Endogenous Matching and Contractual Choice between Agricultural Processors and Farmers in China

Contracts are widely used by agricultural processors for purchasing inputs not only in developed countries but also in developing countries such as China. The total number of formal, written contracts between farmers and food processors is increasing rapidly in China, and the formal contracts that exist are becoming more complex. Contractual design in China is evolving from simple price-quantity contracts toward more complicated arrangements known as cooperation contracts or joint-stock cooperation contracts, designed to share risk and mitigate opportunistic behaviors by the contracting parties. Due to small farm sizes, the contracted amount in the typical contract in China is very small compared with Western countries, and each processor usually has a large number of contracted farmers. This paper uses data from a 2003 survey of food processing firms by the Chinese Ministry of Agriculture to analyze the determinants of contractual choices between these firms and farmers and the number of farmers that each firm contracts with. An important issue identified in the literature in analyzing the determinants of contractual choices is endogenous matching between parties to a contract and the effects of this endogenous matching on contract choice. We find strong evidence to support endogenous matching. In particular, our results indicate that firms which contract with a larger number of farms are more likely to use cooperation contracts than relational contracts.