Sugarcane produced in India is utilized to manufacture three sweetening agents: sugar, gur, and khandsari. Sugar processors must comply with a floor price for cane, but gur and khandsari producers are exempt from the floor price. Thus, any effect of the sugar processor’s choice of procurement method on the incentives facing farmers will depend on the expected cane price in these competing unregulated markets. In Andhra Pradesh (AP), India, private sugar processors use an unusual form of vertical coordination. Rather than conventional pre-planting contracts, they issue ‘permits’ to selected cane growers a few weeks before harvest. I explore the potential motivations behind this choice of sugar processors and hypothesize that the probabilistic permit system is the low-cost way of procuring high-quality cane. I develop a theoretical model of the AP cane procurement market that incorporates the floor price policy that applies only to the cane used for sugar processing, and compare processor profits under the probabilistic ex post permit system and ex ante production contracts. The model predicts that both the quality of cane procured and the profits from unit cane purchase are higher when the processor uses ex post permits. These gains come at the expense of increased cultivation costs incurred by the farmers. I test and confirm the predictions of the theoretical model using data from a household survey conducted in fall 2008.


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