Balancing Grower Protection against Agency Concerns: An Economic Analysis of Contract Termination Damages

By Lee, Myoungki; Wu, Steven Y. et al. | Journal of Agricultural and Resource Economics, August 2008 | Go to article overview
Save to active project

Balancing Grower Protection against Agency Concerns: An Economic Analysis of Contract Termination Damages

Lee, Myoungki, Wu, Steven Y., Fan, Maoyong, Journal of Agricultural and Resource Economics

This study examines legislation that would grant growers termination damages if their contracts are terminated. Our model suggests that, with no contracting frictions, damages would not reduce ex ante efficiency as processors can contract around damages through contract restructuring. Growers would earn less under continuation but would be protected if terminated, although overall expected profits would be unaffected. However, when contracting frictions exist, then efficiency losses can occur as processors would be constrained in restructuring contractual incentives to deal with moral hazard. Growers' expected profits would increase while processors' profits would decrease.

Key words: contract law, contract regulation, damages, incentives, principal-agent


Many policy makers and farm advocates have alleged that contracts used in agricultural production or procurement are unfairly biased in favor of large food processors at the expense of growers. This debate has created political pressure in some states to enact new laws designed to regulate the contracting process. A model state law titled the Producer Protection Act (PPA) was recently proposed by 16 state attorneys general. The PPA provides a list of regulations designed to protect growers and to provide them with some bargaining power in the event they are involved in contract disputes with large food processors.1 Among these regulations are rules that protect growers from undue termination or nonrenewal of contracts by providing growers with the right to be "... reimbursed for damages incurred due to the termination, cancellation, or failure to renew. Damages shall be based on the value of the remaining useful life of the structures, machinery or equipment involved" (PPA, Section 8).

One rationale for termination damages legislation is that, at the outset of a contract, processors often require farmers to make investments in new production facilities, which can be relationship specific whereby the facilities have little value outside the contract, making it difficult for growers to recapture their investments if they are terminated. For example, specialized broiler and hog housing facilities can have various dimensions of relationship specificity, and sugar beet production may require specialized harvesting equipment, investment in seed beds, etc. [see MacDonald et al. (2004) for an extensive discussion of asset specificity in agriculture] . These investments give contracts a longterm flavor in the sense that it may take several trading rounds (e.g., several seasons, flocks, etc.) before growers can pay off debts incurred from their investments.2 However, many processors do not provide farmers with written guarantees that the contracts will not be terminated before all debts can be paid. For instance, a group of contract farmers in Arkansas were terminated by Tyson when Tyson ended its pork operation in the region (Smith, 2003).3

While many states have proposed or passed contract termination damages legislation, relatively few economic studies of these laws have been undertaken. The purpose of this article is to provide an economic analysis of contract termination damages. Specifically, we seek to develop an understanding of the efficiency and distributional consequences of damages. We emphasize that this study is simply an economic analysis of what would happen if damages legislation were passed. We do not make value judgments about the merits of the law, but instead point out potential consequences of the law using an economic framework.

This article makes a contribution to the small literature on agricultural contract regulation. A paper most closely related to ours is a study by Lewin-Solomons (2000), who also focuses on contract termination. The difference between the two papers is that she examines restrictions on termination whereas we evaluate termination damages. Our conclusions also differ. Lewin-Solomons finds that a reduction in the probability of termination is generally distortionary and creates unintended consequences which can actually harm growers.

The rest of this article is only available to active members of Questia

Sign up now for a free, 1-day trial and receive full access to:

  • Questia's entire collection
  • Automatic bibliography creation
  • More helpful research tools like notes, citations, and highlights
  • Ad-free environment

Already a member? Log in now.

Notes for this article

Add a new note
If you are trying to select text to create highlights or citations, remember that you must now click or tap on the first word, and then click or tap on the last word.
Loading One moment ...
Project items
Cite this article

Cited article

Citations are available only to our active members.
Sign up now to cite pages or passages in MLA, APA and Chicago citation styles.

Cited article

Balancing Grower Protection against Agency Concerns: An Economic Analysis of Contract Termination Damages


Text size Smaller Larger
Search within

Search within this article

Look up

Look up a word

  • Dictionary
  • Thesaurus
Please submit a word or phrase above.
Print this page

Print this page

Why can't I print more than one page at a time?

While we understand printed pages are helpful to our users, this limitation is necessary to help protect our publishers' copyrighted material and prevent its unlawful distribution. We are sorry for any inconvenience.
Full screen

matching results for page

Cited passage

Citations are available only to our active members.
Sign up now to cite pages or passages in MLA, APA and Chicago citation styles.

Cited passage

Welcome to the new Questia Reader

The Questia Reader has been updated to provide you with an even better online reading experience.  It is now 100% Responsive, which means you can read our books and articles on any sized device you wish.  All of your favorite tools like notes, highlights, and citations are still here, but the way you select text has been updated to be easier to use, especially on touchscreen devices.  Here's how:

1. Click or tap the first word you want to select.
2. Click or tap the last word you want to select.

OK, got it!

Thanks for trying Questia!

Please continue trying out our research tools, but please note, full functionality is available only to our active members.

Your work will be lost once you leave this Web page.

For full access in an ad-free environment, sign up now for a FREE, 1-day trial.

Already a member? Log in now.

Are you sure you want to delete this highlight?