Role of risk sharing and transaction costs in contract choice: Theory and evidence from groundwater contracts

Empirical modeling of contract choice has been problematic because routine large-scale surveys do not contain sufficient information on matched partners and on contractual terms. This paper is based on a primary level survey of groundwater contracts in India. We discuss several different measures for riskiness and transaction costs and use them to test for alternative theories of contract choice. Although the risk sharing explanation has been most popular in the theoretical literature, it is not found to be significant. The data are more consistent with a double-sided incentive model, where the need for giving proper incentives to the buyer and the seller determines contract choice.