Risk Sharing and Costs of Vertical Alignment
The research on supply chain risk/reward sharing in agriculture has often been focused on producer impacts. As noted, producers are often seeking avoidance of risk in these arrangements. However, governance structures such as contracting that lead to risk avoidance also result in lower returns on average. Governance structures that reduce risks for producers can lead to misalignment of incentives resulting in shirking behavior (moral hazard) if not monitored carefully. For example, producers on fixed payment contracts may be more inclined to deliver lighter weight hogs to the slaughter facility than the processor desires. In addition, governance structures that reduce risks for producers can attract producers that are relatively more risk averse (adverse selection). This risk averse nature often manifests itself in less aggressive adoption of new technologies and business practices - behaviors that do not enable a value chain to reap full benefits of efficiency and productivity improvements over time. Thus, channel partners that absorb more risk in their agreement with producers generally expect and receive higher returns to compensate for the higher risk and/or risk mitigation costs.