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

Contractual breaches are very common in developing countries such as China. In order to prevent breaches of contract, the contractual designs between farmers and agricultural processors (Dragon Head Firms) in China are innovating in two ways: organizational innovations and contractual innovations. Due to contractual innovations, simple price-quantity contracts are evolving into complex cooperation contracts. Using data for over 500 state key processors in 2003 from the Chinese Ministry of Agriculture, we construct econometric models to study contractual choices, contract intensity, and their impacts on sales and profits for agricultural processors in China.The results indicate that capital and the number of contracted farmers are endogenous to contract choices. Processors are more likely to use cooperation contracts compared with price-quantity contracts as the number of contracted farmers increases, because the costs of coordinating, monitoring and enforcing price-quantity contracts may increase dramatically under these circumstances . On the other hand, contract types are not important for the number of contracted farmers, the intensity of contracts, or sales and profits for processors. The results also 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.