Coordination Mechanism for Contract Farming Supply Chain with Government Option Premium Subsidies

In this paper, we propose a new coordination mechanism of contract farming supply chain (hereinafter refer to as “company + farmer + option premium subsidy” or “the new/proposed mechanism”). In the new mechanism, the farmer’s interests are fully guarded by the protection price. Options are adopted by the company to hedge the downside risk and the government provides the company with option premium subsidies aiming to avoid default risk. The superiorities of the proposed mechanism compared with the traditional mechanism are illustrated in the theory and practical application. The results demonstrate that the proposed innovative subsidy mechanism is superior to the traditional and direct subsidy mechanism in regard of enhancing profits and increasing the order quantity, further to reduce the corporate default rate of the company. We also provide suggestions to determine the order quantity for the company and put forward a policy proposal to design the subsidy rate for the government. We advocate that the contract price and the strike price should be decided by the government rather than the company. We deem that the contract price should be the expected primary product price. The coordination of the proposed mechanism is reflected in making the entire supply chain more stable by balancing the interests of both the farmer and the company. By illustrating the predictions of our model under the case of a sudden change in the underlying parameters, we find that the proposed mechanism is robust even when higher volatility happens.