Impact of Third-Party Enforcement of Contracts in Agricultural Markets–A Field Experiment in Vietnam

Asymmetry of information is a fundamental problem in agricultural markets. Production contracts remain incomplete if product quality attributes measured by the buying company remain unobservable for the selling farmer. Opportunistic buyers would report lower than actual output quality, negatively affecting farmers’ compensation given it is directly linked to quality. When farmers factor in the buyer’s opportunistic behavior, underinvestment may occur, negatively affecting farm productivity. Using the example of the Vietnamese dairy industry, a field experiment is conducted in which randomly selected dairy farmers are entitled to independently verify milk testing results. Farm-level output data are complemented with household information from two rounds of comprehensive surveys conducted before and at the end of the intervention. We find a 10 percent higher use of inputs for treatment farmers, also resulting in significantly higher dairy output; welfare levels increase for a specific subgroup of farmers. As the buying company had not underreported output quality despite the existing information asymmetry, third-party enforcement enabled the company to credibly signal its fair type to farmers, leading to a Pareto improvement in the supply chain. While producers benefit directly from higher farm productivity, buying companies are better off due to lower per-unit transaction costs when procuring the farm output.