Prior progress on this study developed financial projections of independent versus contract hog production and surveyed agricultural lenders about the financing terms for these organizations. The final phase of the study utilized a multi-period, stochastic simulation model to evaluate the financial performance of alternative sizes of independent versus contract production under the projections and financing survey results obtained in the prior phases. Simulation results support the risk-return trade-off from portfolio theory, particularly for the large farm option. In the latter case, large non-contract average farm returns were greater than contract returns, as were risks based on coefficients of variation for profitability, liquidity, solvency, and repayment capacity measures. Detailed results are reported in a Ph.D. dissertation, and in two published articles.

Recent finance studies have considered whether gaps between a firm’s costs of internal and external sources of investment funds, arising from capital market imperfections, influence its investment behavior and funding preferences. This study tests the applicability of the pecking order and partial adjustment theories of financial structure to farm businesses by fitting a set of simultaneous financial equations with farm panel data from Illinois. Model results indicate that Illinois farms adjust to long run financial targets for equity, debt, and leasing, but that additional financing needs follow a pecking order that is stronger for farms with greater asymmetric information problems. An article from the study is being published in the American Journal of Agricultural Economics.

Farmers long standing reliance on leasing of farm land under crop shares is being challenged by greater use of cash leases. Results of farmer surveys indicate that cash leasing gives farmers simpler, more flexible bidding opportunities for expanding their leased acreages, and allows landlords to avoid risk sharing and involvement in production and marketing decisions. A lease pricing model for farm land has been developed that is consistent with traditional leasing principles and allows greater flexibility in determining crop share levels either separately or in combination with fixed cash payments. The share levels are linked to the farm’s soil productivity, the costs of each party’s resource contributions, and their respective cost structures. The resulting menu of lease prices can enhance the equitability of leasing contracts, retain the risk management advantages for farmers of share leasing, expand the range of contract choices, promote mutual incentives for the leasing parties, and heighten the efficiency of leasing markets through greater standardization of leases. Articles from the study have been published in the Journal of the American Society of Farm Managers and Rural Appraisers and the Review of Agricultural Economics. Results have also been presented at several workshops and conference with farmers, agricultural lenders, and professional farm managers.

A credit risk valuation model is developed and empirically implemented to estimate the cost of insuring against credit risks in pools of agricultural mortgage loans. Probabilistic information about loss distributions across a broad set of loan-level and pool-level characteristics is used to assess insurance valuation and solvency likelihood. The effects on the value of credit-risk insurance of pool size, deductibles, timing alterations, premium loadings, adverse loan selection, and changing underwriting standards are also estimated. Results indicate that actuarial insurance costs are initially highly-sensitive, and then become relatively insensitive as pool size increases. An article from this study is being published in the American Journal of Agricultural Economics.

Greater market and financial risk resulting from changes in government programs, globalization of markets, and increased price volatilities are increasing the value of information about farmer’s risk positions, risk attitudes, and risk attitude strategies. These elements may differ considerably among farms with different structural characteristics, including farm size. This study addresses the relationship between economic risk (variability in net income) of farm businesses and farm size, together with other structural characteristics. Preliminary results indicate that variability of net farm income (measured as coefficients of variation) is significantly influenced by several structural and demographic variables, but not by differences in farm size. Whether income variability is high or low, it does not appear to be materially influenced by farm size. Further analysis will allow finalization of the study’s results and publication of a study report.

Using a longitudinal farm-level database from the Illinois FBFM system, relationships between changes in a farm’s equity capital position over time and important determining factors have been analyzed to identify long term strategies and growth characteristics of a sample of Illinois farmers. Results of the econometric analysis indicate that long term business growth, measured by changes in net worth, cannot be adequately explained by the separate individual effects of the financial, business, and demographic factors. Interdependencies and non-linearities associated with individual factors and combinations of factors produce complex relationships to business growth and to strategies employed to enhance business growth. An article from this study is currently under review for publication in a professional journal.

The Basle Committee on Banking Supervision is undertaking significant revisions in capital adequacy standards developed in the Basle Accord of 1988, in response to major changes in the structure, scope, and technology base of financial institutions during the past decade. The new capital framework consists of three pillars: minimum capital requirements, a supervisory review process, and effective use of market discipline. This study is providing a case study describing recent data collection and modeling approaches to develop risk-based capital regulations for Farmer Mac and its provision of secondary market and securitization services for farm real estate loans. Measures and modeling specifications for credit risk, interest rate risk and other sources of risk are emphasized in developing an empirical framework for testing Farmer Mac’s capital adequacy under alternative environmental conditions.

An alternative formulation of the expected utility-based optimal debt model is developed using the principles of the location and scale parameter condition. In this new framework, the behavioral hypothesis of constant absolute risk aversion is replace by a specification accommodating decreasing absolute risk aversion and constant relative risk aversion. This new formulation reflects greater intuitive and empirical support than the assumption of constant absolute risk aversion. Comparative static properties of the new model confirm logically established relationships between optimal debt and such variables as level and variability of asset returns, level of risk aversion, and the cost of borrowing. These properties also establish a positive wealth effect that has broader relevance to classes of decision makers. A manuscript is under preparation for submission to a professional journal.

This study describes and analyzes trends in the levels of non-farm investments of a sample of Illinois farmers. Econometric results indicate the significance of farm size, tenure, value of farm production, age, and net worth position in explaining variations in the levels of non farm investments. In contrast, certain profitability-related measures do not substantially influence changes in non-farm investment patterns. These results are presented in a staff paper published by the Center for Farm and Rural Business Finance.

The consolidation and restructuring of rural financial markets coupled with the fundamental changes occurring in agriculture are significantly affecting the delivery of financial services to agricultural producers and rural communities. There are considerable uncertainties about rural banks’ long-term access to cost effective sources of funds. The performance changes of a small commercial banks resulting from different funding alternatives are evaluated with this study. A multi-stage stochastic programming model is used to evaluate alternative economic and risk scenarios. Results indicate that alternative sources of funds similar to Federal Home Loan Bank funds will enhance a small bank’s ability to manage interest rate risk, but have only minimal impact on a bank’s profitability. Future loan growth is a major determinant of the level of alternative funds needed.

The Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994, allowing for the interstate expansion of both banks and bank holding companies, is the culmination of many decades of liberalization. Ambiguities surrounding the impact that holding company acquisitions have on agricultural lending motivate this study. The first objective of this study is to document the extent that agricultural loans are changing ownership. Merger and acquisition data provided by the Federal Reserve Bank of Chicago are used to make this assessment. The second objective is to answer the question, "What happens to the target banks after they get acquired into a holding company?" This study uses a sample of acquisitions occurring from 1990 to 1993 that have a consistent time series of data reported quarterly from 1976 through 1997. To control for industry and market factors, this study employs a sample of non-acquired banks from the same market and of similar characteristics. ARIMA Intervention Analysis is applied to this time series. The results of this study offers evidence that agricultural credit will not be diminished as small, agricultural lenders disappear. Agricultural lenders are not the primary targets in "empire-building" organizations. When they are acquired, they are acquired by like organizations, in terms of geography and asset size. The loan to deposit ratios at acquired institutions tend to increase and the equity to asset ratios tend to decrease at acquired institutions. This study found minimal evidence showing that target banks are the victims of equity and deposit drain.

In today's agricultural environment, significant steps have been taken to improve production technology. However, this progress has increased the capital requirements of production agriculture and increased the barriers of entry to young farmers. Entry into farming requires a developed strategy and infrastructure of financial support. Information is needed on the value of different types of loan programs and entry strategies for beginning operations.

The general objective of this project is to investigate the financial barriers that hinder the next generation of farmers from entering agriculture. The specific objectives are to: (1) evaluate the financial impacts of the alternative financing programs offered by Illinois Farm Development Authority (IFDA) and Farm Service Agency (FSA) on representative farms; (2) investigate financing programs not currently offered by lending agencies; and (3) evaluate the performance of beginning farm operations on alternative farm entry strategies and asset transfer programs.

The three sets of activities that are being performed are: (1) develop representative farms, alternative financing programs, and entry strategies; (2) adapt existing and create additional firm-level simulation and optimization models to the specific empirical issues of this project; and (3) apply the models to project the performance of the specific financing programs and alternative entry strategies.

An essential activity in financial management is the development of a timely, comprehensive information system that provides a means for the decision maker to measure, evaluate, control, report, and improve the financial performance of the farm business. The accounting practices in agriculture are changing rapidly as farms become more commercialized, relying on borrowed funds and leased capital to finance their operations. Moreover, the increased risk environment for agriculture resulting from Federal Agricultural Improvement and Reform Act, trade liberalization, globalization, and other factors increase the need for decision information for farmers and lenders. Consequently, the demands for tools and methods to assist effective financial and risk management in agriculture have increased.

The objective of this project is to develop an interactive information system that will assist users in evaluating the financial performance of farming operations. A dynamic, internet-based tool will be structured around the Financial Characteristics of Illinois Farms, a highly used annual publication produced by the Center for Farm and Rural Business Finance. The publication includes a detailed set of tables that provides users information to compare operations to farms with similar characteristics in addition to information about the aggregate sector and interrelationships between structural and financial characteristics of farms and their associated performance measures. Furthermore, farm business analysis tools are also developed to assist lenders, consultants and farmers.

Several prominent changes have significant implications for the financing and capitalization of agriculture and rural America. Among these are the shifting policy environment, changing structural organization of the agricultural production sector, and the need for new managerial responses to technical change. Among firms providing financial capital, the responses to technical change affect the quality, pricing and quantity of financial products and services. The interface between the customers and financial institutions has undergone significant evolution as information technologies and customer needs become more sophisticated. These effects raise concerns about the availability and access for the capital intensive agricultural production sector. The objective of this project is to assess the impact of technical change on the competitiveness and efficiency of rural commercial banks.

Electronic payments, on-line credit access, home banking, real-time financial information and smart-cards are technologies some banks will offer to farmers. Output of the project will address the interest and pace of farmers (based on perceptions of lenders) to adopt these technologies and enhance their data information systems and potentially improve overall farm efficiencies. The effects of financial service technology on bank-level efficiency, risk management and customer relationships are also primary outputs of the project. A multi-state survey of lenders will collect primary information on the current use of technology by financial institutions, costs associated with using the technology, the degree of partnering with other institutions to access technologies, and the lender's perceptions on the impacts the technology has on institution-customer relationships. Evaluating the wide variations in the sizes of banks, legal structures, regulations and competitive environments among the states is essential in assessing the effects of technical change on financial products and services across different institutional and environmental characteristics. The survey results will be combined with Call Report and Summary of Deposit data.

Farmland comprises roughly 75% of farmland asset values, yet has a market that is characterized as illiquid and thin, high transactions costs, variable, and difficult to assess. Information about turnover rates and variables influencing the value of farmland is needed by potential investors, farmers, lenders, policy makers, and input suppliers. Data from Illinois Department of Revenue transfer declaration records on all farmland sold in the state since 1979 are being maintained and annually updated in a readily useable database and can be used to estimate turnover rates, and price statistics by country, crop reporting district and Farm Credit Association territories, and FBFM association in Illinois. Summary statistics on turnover and price distributions are available and other non-price characteristics of particular regions are identified. Work is being initiated this year to make the summary results available on the web and to provide the ability to conduct interactive searches for specific items over the web. The output from this project will be useful in many ways including establishing improved land value indices, and in explaining differences in land valuation by region. The results could also support future land use-value assessment practices improving the reliability and specificity of the indexes used to establish farmland values.

Measures of soil productivity are relied on extensively in making input decisions, selecting risk management practices, and even have a role in the assessment of farmland for property tax purposes. The most common methods for establishing these ratings relies on soil potential indexes by soil type that are contained in the heavily relied upon "Circular 1156" which contains estimated yield potential by soil type and management level for the predominant soils found in Illinois. Then, on a given farm, a weighted average of soil-type indexes can be used to establish a relative yield index for that location. In many cases, these indexes serve as proxies for relative economic potential across parcels or locations. However, there are numerous reasons why an "economic productivity index" would differ from a soil productivity index constructed from weighted averages across soil types. First, the soil potentials were established a long time ago as fractions of an assumed maximum yield, and the actual capacities of different soils to produce crops under current technologies may not be accurately captured. Next, the same soils in different locations might experience weather pattern differences. As a result, Drummer soils for example in a southern location may have different productive capacity than in a northerly location. Perhaps more importantly, the prices at which the output of the production enterprise can be sold depend importantly on the basis pattern that exists through the state. Crop rotation or tillage practices may differ by region as well, as might pest pressures or management practices aimed at social compliance, or in preparation for development prospects. As a result, an economic productivity index was constructed that should more closely align with the income producing potential in a given location than direct uses of the historically derived SPRs. To do so, actual NASS county level production records and actual prices received were used to construct annual series of revenue from crops for each county. Within year distributional, and acreage differences were controlled and across year differences in variation were controlled. The results disagree to some extent with the implications of using SPRs only as a measure of income producing potential, and provide evidence of the income producing potential by region including the impacts of price differentials that would be likely to exist through the state. The impact of this work could be to affect the practices for farmland assessments, and could provide an important input into market valuation practices as well. Finally, the results could provide "conditioning" information to apply back to traditional SPRs to help improve their correspondence to actual economic potential.

This study examines the impacts of different financial policies of cooperatives on their future financial performance. The difficulty in identifying an optimal capital structure for cooperatives arises from the potential conflicts between the managers and members over the allocation of cooperatives’ capital and from differences among individual members preferences. A simulation approach permits the impacts of a wide variety of choices to be examined and a reasonable set of initial firm conditions to be considered. The model begins with the Farm Credit System’s Financial Planning Model (FPM) and adds stochastic components to generate interest rate distributions, loan volume (demand relationships), and asset quality. The model provides distributions of capital ratios, profitability, and other performance and condition measures. The results provide a set of relationships between capital allocation and retention decisions and their impact on capital conditions for the cooperative in the future. The results could also help contribute to the unraveling of the puzzle about optimal capital structure for a cooperative in general.

This project contained three related efforts. First, statistical evaluations of competing forecasts are used to identify the informational components from competing forecast services from noise and redundant information. Ratings from PRS are being compared to Institutional Investor ratings, Euromoney, and limited data from FAS. The importance of the approach is that it provides a systematic evaluation of information versus noise, and permits the evaluator to avoid the collection and processing of duplicate, redundant, or irrelevant information. The second effort then measures the incidence of nonperformance relative to dispersions in the components of the ranking. The practical importance of this phase is that it permits the recovery of proxies for the severity distributions on loss in the absence of the direct data. The third phase then uses this estimate in a loan guarantee model that permits the estimation of the government’s exposure under various combinations of program terms and guarantee definitions. Some important results are: (1) it was shown that an "optimal" combination of risk measures could be found for predicting country defaults, and that there are several commercial sources of country risk rating information that provide essentially redundant information. As a result, FAS could select a more targeted (and perhaps more economical) approach for evaluating country risks. (2) A new approach for providing an empirical assessment of the value of specific country guarantees was developed. (3) The procedures were used to assess the current GSM programs and provide improved allocation procedures for maintaining risk efficiency at any given program size. Furthermore, the implicit inefficiency of the current allocations was demonstrated along with economic measures of the cost of the inefficiency (essentially, the difference in the actuarial costs of the existing versus the optimal portfolio of guarantees). The results have important implications for future size and allocation practices in export credit guarantee programs. The results could also be used to identify the size of any implicit subsidy for use in trade negotiations.

Work was completed and presented to the National Council of Real Estate Investment Fiduciaries to identify the optimal holdings of farmland in an all-equity institutional portfolio. Data on actual property managed returns by all members of NCREIF were used along with major Real Estate Investment Trusts (REIT) data and indexes of debt and equity returns from the U.S., East Asia, Latin America, and other competing investment alternatives. Results indicate that in circumstances when real estate is included in the optimal or risk efficient portfolios, then permanent crop and some row crop holdings can be desirable, although at relatively low levels. Interestingly, several of the institutional managers establish restrictions on maximum holding by investment class, and farmland often enters risk efficient portfolios when debt categories are constrained. The results contribute to the understanding of the desirability of holding unlevered farmland as an investment.

This study examines whether decision makers are likely to have accurate understandings of the risks faced by eliciting producer’s beliefs about important weather variables that affect their economic well-being. It was found that producers are systematically miscalibrated in their beliefs in a manner that could be described as pessimistic and unable to accurately assess low probability events. The work also demonstrate the impacts on insurance usage and input usage attributable to miscalibrated expectations rather than to actual risks faced. The work has important implications especially for crop insurance design, and also for the form of information about risky events that would have greatest value to producers.

One of the vexing problems of developing practical crop and revenue insurance products as alternatives to historic government commodity program protection, has been that of depicting the individual exposure unit’s yield and price distributions. This fact, in addition to well-known moral hazard and adverse selection problems, has hindered private market development of practical insurance products. Among the proposed risk management devices are the recently introduced yield futures, group and area denominated insurance contracts, variable coverage levels, lookback or asian pricing options and so on. In addition, several researchers have developed packages to compare alternative insurance and risk management techniques given information about firm level yield and price distributions. However, there have been few attempts to improve the depictions of the single exposure unit distributions that drive the results.

Objectives are to develop methods to adjust aggregate level yield and price information to reflect risks of single exposure unit coverage. These in turn can be used to develop simple actuarial schedules to support the pricing algorithms for various insurance designs instead relying on proxies from NASS data and FCIC data each of which are at levels of aggregation that limit their accuracy.

In an era of rapid consolidation in banking, the effect of mergers on the availability of credit to agricultural businesses is an open question. Commercial bank acquisition has profoundly altered the urban credit marketplace and is positioned to do the same for the agricultural credit marketplace. Adjustment models were estimated with data on independent bank consolidations from 1988 through 1995. The regression results bode well for agricultural lending if acquiring banks have larger concentrations of assets in agriculture than acquired banks. Conversely, if acquiring banks have smaller concentrations than acquired banks, acquisitions have a negative impact on agricultural lending. Since most acquiring banks have smaller agricultural loan concentrations than acquired banks, there is concern for agricultural lending. However, other lenders are likely to fill credit gaps that develop. The results were presented as an invited paper at the Southern Agricultural Economics Association annual meeting and will be published in the Journal of Agricultural and Applied Economics.

The cyclical nature of U.S. beef cattle inventories has given rise to considerable research by economists over the last seventy years. Studies have focused on biological constraints and beef cattle as both capital and consumption goods as driving forces behind cattle cycles. Although recent studies are a distinct improvement over earlier studies, they fail to account for a potentially important variable driving cattle cycles, the financial accelerator. The financial accelerator is the notion that financial market imperfections augment and propagate business cycles due to imperfect financial markets. In this context the financial accelerator propels cattle inventories upwards during periods of a strong cattle economy because lenders are more willing to supply loans and/or will do so at lower costs due to the stronger cash flow and collateral values of cattle firms. Similarly, during periods of a weak cattle economy, cattle firms’ cash flow and collateral values are impaired, causing lenders to reduce the supply of loanable funds and/or increase the cost of borrowing--propelling the inventory of cattle downward. The hypotheses that credit constraints, based on fluctuating asset values and cash flow, prolong and accentuate U.S. cattle cycles and that more diversified cow-calf firms are less affected by this phenomenon are tested. Cattle inventory models estimated with state-level panel data are consistent with earlier credit constraint studies, i.e., breeding cattle inventories are sensitive to shifting credit constraint regimes and cow-calf firms with higher diversification levels are less affected by credit constraints. The manuscript is currently under review with the scientific journal Applied Economics.

Major innovations of the 1996 FAIR Act are production flexibility contract payments and almost complete planting flexibility. Because payments are attached to the land and not production, landlords are thought to capture most of the contract payments. With the use of a November 1997 operator survey of crop land leasing arrangements in the Mississippi Delta of Arkansas, the research investigated changes in cropping mixes on leased land, operator attitudes concerning the operator/landlord sharing of FAIR Act benefits, and changes in leasing arrangement as a result of the FAIR Act. Although a number of operators agree that landlords disproportionately benefit from the FAIR Act, about three-quarters felt that there was no change or had no opinion. Little evidence was found that the arrangement of existing leases changed as a result of the FAIR Act. However, a number of operators reported that leases were either dropped or added as a result of the FAIR Act. Articles presenting the results were published in the University of Arkansas Cooperative Extension Service Farm Management and Marketing Newsletter and a manuscript is under review at the Review of Agricultural Economics.

Leasing and debt are substitutes if it is assumed that a lease payment, which is a fixed obligation like a loan, displaces debt and reduces debt capacity. However, results from previous studies have indicated that leasing and debt are complementary activities. The results from this study strongly support the notion that leasing and debt are substitutes. The degree of substitutability is sensitive to shifting farm business conditions and heterogenous farm characteristics. Recognizing the degree of substitutability is important given changing farm business conditions and the fact that 42 percent of U.S. farm land is leased. The results were presented at the American Agricultural Economics Association annual meeting and a manuscript is under review at the Quarterly Journal of Business and Economics.

Many farmers in Arkansas and other parts of the United States are experiencing financial stress. The purpose of the research was to highlight the situation of Arkansas farmers and to offer an outlook for 1999. The research emphasized the price, income and financial situations of eastern Arkansas crop farmers and considered Federal loan programs and Chapter 12 of the Bankruptcy Code, which affects most farmers. For the major crops produced and marketed by Arkansas farmers—soybeans, rice, and cotton—prices were expected to be substantially lower compared to prices from 1998. Income prospects in 1999 for Arkansas crop farmers were heavily influenced by the bearish price outlook. Capital intensity and export dependency were higher for Arkansas agriculture than for the rest of the United States. This makes Arkansas agriculture more vulnerable to exchange rate, interest rate and price volatility. Also, bankruptcy filings were likely to increase as a result of lower income. The results were published in an Arkansas Agricultural Experiment Station special report and in articles appearing in the University of Arkansas Cooperative Extension Service Farm Management and Marketing Newsletter.

Data containing 388 annual observations on commercial banks in Arkansas were used to estimate models of the willingness of these banks to utilize Farm Service Agency guaranteed operating and farm ownership loans. The data were drawn from 1990-1996. Results indicate that operating loans were more frequently used in row crop intensive areas and with banks more heavily involved with agricultural lending. Riskiness of agricultural income encouraged guaranteed loan use. An additional model was estimated for loss claims activities on operating loans. Levels of existing loans were strongly associated with loss claims as were previous levels of loss claims. Interestingly, degree of bank involvement with agricultural lending (the agricultural loan to total loan ratio) was not significant in predicting loss claims. An Arkansas Experiment Station bulletin was published reporting the study.

Data from 40 states in the U.S. were gathered to identify the determinants of the ratio of loss claims paid to guaranteed loan principal outstanding for FSA guaranteed operating and farm ownership loans. Part of the research effort was to construct a state-level data set from various sources within the Farm Service Agency. This data set now contains annual observations on loan activity, outstanding principal, loss claims levels and interest rate assistance payments by state for fiscal years 1990-1997. Regression models were estimated to identify those determinants of variation in loss claims ratios across states and time. Results indicated the importance of debt characteristics of farmers in predicting rates of loss claims. Debt-to-asset ratios, rates of return on assets and cash available to service debts were important factors as would be expected. States with more revenue from crops were more susceptible to farm ownership loss claims. Interest rates paid by farmers were also important and indicated that higher interest rates were particularly detrimental for farm ownership loans. Work on this project continues. The current results are presented in an M.S. thesis.

Effects of Principal-Agent Relationships in Agricultural Lending on Capital Structure and Investment

The high capital intensity of agricultural, significant use of debt capital by farmers, and the relatively small scale proprietary structure of most farm businesses suggest an inherently strong relationship between the investment and the financing decisions of agricultural firms. Modern finance theory based on agency relationships and asymmetric information between a borrower and a lender offers a rich framework for jointly analyzing the investment/financing relationships. This study developed a joint (two equation), partial equilibrium approach to analyzing investment and capital structure decisions given the unique financial characteristics of the agricultural sector. The investment component is based on the neo-classical q theory, and the capital structure component is based on a modification of the pecking order theory. One portion of the empirical analysis employs agricultural sector data over the 1960-1991 period, while the second portion uses a panel data set of Illinois grain farmers for the 1986-1992 period.

The results of a two equation recursive model of investment and capital structure based on the aggregate data indicated that farm investments were constrained and that debt acts as a double-edged sword. The pecking order relationship held in the second capital structure equation. A similar, two equation recursive model was estimated using the farm level data with results indicating that the investment equation supported the q specification, but was not constrained by farm financial characteristics. The capital structure equation again supported the modified pecking order theory for farmers. Detailed results from this project are contained in a Ph.D. dissertation completed by a staff member of the Center for Farm and Rural Business Finance.

Farm Credit System Insurance Risk Simulation Model

A stochastic simulation model is developed for use by the Farm Credit System Insurance Corporation to facilitate the evaluation of the long-term adequacy of the insurance fund, and to serve as a tool for reevaluating fund adequacy as the risks and capital positions of the FCS banks change. The model explicitly accounts for the effects of credit risks, interest rate risk, and part of liquidity risk through a combination of probability distributions, accounting specifications, and estimated relationships among key variables effecting FCS bank performance. Applications of the model are illustrated under alternative risk conditions. An article from this project is published in the 1996 Agricultural Finance Review.

Financial Structure and Efficiency of Grain Farms

The goal of this study is to empirically analyze the relationships between farm level efficiency and financial structure using the agency cost, free cash flow, and credit evaluation concepts of finance theory. The empirical analysis measures the technical efficiency of a panel of Illinois grain farmers and tests the relationships between the efficiency measures and a set of efficiency determinants including financial structure, farm size, tenure position, soil productivity, risk, and age of operator. The empirical results provide evidence of a position linkage between the technical efficiency of farm businesses and their financial structure where the linkages reflect the motivation provided by Jensen's free cash flow concept and perhaps the credit evaluation concept as well. That is, farmers with greater financial leverage put forth more productive efforts to meet their debt obligations, although lenders may also be certifying greater credit worthiness associated with more efficient production. Results from this study are reported in a Ph.D. dissertation completed by a staff member of the Center for Farm and Rural Business Finance, and in an article submitted for publication to the Journal of Agricultural and Resource Economics.

Changing Time Attitudes in Intertemporal Analysis

Intertemporal analysis is extended by generalizing the time weight of an investor's utility function to account for changes in time attitudes. The resulting measures of decreasing, constant, and increasing time attitudes are comparable to the Arrow-Pratt measures of risk attitudes. The measures help to enrich intertemporal theory, provide meaningful hypotheses for testing, and broaden the scope for decision analysis over time. Effects of the time attitude measures are illustrated in a model of an agricultural firm. An article from this project is published in the 1996 American Journal of Agricultural Economics.

Farmer's Preferences for Crop Contracts: A Principal-Agent Analysis

The objectives of this project are to utilize an agency and transactions cost approach to delineate the elements of new contract choices in crop production, and to test the approach based on responses by a panel of grain farmers to simulated decision situations in which preferences are experimentally ordered across contract choices that differ in terms of asset specificity, uncertainty, and risk and cost sharing arrangements with contractors. The empirical results support the hypotheses about the anticipated relationships between contract choice, pricing behavior, financing arrangements, asset specificity and uncertainty. The results also confirm the need to jointly consider transaction attributes and personal and business characteristics to explain vertical coordination decisions. These results will be instructive in understanding farmers' greater use of contract production in the crop sector following the new, market-oriented production environment for U.S. farmers signaled by the 1996 Farm Bill.

Vertical Coordination in Hog Production: Risk and Financing Implications

Rapid changes in U.S. hog production reflect the growing use of production contracts, alliances, vertical integration, and other coordination mechanisms among input suppliers, lenders, farmers, and processors. Risk, financing, and size economies are considered major causal factors. This project is analyzing how risks and the terms of financial capital affect the performance of independent, coordinated, and networked hog systems. Specific objectives are to 1) measure the risk and returns positions of alternative vertical and horizontal coordination mechanisms in hog production, 2) determine the availability, cost and other terms of financial capital for the respective hog production systems, based on lender surveys, and 3) project and compare financial performance for the alternative hog systems based on credit responses to the lenders' surveys.

The Effects of Credit Policy on U.S. Agriculture

Farm financial policy includes operating the consolidated Farm Services Agency (including the former Farmers Home Administration) and sponsoring or backing the various institutions that form the Farm Credit System, including Farmer Mac. These public and government sponsored enterprises serve targeted purposes, but also represent contingent cost liabilities to the federal government. This study evaluated farm financial policy with an emphasis on public credit programs and their effects on the farm sector. Included in the assessments were evaluation of the parallels between structural change in agriculture and structural changes in the institutions providing financial capital for agriculture. The results of this study were published in the bookThe Effect of Credit Policy on U.S. Agriculture by the American Enterprise Institute Press.

Commercial Bank Access to Agency Market Funds Through Government Sponsored Enterprises

Recent policy proposals are intended to expand the access of rural banks to agency market funds through government sponsored enterprises, including the Farm Credit System, a re- engineered Federal Home Loan Bank System, and Farmer Mac. Possible motivations for expanded access include reduction in funding costs, enhanced liquidity management, and more effective management of interest rate risks. Analyses using bank call report data indicate that reductions in funding costs would be minimal for short-term sources of funds, and that effective liquidity management alternatives currently exist. However, expanded access to agency market funds could benefit rural banks' management of interest rate risk through greater flexibility in maturity structures for agency market funds. The project's findings are contained in reports published by the Farm Credit Council and in selected presentations to professional meetings.

Competitive Challenges for Bankers in Financing Agriculture

Increased competition in credit markets and structural changes in agriculturr suggest a need to identify and evaluate lenders' perceptions of future competitiveness, factors important for maintaining customer loyalty, and the role of new products and services in building customer relationships. This study was based on the results of a survey of agricultural bankers in the Mid- West regarding these strategic issues. Key findings involve the importance of various factors for establishing and maintaining customer loyalty, and of various potential products and services toward maintaining a competitive agricultural lending position in future. Specifically, the borrower's relationship with his or her loan officer is considered the factor of highest importance for customer loyalty. Long-term service from the same loan officer is considered the most important service for maintaining competitiveness. The results provided a consistent indication of the importance of maintaining good, long-term relationships with borrowers, over a variety of bank sizes, structures, and locations. The results are useful to agricultural lenders in strategic planning toward enhancing market share in an increasingly competitive industry. The study's results have been published in a research report and in an article in the Journal of Agricultural Lending.

Property Tax Reform

This project evaluates proposals to reduce the Illinois property tax and to replace the lost revenue with an increase in income taxes. The findings show that all farms have a nonzero probability of paying higher taxes under this tax reform proposal. Farms that rent most of the land they operate face about a 50% chance of paying higher overall taxes, while owner operators face a very small probability of paying higher taxes. These results should help farm organizations better understand the consequences of the proposed changes in taxing procedures. Results are being reported in a departmental publication.

Financing Integrated/Contract Production

The changing structure of agriculture toward integrated/contract production and away from independent production has altered the risks faced by agricultural lenders. Two journal articles were published on the topic and four programs were conducted with agricultural lenders. Findings suggest that financial standards and norms applied to traditional independent producers are of limited value in evaluating the financial performance of integrated/contract producers. Likewise, nonfinancial risks tend to be more important for integrated/contract producers.

Expansion in the Hog Industry

This project surveyed expanding hog producers to determine the extent and severity of problems faced during and after expansion. Results have been published in the popular press and as a Center staff paper. Results show that expanding hog producers face the most problems from lower than expected hog prices and building delays, while concerns of neighbors and environmental regulations create few problems.

Investment Options in High Income Periods

Working with the Illinois Corn Growers Association and Prairie Farmer magazine, a series of three articles has been developed to help farmers think about ways to invest their money during high income periods. The first article has appeared in the magazine, and subsequent articles are written and awaiting publication.

Farming Knowledge For Success

As a part of Federal legislation, borrowers from the (former) Farmers Home Administration must be certified as capable in financial planning, or alternatively take instructions on the topic. A home study course on financial management has been developed and is being offered through the Extension Service. Enrollment has been modest, but participants are generally quite pleased with the program.

Farm Business Planning

Working with AgriBank and extension personnel from throughout the Midwest, the purpose of this project is to develop materials for use by facilitators in training farmers to do business planning. Four of five modules have been drafted and several videos have been produced. The materials should be available during 1997 for use by extension personnel and lenders in helping farmers complete business plans for their operations.

Option Valuation

A study of the implications of the distributional assumptions employed in option pricing was conducted. In general, option pricing models relate the current value of a contingent claim to the future probability function of some underlying asset. Although the Black Scholes models have many known biases and shortcomings, its assumption of lognormality remains the primary departure point for most option pricing models. This study examines the implications of that assumption by comparing the resulting pricing errors under various other possible distributions governing future prices. It is found that the lognormal assumption implicit in Black-Scholes type models is frequently improved upon by moving to a distribution with more flexibility in higher moments. In particular, Burr distributions are found to perform better than lognormal in describing future price distributions for soybean futures and Japanese Yen futures. The work also provides a general explanation for the phenomena of volatility smiles often noted in option pricing work as a result of the constraints among moments of the assumed lognormal distribution. The work suggests further, that rather than working to refine descriptions of diffusion processes, greater gains in option pricing accuracy may be obtained through direct modeling of the end-of- period probability measures.

A New View of the Lender-Borrower Relationship

Work is ongoing that examines the lender's position as a contingent equity claimant, and utilizes an option pricing framework to develop conditions for "optimal" financial contracting. The first part of the work depicts the different incentives that arise from two parties' claims on a single productive asset with an agreed sharing of the realized returns. Within this framework, principal- agent costs are depicted as the difference between the maximums that either party could generate and the outcome under the financial contract. The second part of the work looks at how the terms of an ideal financial contract depend on the conditions of the asset returns distribution and on the parties' objectives. The work provides mechanisms for analytically describing principal agent costs in a specific situation and provides additional insights into behavior in financial contracting under uncertainty.

Stochastic Simulation Analysis of Farm Credit System Income Allocations

This study examines the impacts of different financial policies of cooperatives on their future financial performance. The difficulty in identifying an optimal capital structure for cooperatives arises from the potential conflicts between the managers and members over the allocation of cooperatives' capital and from differences among individual members' preferences. A simulation approach permits the impacts of a wide variety of choices to be examined and a reasonable set of initial firm conditions to be considered. The model begins with the Farm Credit System's Financial Planning Model (FPM) and adds stochastic components to generate interest rate distributions, loan volume (demand relationships), asset quality, and so on. The model will be able to provide distributions of capital ratios, profitability, and other performance and condition measures. These outputs will be useful to policy makers, and give Farm Credit institutions information on the implications of alternative management strategies.

Examination of Export Credit Loan Guarantees

As part of a National Research Initiative project, the use, design, and competitive implications of Export Credit Guarantee programs are being investigated. Historic data have been collected relating to activity levels and subsequent repayment experience. Additionally, descriptive data on the activities, motivations, and political circumstances of the programs have been assembled. Several of the persons involved with the administration of the programs have been interviewed. Country risk ratings and alternative methodologies for calibrating the loss experience and the historic country ratings and allocations are being developed. In particular, Institutional Investor, TEID Ratings, and Moody's country risk ratings are being used in models of individual country risks. Finally, concepts central to the valuation of the guarantees have been encoded in a model to examine the exposure to the government from these programs and to evaluate the impacts of changes in program parameters on the contingent risk of default to the government.

Kellogg Foundation Learning Plan

Work on a Kellogg Foundation Learning plan entitled, "The Interaction between the Public and Private Sectors" continues. The activities involve shadowing experiences of leaders in public policy debates, development of seminars in locations with diverse political institutions, and self directed readings in welfare analysis and theories of public choice.

Examination of Interlinked Credit Transactions and the Impact of Credit Markets on Economic Development

In developing markets, it is often observed that credit is provided in conjunction with other economic relationships. Possible theoretical explanations for this phenomenon include economics of information arguments, contract incentive alignment and control, and so on. This project examines the incidence of interlinked credit transactions in developing agrarian economies and the impact of these credit arrangements on the economic growth of an economy. Following a pilot survey, more extensive data were collected in Peru from both formal and informal suppliers of credit with interlinked (other production contracts) relationships. An analytical model describing the provision of insurance and the tradeoffs among reputation and financial performance has been developed.

Examination of Farmer Mac Pool Risks

In light of changes to Farmer Mac authorities and its capital standards, additional models have been developed to examine the risks in Farmer Mac loan pools. In particular, guarantee rates associated with pools having varying underwriting characteristics and varying effective subordinated positions can be computed, and numerous choices about "seed" data can be implemented. The model has been utilized by Farmer Mac to examine various cases for potential and actual loan pools since its authorities have changed.

The Impact of Banking Structure on Rural Financial Markets

The consolidation and restructuring of the financial services industry is changing the delivery of credit to rural borrowers. A major concern is that continued consolidation may lead to a decline in rural banks and ultimately a reduction in the availability of credit to farmers, small businesses and local communities. The first objective of this problem paper is to provide anoverview of the competitive landscape of rural financial markets. The extent that rural banks are involved in funding agriculture in different regions of the country is presented. Trends in the asset shares of rural banks among different regions of the country are also investigated. The second objective is to measure the extent that rural banks have been involved in consolidation. The characteristics of the participants and the transitions in ownership location and structure of rural banks are identified. Call report, summary of deposit and merger and acquisition data are used to measure the extent that bank mergers have involved rural banks. Results were presented at the NC-207 annual meeting (1995) and the ASSA winter meetings (1996) and were published in the August 1996 issue of the American Journal of Agricultural Economics.

Firm-Level Evaluation of Beginning Farmer Loan Programs

The number of new farmers has declined substantially in recent years. Increased capital requirements and reduced profit margins have restricted borrowing and repayment capabilities of farmers. The federal government and many states have programs that target loan funds to beginning farmers. The impact these programs have on the financial viability of beginning farmers is needed. The objective of this study is to evaluate the effects of beginning farmer loan programs on the financial performance of representative beginning farms. An existing Monte-Carlo simulation model is modified to evaluate the financial performance and growth opportunities of beginning farmers under alternative financing arrangements. Data for the development of the case farm situations has been collected from Illinois Farm Development Authority, Illinois Farm Business Farm Management Association, and University of Arkansas. Output will be published in research reports and a journal article.

Implementing Intelligent Credit Evaluation Models

The increased competitiveness in the agricultural credit markets has caused lenders to seek methods to become more efficient in delivering credit. However, the changes occurring in production agriculture have resulted in changing credit demands and borrower characteristics. Current credit evaluation procedures may not apply to specific borrowers since lenders may not have a historical record of borrower performance under these changing conditions. Lenders need to implement credit evaluation methods that can improve efficiency, but permit the flexibility to adapt to changing borrower and economic conditions. The objective of this study is to develop and compare credit evaluation models for use in a lending institution. Neural networks and statistical models will be developed and compared to demonstrate the usefulness of formalized credit evaluation procedures. Neural networks have been successful in loan classification when historical data are limited and noisy. Initial data has been collected from AgriBank, FCB. Initial screening and descriptive statistics have been performed with the data. Output expected includes a lender model, research reports, and journal publications.

Methodological Improvements in Commercial Bank Inefficiency Measurement

Rural financial markets are undergoing a period of rapid transition. Changes in the agricultural economy, technological advances, the competitive structure in the financial services industry and changing borrower demands have combined to impact the delivery of credit to agriculture. A fundamental concern among rural borrowers and depositors is the impact the changes have on the cost and availability of credit and bank services. The ability of commercial banks to continue to deliver agricultural debt efficiently in the future will play a large role in determining the efficiency of U.S. agricultural production. Results from current research suggest that additional empirical work needs to be performed in order to improve the robustness of the results. Weaknesses of existing stochastic models include the selection of appropriate functional form and other distributional properties imposed on data. Weaknesses of existing Data Envelopment Analysis (DEA) models include the inability of the models to incorporate stochastic noise into the model. The approach selected for this project permits stochastic noise to be introduced to current DEA methods through resampling techniques. Resampling techniques, bootstrapping and jackknifing, will be used with Call Report data to measure inefficiency levels of rural banks. The results of the model will be compared to deterministic DEA and stochastic, parametric approaches. Computer programming on the resampling procedure has been completed. Commercial bank data from 1991 to 1995 have been compiled from Sheshunoff Data services. Results will be published in research reports and journal articles.

Farmland Prices, Cash Rents, and Mortgage Rates

The long-run relationships among Arkansas farmland prices, rents and interest rates were examined. The results show the existence of long-run relationships among farmland prices, cash rents and mortgage interest rates. Cash rents were found to have a much larger impact on farmland prices than do mortgage interest rates. Policies targeted at increasing returns to farmland are likely to result in greater farmland price increases than policies targeted at decreasing mortgage rates. The research results have been published in a bulletin and presented as a selected paper at the American Agricultural Economics Association annual meeting.

Financial Risk Implications of Reduced Target Prices for Rice Farmers

The financial performance of a representative rice-soybean farm in Arkansas was evaluated under 1995 target prices and under reduced target rices for rice. The direct effect of reduced target prices on farm financial performance and the indirect effect of reduced target prices on farmland values were considered. Financial statements and ratios were estimated by a simulation model to reflect farmers' financial positions over a ten year period. Financial performance measures indicated that the representative farm under the reduced target price program had more financial risk than under the 1995 target price program. However, the effect of reduced target prices on farmland values was less than anticipated. The results were presented and published in the proceedings of the annual meeting of a regional project on risk.

Weighing Regulatory Costs in Rural Lending

This research assessed the impact of a changing regulatory environment on rural agricultural banks relative to other agricultural lenders. Despite a shifting regulatory landscape, the research concluded that rural banks are likely to remain keen competitors in the agricultural credit market. The results were presented at the American Agricultural Economics Associa tion/Allied Social Science Associations meeting as a principal paper and published in the American Journal of Agricultural Economics.

The Financial Condition of Arkansas Farmers

A survey on the financial condition of Arkansas farmers was conducted in March 1996. The last survey of this detail was done in March 1986. Other states have farm record systems that provide this financial information for analysis purposes. However, this source of information is not available in Arkansas. The current survey will provide valuable financial information to farmers, farm related businesses and the Cooperative Extension Service.

Federal Legislation and Agricultural Credit

This research highlighted the important agricultural finance issues and discussed the financial institutions serving rural America so that legislators and others would have a better understanding of the agricultural credit environment and the potential impact of future credit legislation. The research was presented to legislators and congressional staffers and published in a special report.

Statistical Analysis of Chapter 12 Filing Data

National data from the Administrative Office of the U.S. Courts on Chapter 12 case filings from Chapter 12's inception in November 1986 through December 1994 were obtained. Analysis showed that the number of filings peaked in 1987 and filings have been fairly constant from 1989 through 1994. The data indicate that farmers are still using other bankruptcy chapters, most notably Chapter 7, to file bankruptcy. This is not surprising since Chapter 12 was not intended to meet all the needs of financially stressed farmers. The data also indicate that the proportion of farmers who will successfully emerge from Chapter 12 is probably declining over time. This may indicate a learning effect on the part of borrowers and lenders. There is some evidence to indicate that the institution of Chapter 12 probably changed the negotiating terms between borrowers and lenders and thus farms more likely to be successful in Chapter 12 have been able to use its existence as a framework for negotiation outside of formal Chapter 12 proceedings. Filing and termination data are also analyzed on a regional basis using the ten USDA farm production regions as the basis for the region disaggregation. These results were published in Agricultural Finance Review.

Rural Bank Consolidation Activity

The extent of rural bank consolidation activity was examined and the volume of agricultural loans involved in the mergers or acquisitions was measured. Results indicated that only a small percentage of rural agricultural debt had been transferred due to merger and acquisition activity but that the issue warrants increased and continual research. Results were presented at a regional research project meeting and the American Agricultural Economics Association/Allied Social Science Association meeting. A principal paper is forthcoming in the American Journal of Agricultural Economics.

Measuring and Determining Bank Efficiency

This research examined rural and agricultural bank efficiency methodological issues associated with the choice of a model functional form and determined bank relative efficiency. Results indicated that smaller, rural agricultural banks are generally less efficient in terms of costs and profits than larger, more urban banks. Results were presented at meetings of the Southern Agricultural Economics Association and are forthcoming in the Journal of Financial Services Research.

Profitability of Multiple-Site Contract Hog Production

The profitability and financial feasibility of multiple-site contract hog production were examined and compared to two alternative forms of contract hog production -- farrow-to-finish and two-site production. The results indicated that growth efficiency benefits of multiple-site production result in superior financial performance of multiple-site hog production contract farms. Results were presented at meetings of the Southern Agricultural Economics Association and in review by a professional journal.

The Farm Inventory-Cash Flow Relation, Heterogenous Characteristics, and the Boom- Bust Cycle

The sensitivity of farm inventory investment to shifts in cash flow is tested. Farm inventories should be sensitive to shifts in cash flow because inventory disinvestment is readily reversible and inventories are a significant portion of assets. With the use of panel data (417 farms from 1973-92) results indicate that: 1) farms absorb internal finance shocks by adjusting inventories; 2) the inventory investment of small, livestock, and high debt farms are more sensitive to fluctuations in cash flow than large, crop, and low debt farms; and 3) inventory investment is more sensitive to cash flow during the 1981-86 bust and 1987-92 recovery periods than the 1975- 80 boom period. A manuscript is currently under review in a refereed journal.

The Sensitivity of Farm Investment to Fluctuations in Cash Flow

The study determines if farm investors face finance constraints using a 1976-1992 panel data. Tests are based on q investment equations in which cash flow is added as an additional explanatory variable in the spirit of Fazzari, Hubbard, and Peterson (1988). Both cash flow and q enter significantly. High cash flow coefficients are found on small farms, high debt farms, and younger operators. The magnitude of cash flow coefficients was positively related to cash flow levels, being highest in the 1976-1980 boom period and lowest in the 1981-1986 bust period. Similarly, the magnitude of q coefficients is related to the availability of total investment funds.

Credit Evaluation Procedures

Two projects focusing on improvements in credit evaluation procedures by agricultural lenders were completed during FY '94. One of the projects utilized a joint experience and statistical approach to the formulation of credit scoring models. The results indicate a high degree of conformity between the two approaches in variable selection and classification accuracy. Applications of the models indicate the appropriateness of using separate models for term credit and operating credit, and for selected structural characteristics of agricultural businesses. Project results are being utilized in the formulation of credit evaluation methods by farm credit institutions in the AgriBank district of the Farm Credit System. An article on this project was published in the Agricultural Finance Review.

The second project evaluated and documented the feasibility of using a combination of actual and simulated farm level financial data to formulate credit scoring models. Results confirm the cost effectiveness of this source of credit data relative to the traditional approach of resorting to historic loan level data. The results also indicated classification accuracy similar to models estimated using traditional data sources and statistical procedures. This study comprised a Ph.D. dissertation and an article is under publication consideration in a professional journal.

Debt Capacity of Geographically Dispersed Farms

A combination of farmer surveys and portfolio analysis was conducted to consider the effects of geographic dispersion of farm businesses on costs, returns, and risk bearing capacity. Portfolio analysis results are consistent with the survey responses of farmers that acreage expansion through leasing or land purchase by crop farmers is motivated primarily by income generation goals. Modest gains in risk reduction through lower overall variability of crop yields is more than offset by costs of transporting machinery, monitoring crop conditions, and responding to timeliness problems in field operations and harvesting. Significant gains in risk reduction only appear possible for very large scale farms that are scattered over wide geographic areas and operated as separate units, with common ownership. Articles from this project were published in the Review of Agricultural Economics and the Journal of the American Society of Farm Managers and Rural Appraisers.

Reverse Mortgages and Farm Estate Management

Reverse mortgages combined with the use of life insurance are a way to utilize farmers' equity capital in farm real estate to enhance cash flows in retirement and achieve more cost effective, equitable distributions of assets among farm and non-farm heirs in death-related transfers of farm estates. This project employed simulation procedures for different sizes of representative farm situations in Illinois to evaluate the effects of reverse mortgages on transferable wealth under various transfer scenarios. The combination of reverse mortgages, second-to-die life insurance, and gifts to heirs were found to compare favorably, and in some cases were superior, to traditional methods of farm estate transfers, especially in providing liquidity for consolidation of farm ownership by on-farm heirs from off-farm heirs. An article from this project was published in the Journal of the American Society of Farm Managers and Rural Appraisers and received that journal's Outstanding Journal Article award.

Financing Strategies for Small Farms and Rural Development

Credit rationing among limited resource farms is being evaluated using information economics concepts under adverse selection and asymmetric information between lenders and borrowers. The credit rationing hypothesis will be tested using empirical data on alternative demographic classes of limited resource farms. Strategies for aligning incentives and information between these borrowers and lenders will be evaluated to resolve the rationing problems, including improved signaling methods by rationed borrowers.

Analysis of Agricultural Lender Market Shares

Changes in commercial bank market shares of farm debt were decomposed into portfolio decisions, loanable funds availability and loan market size for 64 counties in Arkan sas from 1986 through 1990. County characteristics were related to changes in commercial bank market shares. Results indicated that county differences in economic activity, the relative risk associated with agriculture, farm structure and regional location contributed to changes in commercial bank market shares. The results implied a market niche for rural commercial banks emphasizing agricultural loans in the presence of unlimited branch banking. An Agricultural Experiment Station Bulletin and articles in Arkansas Farm Research and Journal of Agricultural and Applied Economics were published and a master's thesis was completed.

Effects of Principal-Agent Relationships in Agricultural Lending on Capital Structure and Investment

Evaluating farm capital structure under asymmetric information is necessary to understand and improve investment and capital structure decisions in agriculture. The terms upon which financial capital is provided, reflecting differences in information and incentives between borrower and lender, may significantly influence resource allocations, enterprise choices, investments, and rates of firm growth. Simulation and statistical procedures are being applied to secondary, farm level and aggregate capital structure data to identify the effects of financing terms or capital structure and investment decisions for agricultural producers with different structural and demographic characteristics.

Evaluating Vertical Coordination and Financing Arrangements in Agriculture

Rapid growth of contractual arrangements in agriculture have raised significant concerns about optimal governance structures under different combinations of risk, asset specificity, transaction characteristics and financing arrangements, and other incentive specifications for the contracting parties. An analytical model incorporating cost uncertainty and asset specificity is being built to derive and evaluate alternative payment and risk sharing schemes. Hypotheses about preferences for these schemes will be tested using responses from a panel of agricultural producers in an experimental setting based on different scenarios and combinations of key decision variables.

Related work is focusing on the financing comparisons between independent and contract production in the swine industry, and a comparison of the traditional risks of production and the additional risks associated with vertical coordination in agriculture.

Factors Causing Price of Loan Variation Among Banks

A survey of 34 commercial banks in western Arkansas was conducted to analyze responses to four hypothetical loan requests. Data were gathered on the interest rates lenders would charge if they were willing to make a loan. Even with state usury limits, interest rate variability was observed. Interest rates were explained by measures of competitiveness and bank characteristics. The results were published in the professional journal, Agricultural Finance Review.

Economic Motivations for Vendor Finance

A theoretical framework was developed to better understand the behavior and motivations for vendor-finance in agriculture. Two articles were published relating first to an empirical discussion of these programs and second to theoretical explanation of their behavior. These activities represent one component of a project examining vendor finance operations and their impacts on the supply and demand for financial capital by agricultural producers.

The Chapter 12 Experience in Arkansas

The case histories of 192 Arkansas farmers who have filed for Chapter 12 protection at the federal bankruptcy Trustee's Office in the first five and one-half years of Chapter 12's existence were gathered. Data were obtained about the financial conditions of the borrowers before going into bankruptcy, and the arrangements made under the bankruptcy plan. Of the 283 cases filed in the first five and one-half years of the plan, only 19 had successfully completed the plan. Further analysis showed that the proportion of secured debt owed to various types of lenders was important in indicating whether a case was confirmed. Additionally, the models showed that as time has passed since 1986, the probability of confirmation has declined. Results of this study have been published in the Arkansas Law Notes. In another project, the responses of bankers to Chapter 12 and lender liability were analyzed in an experiment involving 34 western Arkansas banks. The results were published in the Journal of Agricultural and Applied Economics.

Strategic Issues for Illinois Agriculture, Agribusiness and the Rural Economy

This project was designed to identify the major factors creating change and the strategic implications of these changes for various segments of production agriculture, agribusiness, and the rural economy. A publication with 17 chapters reflecting the input of 22 authors was completed and distributed widely.

Farm Level Effects of Young Farmer Lending and Programs

A spread sheet-based computer model was developed to project the financial progress of representative farms eligible for the Farmers Home Administration beginning farmer program. These farms included a poultry/cow-calf farm and a rice/soybean farm. A master's thesis was completed. The results indicate that the beginning farmer program is effective in meeting its goals for the broiler/cow-calf farm, yet the program may be unnecessary since many lenders are willing to undertake the risk in providing funds with only the assistance of FmHA's guaranteed loan program. The results for the representative rice/soybean farm indicate that the assistance from the beginning farmer program is insufficient to sustain a viable farm operation.

Institutional Investment in Farmland

This project focused on issues associated with institutional investment in farmland. The work on this project was completed as a part of an M.S. thesis. A journal article describing the results of the thesis work is under review.

Explaining Farmland Price Dynamics

The long-run relationships among Arkansas farmland prices, rents and interest rates were examined. A statistical model was applied to Arkansas farmland prices for the period 1921 through 1992. The results show the existence of long-run relationships among farmland prices, cash rents and mortgage interest rates. Cash rent was found to have a much larger impact on farmland price than does mortgage interest rate. A summary of the results was presented as a selected paper at the American Agricultural Economics Association meeting in August 1994 and was published in Arkansas Farm Research.

Farm Asset Returns

An article was published examining the return characteristics of agricultural assets disaggregated into various categories. The results indicate that the returns to the majority of agricultural asset classes were at least as high as needed to compensate for their systematic risks.

The time series properties of returns to farmland were examined within the framework of Cointegration analysis. Notable findings are that perceived homogeneity in agricultural type or location is not closely related to the time series properties exhibited in returns. Further, the process of aggregation of individual returns measures often impacts the resulting inferences about the levels and variability in returns from aggregated data with different stationarity properties.

Effects of Government Program Payments on Farm Portfolio Diversification

An article is in review that examines the effect of Government program payments on farm enterprise diversification. The model employed demonstrates that the substitution effect over time toward supported crops more than offsets reductions in production that may occur as a condition for participation in the support program.

Financing Rural Businesses in Arkansas

An extension publication was prepared that surveyed nontraditional business financing programs across the nation by various states. The publication brings together in one source a description of the salient points of various programs being implemented throughout the U.S. This survey should be of particular use to state agencies in trying to further aid the expansion of rural businesses in Arkansas as well as other states.

Monte Carlo Examination of Frontier Function Estimation

Random outputs were generated under varying assumptions about the sources of producer inefficiency. Frontier production functions were estimated under a number of varying assumptions. The results were presented in a paper at the Southern Association of Agricultural Scientists annual meeting. Of the factors considered, results indicate that the most important factor in determining the accuracy of estimating individual firm inefficiency is the relative size of inefficiency error to the random noise. This analysis was extended to consider if it is better to use a primal (production function) or dual (cost function) models. The choice appears to be a function of the producer's behavior in determining input levels. Preliminary results were presented in a selected paper at the American Agricultural Economics Association annual meeting.

Informational Content of Option Prices

An empirical study is examining the implicit information in option prices. Thus far, it has been shown that the options markets, with prices explicitly reflecting both levels and variability, can often provide better forecasts of future prices than by using the asset prices directly. Additional work is underway to assess the reliability and calibration of probability measures from the options markets.

Stress Study of Agricultural Real Estate Loans

This project was conducted on behalf of the Office of Secondary Market Oversight of the Farm Credit Administration, McLean, Virginia. The goal was to create a data base that will be used in formulating the credit risk component of a stressed-based capital test for the Federal Agricultural Mortgage Corporation (Farmer Mac). The Agricultural Credit Act of 1987 stipulated that such a test was to be based on the highest incidences of historic loan losses experienced in a contiguous area containing at least five percent of the U.S. population for real estate loans that would meet Farmer Mac underwriting standards and pool diversification requirements. A thorough study of data availability yielded loan origination, servicing, and loss data for farm real estate borrowers from the Farm Credit Bank of Texas and the Federal Land Bank of St. Paul for the time period including most of the 1970s and 1980s. The highest two year period of loan losses occurred in 1984-85 in Texas and 1983-84 in the St. Paul District, based on loan cohorts defined by year of origination. Analysis of the credit factors associated with loan losses indicated that the debt-to-asset ratio, the loan-to-asset ratio, and a debt servicing ratio tended to be associated with high incidences of loan loss. Output from the study included research reports for the Farm Credit Administration and an article in the Agricultural Finance Review.

Identification of Financial Risks to the Farm Credit System Insurance Corporation and Level of Fund Adequacy

This project was conducted by Center personnel on behalf of the Farm Credit System Insurance Corporation (FCSIC). The goals of the project were to identify and evaluate the major sources of risk facing the FCSIC and to build a model that would allow the FCSIC to determine the adequacy of the secure base amount of their insurance fund in light of the severity of the various sources of risk. As identified in the Risk Profile, the major sources of risk facing the FCSIC are credit risk, interest rate risk, liquidity risk, authorization risk, consolidation risk, concentration risk, and international risk. Credit risk and interest rate risk were judged the most important; most of the other sources of risk serve as modifiers or magnifiers of credit risk. In turn, credit risk and interest rate risk were the major features of the model development.

The modeling approach is based on a combination of simulation and statistical procedures. The simulation component uses a multi-bank portfolio framework to portray a bank accounting and financial performance framework in which loan losses and interest rates are described by probability distributions. The simulation model repeatedly selects values from these distributions and works through the accounting and management structure of the bank to generate an aggregate probability distribution of claims on the Insurance Fund. Statistical regression methods will be employed to relate measures of loan loss to key external variables in a bank's environment in order to relate the characteristics of the loss distribution to alternative phases of cyclical performance in agriculture.

Farmland Income and Appreciation Index

The National Council of Real Estate Investment Fiduciaries commissioned Center personnel to conduct an academic review of the newly composed index of farmland income and appreciation. The index is essential for institutions investing in farmland, so that they have a historical return index to help in making their portfolio decisions. The final presentation was given on September 21, 1994, and the written report and executive summary are still in progress.

Farm Capital Structure and Financial Efficiency

Returns to farm equity of Illinois grain farmers are analyzed using a statistically estimated stochastic mean-variance frontier. The statistical mean-variance approach is used to construct an efficient frontier that allows for random conditions which cannot be controlled by the individual farmers.

Credit Evaluation Procedures

A survey of midwestern agricultural banks was conducted to identify their credit evaluation procedures, risk assessment methods and credit model consistency. Nearly 60% of the banks responding to the survey indicated use of a formal evaluation system, with the proportion increasing with bank size. However, the relatively high disparity among the systems now in place suggests informational deficiencies in this aspect of rural credit markets. Also noticed is the need for further interchange among lenders, borrowers, and analysts about credit scoring models and their properties.

Other credit evaluation activities included 1) using recommendations of the farm financial standards task force and a team of agricultural loan personnel to formulate a credit scoring model for lenders use in reviewing the quality of their agricultural loan portfolios, 2) documenting the feasibility of using a combination of actual and simulated farm-level financial data to formulate credit scoring models with classification accuracy similar to models estimated using traditional statistical procedures, 3) initiating a study of the characteristics of banks using risk-adjusted interest rates and other methods of credit risk management, and 4) reporting selected financial ratios and performance measures for farms classified according to farm type, size, tenure position, and age of operator.

Financial Characteristics of Borrowers Utilizing Guaranteed Loans from the Illinois Farm Development Authority (IFDA)

Borrower-level data on a sample of borrowers from the guaranteed loan program of IFDA were collected and are being analyzed using multiple regression procedures in order to identify financial factors associated with different degrees of change in borrower net worth and leverage positions. The results will indicate important differences in borrower attributes affecting loan performance and will suggest additional data for IFDA to collect and evaluate at loan origination time.

Debt Capacity of Geographically Dispersed Farms

A conceptual portfolio model was developed to portray the risk-cost-and-return effects of geographic dispersion of cash grain farms in Illinois. ASCS data were used to classify farms according to farm size and number of tracts contained in the farm operation. Crop yield data were collected from geographically dispersed units of farms owned by the University of Illinois and a large land trust in Illinois, with regression results indicating significant differences in crop yield correlations for distance among tracts of 40 miles or more. A survey of farms is being conducted to identify the extent of geographic dispersion of farm units and related effects on costs and timeliness of operations.

Seller Financing of Farm Real Estate

Farmers purchasing land utilizing seller financing were identified through court house searches, lender surveys and other sources. These farmers were surveyed by mail questionnaire regarding the financial characteristics, motivations and effects of seller financing. Seller financing was found to offer lower interest rates, lower downpayments, and shorter maturities than financing from commercial lenders. Credit availability from the seller was a major motivational factor to buyers. Capital budgeting analyses indicated that buyers could offer higher bid prices for land under seller financing versus other real estate financing sources. Simulation analyses indicated more rapid net worth growth and higher financial leverage were associated with use of seller financing. Thus, farmers who utilize seller financing experience a significant risk-return trade-off -- otherwise stated, faster financial growth comes at the cost of greater financial risk.

Financial Contracting, Information and Vertical Coordination by Agricultural Firms

Extensive literature reviews were conducted to consider the concurrent evolution of the vertical organization of agricultural firms and recent firm-level theoretical relationships for evaluating these changes, including the relationships to financial structure. Greater pressure for farm level product differentiation, attributed to both consumer demand and processor supply forces, are motivating greater degrees of vertical coordination in agricultural production. The emerging contractual relationships are treated by the new Economies of Organization which is based on elements drawn for principal-agent theory, transactions cost economics, incomplete contracting asymmetric information, and financial contracting. Linkages between vertical coordination and financial structure are tied to differences in incentives and information between borrowers and lenders that affect the cost, availability and other terms of using debt capital. The stability associated with large term contracts and vertical integration may be applied to lenders, especially when financing highly specific, low liquidity assets. However, uncertainties about contractors and possible hold-up problems may occur as well, especially when credit is provided by one of the contracting parties. An important result is that the identification of farm firms now is based on the boundaries of the firm, as defined by contractual and asset control relationships in contrast to the more traditional measures of size and enterprise mix. Transactions costs, monitoring systems, compensation schemes, and safeguards against risk and opportunistic behavior are important determinants of the differences in boundaries of agricultural production firms.

Impacts of Change in Bank Holding Company Affiliation on Rural Credit

Portfolio effects of holding company affiliations were evaluated using intervention analysis and time series procedures applied to call report data for rural and metropolitan banks with different structural characteristics. Pre- and post-affiliation effects were measured relative to differences of the study banks from peer group averages. Results indicated significant increases in loan-deposit ratios resulting from affiliation--suggesting greater availability of loan funds. However, most other important indicators of bank characteristics and performance did not differ significantly between the banks' independent versus affiliate status.

Factors Causing Price of Loan Variation Among Banks

Results from a sample of 34 banks in western Arkansas is being used to evaluate interrelationships between interest rate adjustments on loans, credit availability, and selected characteristics of banks and banking markets. Survey data are being used to estimate a two equation system. One equation determines if a loan is approved and the other specifies the interest rate offered. Data were gathered by presenting four case loans to the loan officers. For the shorter term loan borrower credit worthiness was important in setting the loan rate. For the intermediate term loan credit worthiness was important in determining loan approval instead of setting the loan rate. For both loans, interest rates offered were positively correlated with the bank's loan to deposit ratio.

Agribusiness in Illinois: Impediments to Growth and Expansion

A survey of nearly 500 food processing and distribution firms operating within Illinois has been completed. The results of this survey have been tabulated and a draft copy of a report is nearing completion. A staff paper describing results should be published soon. A second survey of roughly 400 farm input supply firms operating within Illinois has also been mailed. Results of this survey are now being tabulated. Results were published in Agribusiness: An International Journal.

Portfolio Diversification Through Farmland Investments

An article titled "Institutional Portfolios: Diversification Through Farmland Investments" has been accepted for publication in the winter issue of the Journal of the American Real Estate and Urban Economics Association. The article demonstrates the benefits of including farmland in portfolios which are currently dominated by stocks and bonds. Another article titled "Institutional Investment Diversification: Foreign Stocks vs. U.S. Farmland" has also been published in the Proceedings of the NC-161 Regional Research Committee meetings.

Farmer Decision Process When Selecting Lenders

The objective of this project was to better understand the credit decision making process by farmers regarding short term credit. A mail and telephone survey of a sample of 90+ large cash grain farmers in east central Illinois was conducted. Assessing factors that were important in selecting a lender, the farmer respondents stressed interest rate, loan officer knowledge, loan officer personality/integrity and forbearance. While interest rate was noted as important, many farmers noted a satisfactory lender relationship even though their current provider did not have the absolute lowest interest rate available.

Commercial Bank Agricultural Loan Market Share

Data were gathered on commercial banks, other agricultural lenders and county characteristics to test a two-level model of commercial bank agricultural loan market share. The first level results of the model found that commercial bank market share is increasing in agricultural loan-to-deposit ratio and bank deposits and decreasing in total agricultural loan market size. The second level results of the model found percentage changes in agricultural loan-to-deposit ratio, bank deposits and total agricultural loan market size to be a function of nonfarm income, nonfarm income risk relative to farm income risk, land values and region. Policies that affect these factors will have an impact on the distribution of agricultural loans among lenders.

Farm Capital Structure Decisions

A popular capital structure model for farm firms was tested using farm-level data. The results indicate that policies that increase farmers' profits do not increase financial risk through capital structure adjustments. However, policies that decrease farmers' business risk may in fact increase financial risk through capital structure adjustments.

Estimating Farmers' Expected Rates of Return

A structural approach to estimating farmers' expected rates of return on assets is compared to a time-series approach. The results of the analysis using farm-level data indicate that the structural approach is a more efficient way to estimate farmers' expected rates of return. Therefore, it is a more effective approach to evaluating farmers' risk and return tradeoffs.

Impacts of Chapter 12 Bankruptcy Provisions on Agricultural Lending

Thirty-four banks in western Arkansas were asked to respond to four case loan requests. The survey was designed to elicit how the existence of Chapter 12, the threat of lender liability, and usury laws affected lender loan responses. The principal findings of this study are that Chapter 12 and lender liability appear to have had modest, if any, impact on the availability of agricultural loans, at least of those investigated in the study. Lenders did believe that the existence of Chapter 12 would increase the likelihood of borrowers filing for bankruptcy. From the responses to the four loan scenarios presented, such access was not a deterrent to loan approval. An article, "Impacts of Chapter 12 on Bankers' Propensity to Lend in Western Arkansas" will be published in the July 1993 issue of the Journal of Agricultural and Applied Economics.

The Cointegration Properties of U.S. Farmland

The time-series behavior of farmland prices from selected states was examined. Notable findings are that lack of cointegration cannot imply market inefficiencies given the process used to compute returns. Conventional bivariate cointegration restrictions are also violated. The findings were presented at two meetings of professional ag-economists. Further work is in progress to examine the impacts of aggregating data with differing time series representations on the estimation of capitalization relationships.

Nonland Farm Asset Returns

The performance of various categories of farm assets based upon various (ad hoc) rules for allocating returns among classes of asset has been examined. Findings are that many policy debates founded on the premise of low returns are potentially misguided. The specification of the "factor model" is also sensitive, and an approach is proposed that performs slightly better than two-factor CAPM models from the literature. Given the somewhat arbitrary nature of allocating aggregate returns to asset classes, two different procedures were undertaken. Both gave qualitatively similar results.

Modeling Stochastic Interest Rates in Financial Institution Budgeting

Financial institutions prepare budgets based on fixed levels of projected interest rates. Most asset/liability management systems evaluate impacts of hypothetical 100 basis point shifts in the yield curve on net interest income. A bank budgeting model was developed to simulate the variability in net interest income caused by unpredictable movements in the level and term structure of interest rates. The Lotus 1-2-3-based probabilistic simulation model also included uncertain levels of problem loans and loan losses. The probability distributions on net interest income are much more informative than traditional gap analysis reports, as the probability of achieving net interest income below any target level can be readily identified. Expanding the model beyond net interest income does not appear to be useful as a planning tool. More research is needed in the specification of how demand for loans and supply of deposits change with interest rates and in adapting the model to simulate changes in market valuation of asset and liability portfolios in response to probabilistic changes in interest rates.

Debt Service Reserve Fund

Repayment flexibility for highly-leveraged farm borrowers often is accomplished through loan workouts, carryovers, and rescheduling of repayment obligations. In addition, debt service reserve funds sometimes are established to serve as buffer funds in response to repayment risks and as a transition account for making loan payments on their due dates. This study explored the specifications of a debt reserve fund that would be jointly equitable to both borrower and lender. A theoretical model is developed and illustrated for finding the lender and borrower optional debt service reserve fund for a two period loan. The empirical applicability of these models also was assessed.

Return to The Center's Home Page

Maintained by: Heather Dall Weber