It can not be obtained a explicitly closed-form solution for the values of x and e
from the previous equations. Thus, a numerical simulation exercise will be carried out
as a solution to this model.
The Incentive Contract
We develop here a generalized moral hazard model for analyzing a general linear
contract for sharing an uncertain outcome between a processor and a grower. We
assume that in absence of transaction costs5 each processor offers each grower an
individual contract and that the growers choose their efforts levels no cooperatively.
We do not consider the optimal allocation of land ownership between the growers who
work with land directly, and their intermediaries who process and sell the growers´
output in some downstream market because it does not affect the total joint certainty
equivalent.
According to Holmstrom & Milgrom (1987), when contracting is repeated many
times and the agent has discretion in actions, the optimal contract offered to each agent
is linear, consisting of (i) a fixed rent, α, which is independent of the observed outcome,
and (ii) a share, β, of the observed outcome. Hence, risk-sharing is combined with the
incentive effect in this contract. A lower output share exposes the grower to less risk
while a higher share gives him greater incentives to supply his effort adequately.
We do not consider the optimal allocation of land ownership between the grower
who works with land directly and his intermediary who processes and sells the growers´
output in some downstream market because it does not affect the total join certainty
equivalent.
Within this multi-period framework, reputation plays a significant role in
contractual enforcement. As growers and processors consider long-term relationships,