Designing incentive mechanism in contract farming considering reciprocity preference

Abstract

Contract farming is a growing practice in agricultural economy. A well-designed crop-planting and buyout contract, offered by an enterprise, to a fraction of contract farmers brings benefit to farmers as well as to the enterprise itself. However, in the process of contract fulfillment, farmers possess private information about the degree of effort on fulfilling the contract of themselves. Thus, the more informed farmers may not work hard in the process of planting crops. This opportunistic behavior of farmers caused by asymmetric information has seriously affected the sustainability of contract farming. An enterprise with reciprocity preference tends to make a contract both improves farmers’ welfare and brings enough profit to sustain its own operations, while a farmer with reciprocity will work hard in return for the enterprise’s reward. In this paper, we develop a non-profit index principal-agent model between enterprises and farmers, assuming both have reciprocity preference, to investigate how to design an incentive mechanism in contract farming. We begin our analysis by establishing a non-profit index evaluation system to evaluate farmers’ effort degree in contract fulfillment. Then we solve principal-agent problem with the assumption that farmers’ expected certainty income premium (ECIP) is constant. We find that in the perfect Bayesian equilibrium, farmers with higher degree of reciprocity preference require less ECIP, and will improve efforts to complete contract tasks, even actively sacrifice their own interests to repay extra rewards from enterprises. Furthermore, we explore our model to the scenario in which farmers’ ECIP is a function of enterprise payment difference (EPD). We find that the higher the degree of reciprocity preference of farmers, the greater the probability of enterprises to increase income. Numerical simulations are conducted to verify the validity of the conclusions. Our study shows that the reciprocity preference behavior of enterprises and farmers improves the fulfillment rate of contract farming, which contributes to the realization of the incentive mechanism of contract farming.