The study, conducted by Dan Liu of Anhui University of Finance and Economics and Tong Zhao of Anhui Agricultural University, addresses a structural feature of Chinese agriculture: production is dispersed across millions of smallholder farmers, while demand is concentrated in unified urban markets. Contract farming, in which companies sign purchase agreements with farmers before planting and procure the harvest afterward, has become a primary bridge between smallholders and modern agriculture. Yet the interests of companies and farmers often conflict, and farmers typically occupy a weak bargaining position because of limited access to capital, technology, and information.

The authors set out to determine how government subsidies interact with this unequal bargaining structure. China provides a natural setting for the question because it has run two distinct subsidy mechanisms in recent years. In 2014, the government launched the Target Price program for cotton in Xinjiang and soybeans in Northeast China and Inner Mongolia, allocating 32.5 billion yuan that year and 60.11 billion yuan in 2016.

Under this scheme, farmers receive compensation proportional to the shortfall when the market price falls below a reference price. In 2017, the soybean program was replaced with the Producer Direct subsidy, which pays farmers a fixed amount per unit of cultivated area regardless of market prices. Both mechanisms aim to stimulate production, but they operate through different channels, and the authors ask whether their effects change when farmers sell through a contract rather than directly to the market.

To answer this, the researchers built a two-stage Stackelberg game model of a contract farming supply chain consisting of one company and one aggregated farmer decision-making unit, which could represent a large commercial grower or a cooperative. The company moves first and sets the wholesale price it will pay per unit of output. The farmer, observing that price, then chooses how much land to plant.

Per-acre yield is uncertain, modeled as a random variable, and the market price falls as total supply rises according to a linear inverse demand function. Production costs are quadratic in acreage, capturing the rising marginal effort, labor, and resource constraints farmers face as they expand. The company, as the Stackelberg leader, anticipates how its pricing decision will shape the farmer's planting response.

The model's first major result concerns who actually captures subsidy benefits. Both subsidy schemes increase the company's profit relative to a no-subsidy benchmark. For farmers, however, the Target Price program does not always raise profits above the no-subsidy level.

When the farmer's production cost coefficient is relatively low, meaning the marginal cost of expanding acreage rises slowly, the subsidy induces a large expansion of planted area. The resulting surge in supply pushes the market price down, and the company, acting as the dominant player, responds by substantially cutting the wholesale price it pays. This adjustment redistributes part of the target-price subsidy benefit from farmers to the company, and when the lower margin and higher production costs outweigh the subsidy payment, the farmer ends up poorer than before the policy.

By contrast, when expansion is costly, the farmer's production response is muted, the wholesale-price cut is smaller, and the subsidy benefit stays with the farmer. Yield uncertainty adds a further twist. In the no-subsidy benchmark, greater uncertainty always discourages production: farmers plant less and the company lowers its price.

Under the Target Price program, however, the relationship is non-monotonic. Because the subsidy compensates farmers when prices fall below the reference level, greater uncertainty increases the expected subsidy payment, which can strengthen production incentives at low-to-moderate uncertainty levels. Only when uncertainty becomes sufficiently high does the erosion of expected production returns dominate, and farmers reduce their planting.

Numerical experiments calibrated to Chinese soybean parameters, using an estimated demand elasticity of about minus 0.5, a benchmark price of 5 yuan per kilogram, and a mean yield of 120 kilograms per mu, confirm this pattern and show that the Target Price program outperforms the Producer Direct program on production, profits, and social welfare when yield uncertainty is relatively high. The second major finding concerns supply chain coordination. The authors show that under both subsidy programs, no wholesale price can induce the farmer to choose the acreage that a centralized, jointly owned supply chain would choose while still leaving the company at least as well off as in the decentralized equilibrium.

Any price that aligns production incentives would violate the company's participation constraint, so the traditional contract cannot coordinate the chain when subsidies are present. To fix this, the researchers propose a wholesale price plus fixed transfer contract. The wholesale price is set to align the farmer's production incentives with the centralized optimum, while a separate lump-sum transfer between the parties reallocates the coordinated surplus without distorting marginal decisions.

Under both the Target Price and Producer Direct programs, the authors derive conditions under which this two-part contract achieves full coordination and identifies a Pareto improvement region, a range of transfer values within which both the farmer and the company earn more than they would under the traditional wholesale-price contract. The design separates incentive alignment from surplus division, allowing the contract to satisfy both parties' participation constraints simultaneously. The study's most surprising result concerns social welfare rather than private profits.

Although the coordinating contract eliminates double marginalization, the analysis shows that under the Producer Direct program, the traditional wholesale-price contract can generate higher social welfare than the coordinating contract when the per-unit-area subsidy exceeds a certain threshold. The welfare ranking of the two subsidy programs also depends on subsidy intensity: the Producer Direct program delivers higher social welfare within an intermediate range of subsidy levels, while the Target Price program performs better when subsidies are either relatively low or relatively high. These conditional results underline that neither subsidy scheme uniformly dominates the other, and that the best contractual arrangement depends on the policy environment.

The authors argue that their findings carry practical implications for subsidy design. Under the Target Price program, production expansion can coexist with lower farmer income because the dominant company captures part of the benefit through procurement price adjustments, whereas the Producer Direct subsidy has a more stable effect on farmer profitability. They recommend that governments coordinate subsidy design with contractual arrangements rather than treating the two as independent instruments.

The paper also sketches a path for empirical validation: a triple-difference research design comparing listed Chinese agricultural enterprises in soybean subsidy reform regions, before and after the 2017 reform, and across firms using coordinated versus traditional contracts. As a theoretical modeling study, the analysis rests on specific assumptions, including linear demand, quadratic costs, and a single dominant company, and the authors note that farmers' risk and fairness preferences, as well as heterogeneity in company objectives, remain directions for future research.

Subject of Research: Supply chain coordination in contract farming under yield uncertainty and alternative agricultural subsidy policies

Article Title: Supply chain coordination in contract farming under yield uncertainty and alternative agricultural subsidy policies

Article References: Liu, D., & Zhao, T. (2026). Supply chain coordination in contract farming under yield uncertainty and alternative agricultural subsidy policies. Frontiers in Sustainable Food Systems, 10, 1910949. https://doi.org/10.3389/fsufs.2026.1910949

Image Credits: AI Generated

DOI: 10.3389/fsufs.2026.1910949

Keywords: contract farming, agricultural subsidies, Stackelberg game, yield uncertainty, target price program, producer direct subsidy, supply chain coordination, wholesale price contract, social welfare, China agriculture, fixed transfer contract, double marginalization