Agency Problem and Hedging in Agri-Food Chains: Model and Application

The last 4 decades have seen the transformation of food supply chains from being supply driven to becoming much more closely integrated with consumer demand. With this development, the transaction mechanism in food marketing channels has changed from an open-market mechanism to coordination through the use of contract-supply arrangements between farmers and food processors and retailers. In this article, we assess the interaction of marketing channel members through the use of contracts and its impact on incentives, coordination costs, risk aversion, risk allocation, and risk management strategies. For this purpose we specify a 3-stage principal-agent supply chain model involving producers, wholesalers, retailers, and a futures market. We compare the situation with and without a futures market. The empirical results regarding the Dutch ware potato marketing channel during 1971 to 2003 reveal that as a result of increases in incentives to producers and wholesalers, the coordination costs of the marketing channel decreased significantly, both with and without futures trade. The coordination costs of the marketing channel in the case with a futures market appear to be lower than without futures, demonstrating the informational (i.e., price discovery) role of futures markets.