Double Moral Hazard in Contract Farming: An Experimental Analysis

Abstract

Weak enforcement and power imbalances in developing-country contract farming can create opportunities for both farmers and processors to renege on agreements; a situation known as double moral hazard (DMH). Drawing on a principal–agent framework, we use a controlled laboratory experiment to compare DMH, where processors can reduce agreed-upon prices ex post and farmers can side-sell, to single moral hazard (SMH), where only farmers can deviate. Contrary to the standard theoretical prediction of identical outcomes under full rationality, allowing processors to lower prices ex post leads to significantly lower initial price offers, greater side-selling and reduced contract acceptance; ultimately harming farmers' earnings. By contrast, SMH produces higher prices and a Pareto improvement in welfare. These findings highlight how buyer opportunism, exacerbated by weak legal systems and asymmetrical bargaining power, can erode smallholders' livelihoods in practice. We conclude that policies and contract designs aimed at limiting buyer discretion can mitigate double moral hazard and enhance the stability and equity of contract farming arrangements.