Choice of Agricultural Tenancy in the Presence of Transaction Costs

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In recent years, transaction costs have been given a central place in explaining the behavior and structure of firms, the level and degree of hierarchy, intrahousehold relationships, broad sweeps of economic history,' and the nature and incidence of different contracts, including agricultural contracts.2 In the latter context, however, with the exception of Roumasset and Uy (1980, 1984), no formal model of transaction costs has been developed. The purpose of the present paper is to utilize the insights of the authors cited in the preceding footnotes to develop and test with Indian data a model of transaction costs capable of explaining the choice among three major forms of agricultural land contracts-namely, wage, share, and rent contracts. Standard economic theory implicitly assumes that the factors of production are subject to complete control and predictable performance. This assumption holds, however, only when all factors are owned by the same party. In other cases, for example, in agricalture, when land and labor are owned by different parties, control by any one agent is necessarily incomplete, requiring one agent to monitor the performance of the other(s). While monitoring is required under all forms of contract and with respect to all inputs, it tends to be more serious for labor and land. As a result, landowners undertake monitoring expenses and tenants spend time in both searching for future jobs and assuring landowners of adequate compensation should some harm be done to their interests.3 In this paper we follow Jensen and Meckling (1976) in broadening the definition of the relevant total transaction costs (TC) of any contract to include both the loss to the landowner arising from labor-shirking, output underreporting, and land mismanagement on the part of the worker-tenant (net of the latter's gain from these activities) and the expenditures by both the landowner in monitoring the worker-tenant and the worker-tenant in job-search. While institutional rigidities may sometimes arise, apparently allowing inefficient contractual choices to prevail, in general and in the long run, competition with alternative forms of contract should result in a form of contract which minimizes the total (or excess burden of) transaction costs.