Abstract
The European Union is increasingly relying on direct payments to support farm incomes. Recent research has shown that a direct payment may increase production and investment by risk-averse farmers via a link between wealth, risk aversion and decision making. This paper shows that, even in the absence of risk aversion, a direct payment may stimulate farm investment. With lenders using a standard insolvency rule for determining bankruptcy, the direct payment raises the expected value of marginal investment because it reduces the risk of bankruptcy over the farmer's operating time horizon. The investment response to the direct payment is larger for a farmer with an intermediate versus low or high level of equity, and for a farmer with a long versus short-time horizon.
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