Dancing with the Dragon Heads: Enforcement, Innovations and Efficiency of Contracts between Agricultural Processors and Farmers in China

Contractual breaches are very prevalent in developing countries, such as in China. In order to prevent breaches of contracts, the contractual designs between farmers and agricultural processors (Dragon-Heads Firms) in China, innovate in two ways: organizational innovations and contractual innovations. In particular, contractual innovations are that initial simple price-quantity contracts involve into complex cooperation contracts. Using the data for over 500 State Key Processors in 2003 from Chinese Ministry of Agriculture, we construct econometric models to study contract choices, contract intensity, and the impacts on sales and profits for agricultural processors in China. The results indicate that capital and the number of contracted farmers are endogenous in contract choices. Processors are more likely to use cooperation contracts compared with price-quantity contracts as the number of contracted farmers increases, because then the costs of coordinating, monitoring and enforcing price-quantity contracts may increase dramatically in the case of price-quantity contracts. On the other hand, contract types are not important for the number of contracted farmers, the intensity of contracts, sales and profits for processors, because the purposes of different contract types are related with prevention of breaching contracts. By the way, the results indicate that the elasticity of profits with respect to capital is 0.52, which implies that the returns to investing in the food processing industry are relatively high in China.