Risk Sharing, Diversification and Moral Hazard in Roman Palestine: Evidence from Agricultural Contract Law

We investigate the economic rationale for a law pertaining to tenancy in Roman Palestine, found in a Jewish legal text. This law allows for risk-sharing (through rent reduction) between tenant and landlord when the macro-economic situation is severe (makas medina), but not if the particular rental plot has a bad harvest. We consider and critique the possibility that the restriction of risk-sharing to times of makas medina can be explained from a moral hazard perspective. Next, we show that this feature of the rental contract can be well explained as an optimal characteristic of rental contracts in an economy characterized by tenants whose income sources are diversified. We provide empirical evidence supporting this possibility. RISK SHARING, DIVERSIFICATION AND MORAL HAZARD IN ROMAN PALESTINE: EVIDENCE FROM AGRICULTURAL CONTRACT LAW I. Risk Sharing and Moral Hazard Risk is an integral part of most economic environments. The desire to transfer risk is, consequently, an important motivation for many contractual arrangements. However, the efficient transfer of risk is sometimes hindered by the inability of the parties to condition on specific contingencies because they are difficult to observe. These observational difficulties may sometimes lead to moral hazard, i.e. insurance against some risk causes the insured party to take greater risk, or to take less care than is socially optimal in preventing that risk. Such inefficiencies in principal-agent relationships give rise to what are called agency costs. Agency costs in the area of financial economics and the economics of the firm have been intensively studied since the work of Ross (1973) and Jensen and Meckling (1976), and many disparate contracts in this area and in others, have been explained on the basis of these costs.1 At the same time, there may also be risk-sharing aspects to contract features that seem, on the face of it, to exist solely to control moral hazard. For example, Green (1984) presents the convertibility feature of some corporate bonds as a means of reducing 1 For example, the call options in the compensation packages of firm executives help to reduce the tendency of managers to protect their jobs by being overly conservative. Bond covenants, such as restrictions on dividend payments, can help eliminate agency conflicts between bondholders and stockholders. Share cropping can mitigate the tendency of direct tenants to over-work the field (Alston et al., 1984; Basu, 1992). Other areas in which this concept has been applied are procurement contracting (Cox et al., 1996), labor contracting (Lazear, 1979), deposit insurance (Grubel, 1993) and voting theory (Banks and Sundaram, 1993).