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Risk Sharing and Incentives with Crop Insurance and External Equity Financing

Author

Listed:
  • Seo, Sangtaek
  • Leatham, David J.
  • Mitchell, Paul D.

Abstract

Farmers have increasingly been procuring external equity financing through either written or verbal business arrangements. Passage of the Agricultural Risk Protection Act in 2000 has resulted in widespread adoption of crop insurance among farmers. Crop insurance changes farmers’ production decisions, so that investors providing external equity may want to adjust the equity financing contract to account for these changes. This paper uses a principal-agent model to determine optimal risk sharing and incentives under crop insurance and external equity financing. Results show that with the introduction of crop insurance, the investor’s optimal equity financing contract requires that the farmer bears more risk in order to have the incentive to work hard.

Suggested Citation

  • Seo, Sangtaek & Leatham, David J. & Mitchell, Paul D., 2003. "Risk Sharing and Incentives with Crop Insurance and External Equity Financing," Proceedings: 2003 Regional Committee NCT-194, October 6-7, 2003; Kansas City, Missouri 132523, Regional Research Committee NC-1014: Agricultural and Rural Finance Markets in Transition.
  • Handle: RePEc:ags:nc2003:132523
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    File URL: http://purl.umn.edu/132523
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    References listed on IDEAS

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    1. Chambers,Robert G. & Quiggin,John, 2000. "Uncertainty, Production, Choice, and Agency," Cambridge Books, Cambridge University Press, number 9780521622448.
    2. Leatham, David J. & McCarl, Bruce A. & Richardson, James W., 1987. "Implications of Crop Insurance for Farmers and Lenders," Journal of Agricultural and Applied Economics, Cambridge University Press, vol. 19(02), pages 113-120, December.
    3. Bruce A. Babcock & David A. Hennessy, 1996. "Input Demand under Yield and Revenue Insurance," American Journal of Agricultural Economics, Agricultural and Applied Economics Association, vol. 78(2), pages 416-427.
    4. Vincent H. Smith & Barry K. Goodwin, 1996. "Crop Insurance, Moral Hazard, and Agricultural Chemical Use," American Journal of Agricultural Economics, Agricultural and Applied Economics Association, vol. 78(2), pages 428-438.
    5. Syed M. Ahsan & Ali A. G. Ali & N. John Kurian, 1982. "Toward a Theory of Agricultural Insurance," American Journal of Agricultural Economics, Agricultural and Applied Economics Association, vol. 64(3), pages 510-529.
    6. Douglas W. Allen & Dean Lueck, 2004. "The Nature of the Farm: Contracts, Risk, and Organization in Agriculture," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262511851, January.
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