork the land.
This reduction in soil exploitation is the benefit of the cropshare contract. Cropshare
contracts do not always dominate cash rent contracts because they also contain an
incentive for the farmer to underreport the crop. For example, when a farmer must
pay the landowner every other bale of hay in a 50–50 contract, every bale he
underreports is an implicit increase in his share.
26
This framework also explains much of the contract choice found in other parts of
the world. For example, a study of historical vineyard contracts in Spain (Carmona &
Simpson, 1999) shows that share contracts dominate because of the incentives they
provide for proper long-term care of the vines.
27
Similarly, Dubois (2002)finds that
in the Philippines, corn—a crop that is hard on the land—is more likely to be
cropshared than are the main alternatives of rice and sugar. Indeed, this view
explains Adam Smith’s long-standing observation that sharing was more common
in France and southern Europe than in England. In northern Europe, the most
common type of farming would have been of small grains and grass crops. In
Southern France, Italy, and Spain, grapes, olives, and fruit were much more impor-
tant. With fruit trees, the share contract prevents the farmer from exploiting the tree
or vine asset over the short term. With grapes and fruit, pruning can be done in
certain ways to increase the short-run volume of fruit, but which, over time, kill the
tree or drastically reduce the long-term productivity of the tree. Sharing lowers the
incentive of the farmer to do this in the same manner that it lowers the incentive to
exploit soil attributes. The observations about European land leasing, first made by
Adam Smith and John Stuart Mill (1871), thus suggest that land contracts were
chosen in response to the costs of enforcing contracts over assets with many
attributes. The dominance of cash rent contracts in England and northern Europe
can be explained as the result of the relative dominance of small grain and grass
farming. Similarly, the dominance of cropsharing in the Romance countries can be
explained as the result of the relative dominance of orchard crops.
28
26
Other transaction cost models, for example, Allen and Barzel (2023), are based on moral hazard
on both sides of the transaction.
27
Galassi (1992) and Hoffman (1984) are studies of historical European contracts that are also part
of this literature. Allen and Lueck (2019) also show how transaction costs explain the different
organization found in vineyards versus wineries.
28
As we note in Sect. 27.2, just over 10% of all farmland leases in the United States are a cash-share
combination. Our data are not detailed enough to examine these contracts and we are not aware of
any study that attempts to explain the use and structure of such contracts. It thus remains an
important open area for study.
686 D. W. Allen and D. Lueck

27.4.3 Input Sharing in Share Contracts
An important feature of share contracts is whether or not the inputs are shared.
Beyond land and labor, seed, fertilizer, machines, water, pesticides, and a host of
other inputs are also required, and these other inputs are often shared.
29
In one of the
few early studies of input sharing, Heady (1947) argued that sharing input costs in
the same proportion as the output share offsets the moral hazard effect of the share on
that input.
30
Recall that a share on output lowers the marginal product of every input,
which is the “tax”effect introduced by Adam Smith. When an input cost is shared,
this lowers the cost of the input and acts as an input subsidy. When the two shares are
the same, the tax and the subsidy completely offset each other, and the input is used
at its first-best level. Heady’s model predicted that all inputs should be shared in the
same proportion as the output. But this is refuted: inputs are either shared in the same
proportion as the output, or they are not shared at all.
31
When the costs of monitoring shared inputs are incorporated into the analysis, this
dichotomy can be explained. Whenever inputs are shared, there is an incentive for
the farmer to overreport the actual cost of the inputs. Thus, input sharing requires
monitoring effort on the part of the landowner. When these costs are high, the
landowner opts to have the farmer pay for all input costs, and the share of output
to the farmer is adjusted upward. When these monitoring costs are low, the inputs are
shared in the same proportion as the output. For example, when a farmer has more
than one plot of land, his cropshare contracts tend not to share input costs, so the
landowner can avoid the potential for input cost shifting away from the leased plot
(Allen & Lueck, 1993,2002, Chap. 5).
27.4.4 Equipment Contracting and Custom Operation
For equipment, the main question is not contract choice per se but, rather, the choice
between ownership and contracting for the use of equipment. Both ownership and
contracting have costs: ownership costs include the foregone gains from specializa-
tion and the costs of borrowing if there are wealth constraints; contracting costs
include moral hazard and timelines—that is, the reduction in output when tasks are
not undertaken at the optimal time.
32
Since equipment is often specialized and used
29
The cost of the farmer’s labor and the cost of the land’s attributes are never shared
30
Other studies include Bardhan and Singh (1987), Berry (1962), and Braverman and Stiglitz
(1986).
31
Braverman and Stiglitz (1982,1986) reach similar conclusions in a principal-agent framework.
32
Timeliness costs, though not often given much attention by economists (an exception is Masten
et al., 1991), are considered very important in the agricultural literature. See Edwards and Boehle
(1980), Hopkin (1971), or Short and Gitu (1991).
27 Agricultural Contracts and Transaction Costs 687

for specific stages of production, it is extremely costly to use rental markets.
33
As a
result, the farmer often owns even seldom-used equipment.
34
For example, trucks and tractors, used for many general farming tasks, are more
likely to be contracted than owned, whereas specialized equipment, such as a
combine, are more likely to be owned than rented (Irwin and Smith 1972). Farmers
who use more than one piece of a particular type of equipment are more likely to
contract for one piece than farmers who use just one piece. This evidence is
consistent with the importance of timeliness costs in determining the ratio of
contracted to owned assets.
35
Custom harvesting provides an example of the trade-offs between specialization
gains, moral hazard costs, and timeliness costs. The benefit from contracting for
custom combining is, of course, derived from the intensive use of highly specialized
equipment with skilled operators. Typical wheat farmers may use their own com-
bines for just 20 days each year. A custom cutter (or wheat harvester) could,
however, by moving north with the ripening wheat, use his combines for
100–150 days each year. Williams (1953, p. 53) notes these tremendous gains to
specialized equipment:
The economic keynote of the cutters’activities is the ability to get maximum utilization of
their expensive and complicated specialized machinery, as they follow the progressive
ripening pattern of the south-to-north contour of the wheat belt.
The gains from specialized labor are also important. Combine operators and truck
drivers repeatedly working long seasons are more specialized than any farmer and
his short-term help. These specialized operators are extremely knowledgeable in the
use and maintenance of this expensive equipment.
The gains from specialized machines and labor would seem to imply that
contracting for harvesting would dominate wheat and grain farming. Timeliness
costs for a wheat harvest, however, are severe and limiting. For any given wheat
farmer, the window for optimal harvest is just a few weeks, and standing grain
is extremely vulnerable to hail, rain, and wind. How do migratory custom
cutters and the farmers who hire them reduce these timeliness costs enough to
sustain a viable industry? The answer is found in the geographic and climatic
contiguousness of the Great Plains. Custom cutters know they can reliably
follow the ripening wheat north in order to make intensive use of their expen-
sive equipment. The exceptional circumstances of the contiguous wheat harvest
of the United States point to how rare yearlong custom contracting is. For
instance, wheat is also an important crop in California and Washington, but
33
Studies of ownership and contracting in trucking show similar empirical findings Baker &
Hubbard, 2003, Nickerson & Silverman, 2002).
34
Although this has started to change, and some of the largest equipment can now be rented by the
day.
35
Allen and Lueck (2002) also find that wealthier farmers are more likely to own equipment.
688 D. W. Allen and D. Lueck

the lack of a long and continuous harvest has limited the emergence of large
custom harvest industry.
27.4.5 The Role of Customs and Traditions in Contact Design
As noted in Sect. 27.2, cropshare contracts typically use a rather small set of
fractional sharing ratios that are seemingly resilient to changes in underlying eco-
nomic forces, such as differences in land and labor quality. Allen and Lueck (2009)
show that cropshare contracts automatically adjust for changes in many fundamen-
tals, and therefore, shares are less sensitive to the changes. In this sense, it “appears”
that customs play a role, even though they do not.
Allen and Lueck focus on the distinction between the use of simple discrete
fraction terms in cropshare contracts and the nearly continuous payment terms used
in cash rent contracts. They show that the pattern of shares is best explained as a
response to moral hazard problems spread over large numbers of inputs; that is, as
the number of inputs increases, the optimal share becomes a simple fraction. Their
transaction cost model explains the pattern of shares, the difference in flexibility with
cash rent contracts, and the lower bound on shares. Empirical analysis that tests the
model implications finds a wide range of support for the model based on moral
hazard and measurement costs.
36
27.5 Transaction Costs and/or Risk Aversion
The transaction cost approach assumes risk-neutral parties and relies on a trade-off
between different incentive margins to explain contractual terms. Since Cheung
(1969), Stiglitz (1974) and Newberry and Stiglitz (1979) the main alternative
approach has been to assume contracts are designed to balance risk against moral
hazard incentives.
37
Huffman and Just (2004) have the most general model which
allows for landowner and farmer heterogeneity in productivity, cost of effort,
reservation levels of utility, and risk preferences. With this large set of parameters,
they explain a wide range of stylized facts. The observation that cropshare contracts
are more common in developing rather than developed economies is explained in
their model by arguing that in the developing world farmers are more risk averse than
landowners but that in the developed world farmers are less risk averse than
landowners. Huffman and Just similarly offer an explanation for why cash renting
36
Alternatively, Young and Burke (2001) explain the custom of common shares using evolutionary
focal points as a method of reducing bargaining costs.
37
In the most canonical form, this approach is called the principal-agent model (Garen (1994),
Sappington (1991)). Risk-based models of contract choice, however, have developed far beyond the
original simple models.
27 Agricultural Contracts and Transaction Costs 689

became more common in North America over the past 20 years, arguing that
landowners have become more risk averse relative to farmers.
38
A long literature has showed evidence inconsistent with risk as a factor to explain
contracts.
39
In an effort to reconcile this, Chiappori and Salanie (2000) and
Ackerberg and Botticini (2002) have argued that standard regression estimates of
contract choice determinants using various covariates, including proxies for risk
aversion, may be biased if there is endogenous matching or selection between
landowners and farmers. If such matching is based on risk preferences of the
contracting parties, then it could be the case that more risky situations are governed
by high powered cash rent contracts—the opposite of the standard prediction. The
intuition is straightforward: higher powered contracts may be necessary to induce
stronger effort in cases where there is much variability; however, such contracts may
attract only risk-neutral or risk-taking farmers. Risk-averse farmers will opt for
low-risk contracts in areas where variability is limited.
A small number of studies have found evidence for matching between firms and
workers, including landowners and farmers.
40
In their historical agricultural appli-
cation, Ackerberg and Botticini (2002) control for matching using geographical
location as an instrument and find that this makes their risk proxy variable significant
in their contract choice regression. They take this as evidence that risk aversion is an
important factor in contract design through a selection effect.
Endogenous matching can help explain why the empirical evidence for the
effect of risk preferences is mixed. If all farmers were risk neutral, then contracts
wouldbedrivenonlybytransactioncostincentives. In this context, the presence of
risk-averse farmers or landowners becomes a cost of contracting because it neces-
sarily lowers overall surplus. Risk-averse participants must have lower powered
contracts to avoid some risk, and this lowers the total wealth created by distorting
incentives.
Consider a situation with a group of landowners potentially contracting with an
even larger group of potential farmers who also have many alternative forms of
employment, and assume the farmers have various risk preferences distributed from
risk loving to risk hating. In such a case, landowners will design contracts solely in
38
Within the agricultural economics literature, it is common to find risk aversion as the go-to
explanation of various contract features. See Mishra et al. (2020), Hayami and Otsuka (1993),
Dubois and Vukina (2004), and Fukunaga and Huffman (2009).
39
See Rao (1971), Hobbs (1997), Allen and Lueck (1995,1999,2002), Masten and Saussier (2000),
Ackerberg and Botticini (2002), Vassalos and Li (2016), and Prendergast (1999,2000) for examples
and summaries of the evidence. Some work finds evidence that risk preferences do matter for contract
design (e.g., Fukunaga and Huffman 2009). Outside the area of agriculture, a series of papers have
found similar results. See, for instance, Hallagan (1978), Martin (1988), Laffontaine (1992), Leffler
and Rucker (1991), Lyon and Hackett (1993), and the summary in Prendergast (2002).
40
Prasada and Salmon (2013), for example, examined self-selection based on risk profiles and
market power on either side of the market and, within the context of their experiments, found
evidence for matching and risk aversion affecting contract design under some market power
scenarios.
690 D. W. Allen and D. Lueck

terms of mitigating transaction costs: some will be high powered, others low
powered. Farmers will match with contracts they prefer. Risk-averse “farmers”
might take wage jobs in town if none of the farming contracts appeal to them.
Risk-neutral or risk-preferring farmers will accept cash rent contracts in risky
environments. In the presence of many landowners and farmers, transaction costs
still best explain the contract form.
41
On the other hand, when there are not enough risk-neural/loving farmers, the
marginal contract will be made with a risk-averse farmer, and risk will become a
factor in the contracting terms. In this case, controlling for endogenous matching,
evidence for risk in contact design will show up. It is possible that Ackerberg and
Botticinni’sfinding of evidence for risk aversion in the small villages of fourteenth-
century Italian villages and Allen and Lueck’s(1999) failure to find such evidence in
modern North American agriculture simply reflect the size of each market and the
effect this had on the risk preferences of the marginal contractor.
Beyond the potential for matching over risk preferences, arguments based on risk
aversion remain problematic. Measuring exogenous risk and risk preferences are
notoriously difficult. This often means risk-based arguments are often ad hoc and
hinder the incentive to dig deeper and find incentive-based determinants of contract
choice.
42
Consider the enormous growth of cash renting in North America over the past
quarter century. Huffman and Just (2004) claim this is because landowners became
more risk averse compared to farmers over this period. Allen and Borchers (2016),
using annual cross-sectional, field-level data from the Agricultural and Resource
Management Survey from 1996 to 2011 on nine different crops, show that the rise of
no-till conservation farming is the source of the change.
43
The finding of Allen and
Borchers is consistent with Allen and Lueck (2002) in that cropsharing is used to
mitigate soil exploitation problems caused by tillage and other soil manipulation
practices, and if farmers adopt methods of planting that do not require tillage, then
the cash rent contract dominates because it avoids the costs of sharing. Exploiting
field-level panel data on crop insurance, Allen and Borchers find no evidence that
risk aversion played any role in the switch.
44
41
Many farmers and landowners mean the market is “thick,”and there is a sufficient supply of any
given risk type, such that risk is never a binding constraint on contract choice.
42
Given that (i) landowners are often simultaneously lessors and lessees, (ii) farmers often own their
own land, and both parties simultaneously engage in cash rent and cropshare contracts, risk-based
arguments can stretch credulity.
43
“No-till”farming is the practice of planting seeds directly into the previous year’s stubble and not
tilling or cultivating the soil. It often requires genetically modified seeds and the use of herbicides
but leads to a regenerated soil.
44
Allen and Borchers use several methods to identify the causal relationship between no-till
practices and the adoption of cash rent contracts. The magnitude of their finding is very large and
dominates all other explanatory variables. Furthermore, they have data on the presence of crop
insurance for every crop at the plot level, and therefore can identify when crop risk is eliminated.
27 Agricultural Contracts and Transaction Costs 691

27.6 Conservation and Contract Design
Of all the extensions done with respect to the matter of contract choice, no topic has
received more attention than the role played by the form of agricultural contracts in
soil conservation. This literature can generally be divided into economic research
and environmental science research. Economics research on soil conservation and
contracts includes Dubois (2002), Ray (2005), Lichtenberg (2007), and Fukunaga
and Huffman (2009). This literature is a response to the transaction cost literature’s
innovation of recognizing the exploitation of soil as a contracting problem.
In Dubois’s(2002) model, cropshare contracts lower the incentive to exploit the
land variable, and when the land variable becomes very important, leasing is aban-
doned for owner operation.
45
Lichtenberg (2007) uses a multi-task framework that
allows for landowners to make decisions that might reduce the moral hazard of land
exploitation and notes that choices of rental contracts and conservation practices will
be made simultaneously. This often includes not just the choice of cropshare contracts
but more tenure security. For example, Deaton et al. (2018)find that even with sharing,
farmers with more secure tenure are more likely to engage in conservation practices
around tillage and cover crops.
Huffman and Fukunaga (2008) present the economics of contracts to the envi-
ronmental science literature. It tests both risk aversion and transaction costs factors,
including landlord and land variables, and concludes:
... that under diverse economic conditions crop-share contracts are long-run sustainable
contracts relative to cash leases. Moreover, they create stronger incentives for long-term
sustainability of land quality for agricultural purposes because of the direct involvement of
landlords in production and management decisions. (2008, p. 394)
The environmental science literature has adopted the idea that positive transaction
costs lead to incomplete contracts, both in terms of a farmer’s ability to exploit soil
and other land attributes because of high measurement costs but also because
contracts are necessarily defined over shorter time horizons than ownership. Since
cropshare contracts slow the farmer down in terms of exploiting the assets of the
landowner, this literature argues for long-term cropshare contracts to mitigate con-
servation issues (Kassie et al. 2012; Eder et al. 2021; Zhanga et al. 2018;
Stevens 2022).
The environmental science literature related to contract choice tends to take the
form of the contract as given. As a result, it is full of policy recommendations to
discourage cash renting over cropsharing, impose regulations on contracting parties,
subsidize conservation improvements, force longer-term agreements, and more gen-
erally discourage short-term leasing, and develop methods of measurement of ero-
sion.
46
This literature does not acknowledge that contract form and conservation are
45
This issue of ownership vs. leasing is more generally explored in Chap. 8 of Allen and Lueck
(2002).
46
An irony here is that the agricultural economic policy literature has long discouraged the use of
cropshare contracts because of its supposed inefficient use of labor!.
692 D. W. Allen and D. Lueck

endogenous choices made simultaneously. A cropshare contract is likely chosen in
situations where soil conservation is a problem, and the landowner is unable to prevent
farmer-induced erosion at a reasonable cost. On the other hand, a cash rent contract
may be chosen because the soil erosion problem has been solved or reduced. Calling
for a blanket reduction in cash renting would therefore be wealth reducing.
Allen and Borchers (2016) address the simultaneous choice between conservation
practice in the form of no-till agriculture (which has come to dominate many dryland
crops over the past 30 years) and contract choice. This form of tillage almost
eliminates soil manipulation and therefore provides fewer opportunities for soil
exploitation and damage. The reduced tillage also encourages the regeneration of
the soil and reduces the need for fertilizers. All of these factors reduce the incentives
for cropshare contracts and explain the rise in cash renting across North America.
Farmers and landowners have a joint incentive to mitigate transaction costs, includ-
ing those related to soil and other asset overuse. As a result, contract design and the
distribution of ownership across all assets will reflect this joint wealth maximizing
interest. It is possible that in equilibrium, the actual amount of soil erosion or
conservation practices would be similar across the different forms of ownership.
Indeed, this is what was recently found by Deaton et al. (2018), and a USDA study
(Burnett et al. 2022), which concluded:
... we examined conservation practice adoption and behavior across eight separate survey
years of the USDA’s Agricultural Resource Management survey from 2010 to 2019 ... The
trend analyses across these survey years suggest that renters behave almost identically to
owners with conservation tillage adoption, as demonstrated by similar soil tillage intensity
rating values. (p. 44)
27.7 Conclusion
The transaction cost approach has an empirical focus on real contracts, emphasizing
testable hypotheses and recognizing the complexity of assets in the market and
within the firm. When this approach is brought to bear in the study of agricultural
contracts, it yields robust and empirically supported explanations for the structure of
contracts, in both historical and modern agriculture. The transaction cost approach
abstracts from risk aversion and risk avoidance and, instead, focuses on pure
incentive trade-offs. As we have mentioned, the inclusion of risk sharing adds
analytical complications without adding empirical tractability.
We have argued the transaction cost approach explains the basic facts regarding
agricultural contracts, and this includes several findings. First, when farmers and
landowners contract for land, the contracts are simple in the sense that they are
mostly oral and short term. They tend to be enforced through the market via
reputation and through the common law via its default rules that simplify the
structure of contracts. Second, contract structures are used to police behavior that
is difficult to verify by a third party. This costly to observe behavior is present when
individuals are not full residual claimants, and this behavior is strongly influenced by
27 Agricultural Contracts and Transaction Costs 693

enforcement and measurement costs. For example, the choice between cash rent and
cropshare is a trade-off between soil exploitation and crop underreporting incentives.
Third, and perhaps the most important, the classic trade-off between risk and
incentives does not explain the choice of contracts or organizations in agriculture,
nor elsewhere, as the recent agency literature has shown. Fourth, farming is domi-
nated by family production when the random and systematic effects of nature cannot
be controlled. Nature not only provides an opportunity for moral hazard, but it limits
the possibilities of specialization. Farm production provides many opportunities for
moral hazard, and few for exploiting economies of size. Thus, the dominant labor
contract in agriculture is the residual claim farmer.
Acknowledgment of Funding Open access made possible through a generous donation in honor
of the Ronald Coase Institute
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