The effects of direct payments on liquidity and repayment capacity of beginning farmers

Purpose – US decoupled direct payments, paid to farm operators based on historic yields and base acreage under the 2002 Farm Bill, may alter a farmer's access to credit or his ability to meet debt servicing obligations. More specifically, direct payments might improve the farmer's liquidity position or repayment capacity enabling the farmer to obtain more favorable credit terms. In turn, more favorable credit terms might allow a farm to remain in business or expand production, leading to current production distortions. Since direct payments are based on historic production, beginning farmers tend to receive lower levels of direct payments and hence these payments might impact beginning farmers differently than more experienced farmers. The purpose of this paper is to investigate the effects of direct payments on liquidity and repayment capacity for experienced and beginning farmers. Design/methodology/approach – Given the manner in which direct payments are calculated and administered, it is likely that direct payments affect beginning farmers and more experienced farmers differently; hence the authors analyze the impacts of direct payments on the current and term debt coverage ratios for these two groups separately. In the analysis, the authors control for farm financial characteristics, farm operator characteristics, and other factors. Data from the US Department of Agriculture (USDA) Agricultural Resource Management Survey (ARMS) for the years 2005, 2006, and 2007 were used in the weighted regression analysis and jackknifed standard errors computed. Findings – A positive significant relationship was found between the level of direct payments (in dollars) and the term debt coverage ratio for experienced farmers, suggesting that direct payments improve repayment capacity. However, this relationship is not significant for beginning farmers. Also, a negative significant relationship was found between the number of base acres and the current ratio for experienced farmers, while this relationship lacks significance for beginning farmers. Originality/value – The paper provides evidence that decoupled direct payments impact a farmer's liquidity and repayment capacity. Furthermore, direct payments impact beginning and experienced farmers differently. This paper also contributes to the growing body of research investigating the mechanisms by which decoupled payments have the potential to distort current production.