How Does Crop Insurance Enrollment Affect Marketing Contracts Participation: Theory and Empirical Evidences

Agricultural contracts and crop insurance are important ways for farmers to mitigate risks in modern U.S. agriculture. In this paper, we investigate the effect of crop insurance enrollment on farmers’ participation of marketing contracts. Following Ligon (2003), we setup a mechanism design framework to demonstrate an integrator’s contract design problem where farmers are assumed to be expected utility maximizing agents. We use a Babcock (2012) style specification to depict farmers’ optimal choice of insurance coverage and the incentive compatibility and participation constraints for the integrator. Our model shows that, under certain assumptions, a lower crop insurance premium rate could induce higher compensation from integrators. Moreover, crop insurance subsidy allows for higher marketing contract participation. The rationale is that when farmers purchase crop insurance, they rely less on contracts to mitigate risk and become more independent from integrators. Therefore, integrators may revise their contract offers so that the they are more attractive and incentive compatible. This result indicates that the use of one risk management tool may not crowd out the use of the other. For the empirical estimation, we use various data sources and 2SLS to see how crop insurance enrollment affects farmers’ participation in marketing contracts. We use pre-growing season weather variables as IV for insurance enrollment. The second stage result indicates that farms with higher possibility of insurance enrollment will have about 40 percent higher chance of participation in marketing contracts as well. Moreover, we show that the subsidy effect of crop insurance is heterogeneous among different crops.