Effects of federal risk management programs on investment, production, and contract design under uncertainty

Agricultural producers face uncertain agricultural production and marketconditions. Much of the uncertainty faced by agricultural producers cannot be controlledby the producer, but can be managed. Several risk management programs are availablein the U.S. to help manage uncertainties in agricultural production, marketing, andfinance. This study focuses on the farm level economic implications of the federal riskmanagement programs. In particular, the effects of the federal risk managementprograms on investment, production, and contract design are investigated.The dissertation is comprised of three essays. The unifying theme of theseessays is the economic analysis of crop insurance programs. The first essay examinesthe effects of revenue insurance on the entry and exit thresholds of table grape producersusing a real option approach. The results show that revenue insurance decreases theentry and exit thresholds compared with no revenue insurance, thus increasing theinvestment and current farming operation. If the policy goal is to induce more farmersin grape farming, the insurance policy with a high coverage level and high subsidy rateis effective.In the second essay, a mathematical programming model is used to examine theeffects of federal risk management programs on optimal nitrogen fertilizer use and landallocation simultaneously. Current insurance programs and the Marketing LoanProgram increase the optimal fertilizer rate 2% and increase the optimal cotton acreage119-130% in a Texas cotton-sorghum system. Assuming nitrogen is harmful to theenvironment and cotton requires higher nitrogen use, these risk management programscounteract federal environmental programs.The third essay uses a principal-agent model to examine the optimal contractdesign that induces the best effort from the farmer when crop insurance is purchased.With the introduction of crop insurance, the investor’s optimal equity financing contractrequires that the farmer bear more risk in order to have the incentive to work hard, whichis achieved by increasing variable compensation and decreasing fixed compensation.