Uncertainty and Incentive Effects in Share Contracts

Abstract

Cheung and Sutinen have emphasized the ability of share contracts to disperse risk. However, if both landlords and workers can mix share, fixed rent, and wage contracts, then risk dispersion under share cropping is redundant (Reid 1976). Other works have emphasized the positive incentive effects of share contracts on input decisions where tenant actions are difficult to monitor (Reid 1976, 1977; Stiglitz). The purpose of this paper is to examine the of incentive effects and their role in contractual choice under uncertainty. Two different models are developed. In the first, input decisions must be made at the beginning of the production period before the of nature is known. In the second model, the tenant can choose input levels after the state of is known. It is shown that a share contract will be chosen only if an increase in the tenant's share causes expected output to increase. However, in the first model this incentive effect may be either positive or negative. Thus, in this case the presence of incentive effects does not imply unambiguously that share contracts will be preferred. In the second model, the incentive effect is always positive and leads to a preference for share contracts.