Gains from Contracting

Vertical coordination through contracts between farmers and other stages of the agro food chain have been of growing importance in US agriculture. Production contract arrangements between contractors and individual growers have been one of the major vehicles of this emerging system of vertical coordination. Despite the unprecedented success of production contracts as claimed by many through risk reduction and income stabilization, contract growers dissatisfied with existing contract payments complain that contractors are extracting too much of contract benefits while growers gain only small, or even negative, returns from contract production. Hog growers¿ gains from contracting and the distribution of the gains from contracting among contract hog growers are examined here. The main finding is that for the most plausible information structure, that is, when growers have partial but better knowledge of their ability than contractors, some low ability growers with below average productivity receive negative gains from contracting on average. This conclusion holds even when renegotiation-proof long-term contracts are in place for each ability distribution.