Farm Financing Strategy and the Lending Policy From Financial Institutions
The analytical framework is extended to a Monte-Carlo simulation after the econometric examination of the applicability of capital structure theories to farm businesses. Farm business performance under different combinations of financial strategy scenarios is simulated for a 10 year period to determine the benefits for both farmers and lenders in the agricultural credit relationships. Based on the forecasted net equity, credit score and the default rate, the simulation results demonstrate that farm businesses can expand at a faster speed with a relatively high financial safety when they jointly employ the pecking order financing in the short-run, and trade-off their capital structure in the long-run. Concurrently, low credit risk farm businesses which send credible signals to lenders could benefit from lower interest rates, further strengthening their financial performance. The simulation results document that responding to borrowers' signals and adopting risk-adjusted interest rates is a dominant lending policy for lending institutions to improve the management of their loan portfolio.
University of Illinois - Urbana-Champaign
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University of Illinois at Urbana-Champaign