Cross-Commodity Perspective on Contracting: Evidenc e from Mississippi
transactions cost.
The above model also has bearing on the impact of asset specificity on the contracting
decision. By the envelope theorem:
¼m = -Ca (Xm;km; ®) ; and
¼α = -Ca (Xi;ki; ®)
The first order conditions from profit maximization from above suggests that Xi > Xm
and ki > km . Given the assumption that production cost between i and m are equal, then
¼ia > ¼am . Therefore, as asset specificity has a greater cost-reducing impact, contracting
will be preferred to spot sales. Viewed from another direction, asset specificity can lead to
“hold-up” problems and appropriation of rents. To avoid this rent appropriation, producers
are more likely to contract as asset specifity increases. Thus, this model also suggests that
examining asset specificity is also important.
2.2 Risk and Risk Shifting
Much emphasis has been placed on the role of risk in contracting and vertical integration
(Allen and Lueck, 1995). Risk matters in economic organization from an expected utility
framework as has been shown by Stiglitz. Attention has been paid to the risk shifting
properties of contracts (Sheldon) and at least some researchers hypothesize that risk affects
contracting decisions in agriculture (Hobbs; Kleibenstein and Lawrence).
Risk averse pro ducers are assumed to be willing to forgo some level of income, called