ABSTRACT
As described in Chapter 1, the use of purchasing power to buy factors of production is an important dimension to all business today. In fact, the emergence of financial intermediation (institutional arrangements linking the demand for this purchasing power with sources of purchasing power) has been critical in economic development.
Perhaps the best way to appreciate the importance of financial intermediators is to consider what the world would look like without them. In their absence, firms seeking finance and savers looking for investment opportunities would have to find each other and negotiate detailed contracts. Will funds be loaned or will they purchase a share of the enterprise? If loaned, for how long, at what interest rate, and against what collateral? If the funds purchase an ownership share, to what fraction of profits and seats on the board of directors will investors be entitled and, if the enterprise fails, how much liability will they bear? A system without financial intermediators would be, to put it mildly, inefficient. The transaction costs involved in seeking out investors and reaching agreements would be prohibitive, and firm managers, in all likelihood, would be forced to rely on retained earnings (i.e., funds generated by the firm but not distributed to owners) and the fortunes of friends and family to finance expansion. Economic growth, as typified by the modern industrialized – or industrializing – economy would seem impossible.
(Grossman, 2010, p. 1) For the most part, farmers tend to borrow capital for the purchase of operating inputs, equipment, and land ownership. In principle, this demand for capital could take several forms from equity investment (through capital stock or limited partnership) to debt (such as bonds or collateralized loans and mortgages). Capital stocks and bonds are common instruments used in the capital markets by publicly traded corporations. The market price for each instrument varies as general market conditions in the economy change or as factors specific to the firm or its industry vary. Some agribusinesses are large enough to access the capital markets through stocks and bonds, but few farms are sufficiently large to do so. Some partnerships exist, but these are often limited to family relationships or professionals who desire investments in farmland. The most frequent source of capital for agriculture is through collateralized loans where the title of equipment is used as a pledge to guarantee the repayment of an equipment loan, or the title of farmland is used as a guarantee for a real estate loan.