We examine what determines a firm’s decision to use external private equity by firms in agricultural production. Unlike other mature industries, the agricultural production sector is dominated by family firms, partnerships, and cooperatives, with few corporations and limited access to external equity capital (i.e., capital derived from a source other than retained earnings and existing owners). However, use of external equity in agriculture has increased since 1990. This source of capital allows farms to exploit business opportunity, particularly for companies that pose risks that discourage debt capital, and private equity has fostered entrepreneurial activity.

Following Williamson (1988), we argue that debt and equity are best regarded as alternative governance structures and that transaction cost economics offers insights on firms’ financial structure beyond that provided by agency theory. Specifically, financial structure is related to asset specificity, the extent to which assets are redeployable to alternative uses, a particularly important attribute in agricultural production.  Although the asset specificity approach offers insightful contributions to understand the use of different financial mechanisms, empirical analysis and tests of this approach to financial decisions has been limited, partially because of data constraints and difficulties to find good measures of asset specificity in databases of secondary data.

We construct an international dataset of agricultural companies that receive external private equity finance to test hypotheses about the determinants of using external equity finance. Our dataset contains 99 private firms in agricultural production industries operating in North America (52), EU-15 (36), and Oceania (11). We use two data sources: (i) we use Venture Economics to identify companies that received external equity; (ii) we use primary data from a survey to credit officers conducted to measure the degree of relationship-specific investments for each farm activity in the agricultural production sector (dairy, beef, corn, etc.).

Results show that the different attributes of the assets involved in agricultural production constitute an important source of variation across farm activities and a key factor to explain financing choices in agriculture. Asset specificity helps to explain why some companies receive investment from multiple funds as opposed to only one fund, which indicates the use of higher total amount of investment from external equity investors.

Although scholars have addressed the effect that the non-depreciable attribute of farmland has on the financing of agriculture, the literature on agricultural finance has little to say about the effect that other attributes of the assets involved in agriculture have on the use of alternative financing mechanisms. In this context, the contribution of this study to this literature is twofold. First, it goes beyond previous studies and identifies factors at the firm level that explain the use of external equity capital in farming businesses. Second, it introduces and develops the analysis of differences across farm activities. In particular, it addresses the implication that difference in the assets involved in a farm activity has on the financial choices.

An implication of these results for the transaction cost literature is that the asset specificity approach to financing decisions is useful to understand financing choices in agriculture. In addition, this study contributes to the discussion on what types of asset specificity play an important role in agriculture. Masten (2000) argues that temporal and site asset specificity play an important role in agriculture. Allen and Lueck (1998) explicitly dismissed physical asset specificity from their model to explain organization forms. The results of this investigation suggest that physical asset specificity plays a relevant role in agriculture.

Key words: asset specificity, strategy, external equity, capital structure.

JEL Codes: D23, Q14, G32

Williamson, O. E. 1988. Corporate Finance and Corporate Governance. The Journal of Finance, 43(3): 567-591.

Masten, S. E. 2000. Transaction-cost economics and the organization of agricultural transactions. In M. Baye (Ed.), Advances in Applied Microeconomics: Industrial Organization, Vol. 9: 173-195. New York: Elsevier Science.

Allen, D., & Lueck, D. 1998. The Nature of the Farm. The Journal of Law and Economics, 41(2): 343-386.