The Theoretical Effects of Farm Policies on Optimal Leverage and the Probability of Equity Losses

Featherstone, Allen M.; Moss, Charles B.; Baker, Timothy G.; Preckel, Paul V.

doi:10.2307/1241495

Cited by 60 publications

(48 citation statements)

References 10 publications

Supporting

Mentioning

Contrasting

Order By: Relevance

“…This is not an uncommon results, and similar results can be found in the models of Collins (1985) and Featherstone, Moss, Preckel and Baker (1988). Essentially the result states that as underlying commodity price risks rise, there will be a decrease in debt in order to keep the change in total risk constant.…”

Section: IVsupporting

confidence: 75%

“…On the one hand it is well known that there are agency costs associated with business risks, particularly in the pricing and access to credit and credit markets. In agriculture Collins (1985) and Featherstone, Moss, Preckel and Baker (1988) have argued that total risk is the sum of business risk plus financial risk, and financial risk is defend as the incremental increase in the variability of the return on equity due to increased debt use. From this emerges the risk-balancing hypothesis that in order to maintain constancy in total risk any increase in leverage will need to be offset by a decrease in business (operating) risk.…”

Section: IImentioning

confidence: 99%

See 1 more Smart Citation

Managing food industry business and financial risks with commodity‐linked credit instruments

Turvey

2006

Agribusiness

View full text Add to dashboard Cite

This paper reviews the use and structure of commodity-linked credit instruments. It is argued that in the absence of contingent markets food firms face increasing financial risk reduced investment, and limited access to debt markets. One strategy is to issue commodity-linked credit whose payment structure is linked to the price of an underlying commodity. In some cases, a commodity-linked bond (CLB) can be structured to provide an incentive to investors by sharing in profit gains. If the goal is to hedge financial risks, CLB's can also be constructed that reduce the loan principle or coupons depending on price movements. I.Introduction One of the most important managerial roles facing the agriculture and food industry is the management of business risks arises from commodity price fluctuations. The prevalence of these risks affects not only capital structure decisions on the optimal balance between debt and equity but also the timing of commitments for capital investment. Unmanaged, business risks give rise to higher costs of capital and volatile share prices. To mitigate risks a number of financial instruments such as forward contracts, futures, swaps, and options have been developed and most companies have established risk management strategies. For example farmers, grain marketers and other sellers of commodities can hedge there risk by taking short positions in futures markets or purchasing put options, while buyers of commodities can hedge risk by taking long positions in futures contracts or buying call options.The purpose of this paper is to examine a different class of structured financial products, collectively referred to as Commodity-Linked Credit Instruments, that links the payoff from a derivative such as a forward contract, futures contract, or option to the repayment covenants of a loan or bond. In section II we discuss the relationship between financing, hedging, and investment, Section III introduces the structure of a commoditylinked bond and discusses how they can be used to balance business and financial risk for the food industry. Section IV develops a general framework to support the main contentions, from a finance point of view, of sections II and III. Section V provides an overview of CLB pricing issues including convenience yield, interest rate risk, convenience yields and bankruptcy risk. Section V concludes with a general model framework based upon the work of Harrison and Kreps (1979). Section VI delves into structure issues in more depth. While the models of section V provide a framework for understanding CLBs in general, in practice firms that have issued commodity-linked bonds have used a variety of different structures. Therefore, section VI builds on the review in Attah Mensa (1992) by reconstructing the payoff or boundary conditions to a number of actual CLB products. The paper concludes in section VI.I

show abstract

Section: IVsupporting

confidence: 75%

Section: IImentioning

confidence: 99%

Managing food industry business and financial risks with commodity‐linked credit instruments

Turvey

2006

Agribusiness

View full text Add to dashboard Cite

show abstract

“…Specifically, the optimal debt to assets ratio is inversely related to BR as long as the interest rate of debt does not exceed the rate of return on assets from operations and capital gains—that is

\frac{\partial δ^{*}}{\partial σ_{ROA}^{2}} = - \frac{α}{E [italicROA] - i} < 0

which is consistent with the trade‐off derived by Gabriel and Baker ()—a decline in BR would produce an increase in desired FR, everything else held constant, for a risk‐averse expected utility maximizer. Collins () and Featherstone et al () also show formally that agricultural policies that increase income, as well as reducing risk, would induce an increase in the debt to asset ratio, which, in turn, increases FR.…”

Section: Conceptual Frameworkmentioning

confidence: 98%

“…The sources of total risk facing a business are universally equated to the sum of BR (operating) and FR (e.g., Collins ; Robison and Barry ; Featherstone et al ; Harwood et al ). BR is defined as the inherent variability in the operating performance of the firm, independent of the way the firm chooses to finance its operations.…”

Section: Conceptual Frameworkmentioning

confidence: 99%

Farm Support Payments and Risk Balancing: Implications for Financial Riskiness of Canadian Farms

Uzea

Poon

Sparling

et al. 2014

Canadian J Agri Economics

View full text Add to dashboard Cite

Risk balancing refers to the balancing of business risk (BR) and financial risk (FR) by firms through their investment and borrowing decisions. Assuming the concept holds, a decrease in income variability (BR) prompts the firm to incur greater debt levels thereby increasing FR. Reducing (BR), which continues to be the central objective of Canadian agricultural policy through programs such as Canadian Agricultural Income Stabilization Program (CAIS)/AgriStability, may lead farmers to take on more FR than they would take otherwise, which, in turn, increases the risk of equity loss. However, it is not known whether Canadian business risk management (BRM) programs offset BR as intended, and whether any potential reduction leads to increased FR (risk balancing) and possibly higher levels of overall risk for individual farm operations. This paper represents the first attempt to shed light on whether Canadian BRM programs fail to reduce farm risk as a result of farmers' risk balancing behavior using a longitudinal farm-level data set from Ontario. Results are mixed: (1) BRM payments reduce BR for beef farms but not for field crops farms (though the latter result may be due to the lack of data on Crop Insurance payments); (2) risk balancing holds particularly for the larger farms, and (3) BRM programs overall have no significant effect on the likelihood of increased debt use for either sector, on average; however, participation in CAIS/AgriStability increases the probability that farms take on more debt than they would take otherwise for both sectors. Further analysis is needed to determine whether BRM programs increase the probability of default for farms. L'équilibre des risques fait référenceà l'équilibre des risques de l'entreprise et des risques financiers que visent les entreprises dans leurs décisions d'investissement et d'emprunt.À supposer que le concept soit valable, une diminution de la variabilité du revenu (risque de l'entreprise) inciterait l'entreprisè a hausser son niveau d'endettement, ce qui ferait augmenter le risque financier. La diminution des risques de l'entreprise, qui constitue le principal objectif de la politique agricole canadienne et de divers programmes, tels que le Programme canadien de stabilisation du revenu agricole (PCSRA) et * Senior authorship is shared by the first two authors. 595 596 CANADIAN JOURNAL OF AGRICULTURAL ECONOMICSle programme Agri-stabilité, pourrait amener les agriculteursà courir davantage de risques financiers ce qui, par conséquent, augmenterait le risque de perte de capitaux propres. Toutefois, on ne sait pas si les programmes canadiens de gestion des risques de l'entreprise (GRE) contrebalancent ou non comme prévu les risques de l'entreprise ni si une diminution potentielle des risques de l'entreprise entraîne ou non une hausse du risque financier (équilibre des risques) et possiblement une hausse des niveaux de risques dans le cas des exploitations agricoles individuelles. Le présent article se veut une première tentative visantà déterminer,à l'aide d'un ensembl...

show abstract

“…Crop insurance subsidized at the federal level, and especially utilized by major field crop producers that tend to be larger than other farms, is one risk management tool that has gained in popularity in recent years. However, research has shown that due to risk-balancing tendencies on the part of a farmer, policies that decrease the variability of farm income could induce farmers to increase their risks elsewhere, such as through increased financial risk (Featherstone et al, 1988). For example, increased financial leverage could provide incentives to increased concentration of production.…”

Section: Risk Managementmentioning

confidence: 99%

Changing Structure and Organization of US Agriculture

Armbruster

Ahearn

2014

Encyclopedia of Agriculture and Food Systems

View full text Add to dashboard Cite

The Theoretical Effects of Farm Policies on Optimal Leverage and the Probability of Equity Losses

Cited by 60 publications

References 10 publications

Managing food industry business and financial risks with commodity‐linked credit instruments

Managing food industry business and financial risks with commodity‐linked credit instruments

Farm Support Payments and Risk Balancing: Implications for Financial Riskiness of Canadian Farms

Changing Structure and Organization of US Agriculture

Contact Info

Product

Resources

About