Customs and Incentives in Contracts

This paper examines customary practices in the context of an incentive model. In particular it examines discreteness in agricultural contracts, and focuses on the distinction between simple cropshare fractions and continuous payments in cash rent contracts. We suggest that the pattern of customary shares is best explained as a response to moral hazard problems spread over large numbers of inputs. A contracting model explains the pattern of shares, the difference in flexibility with cash rent contracts, and the lower bound on shares. Empirical analysis using micro data on over 3,000 contracts are used to test implications of the model. A wide range of support is found for a model based on moral hazard and measurement costs.

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