Contracts Between Small Scale Soybean Farmers and the Biodiesel Industry in Brazil: An Application of Principal-Agent Model

Abstract

A contract is considered incomplete when the optimal solution for a contractual problem requires some information from the parts which is not observable by one or both parts. This problem is found in the biodiesel production chain among small scale farmers and biodiesel companies in Brazil, which is regulated by a certification called Social Fuel Seal under the framework of the PNPB (Brazilian Program for Production and Use of Biodiesel). In order to minimize this hindrance, an incentive structure was elaborated utilizing the nonlinear programming. The Principal-Agent approach was used to verify if these new incentives allow for the small scale soybean farmer to put great effort level in the agricultural production. When the incentive structure is evaluated through the model proposed, the result indicates that both the farmer and the biodiesel company will have their profits maximized if the producer puts on great effort. Thus, it is clear the importance to include this mechanism of stimulation to productivity increase into the PNPB framework in order to contribute to the competitiveness of the Biodiesel chain in Brazil.