Risk Management Externalities in Food Supply Chains

Abstract

Firms may under- or over-invest in risk management from the social planner’s perspective, resulting in a negative externality on other economic agents in the supply chain. This risk management externality is particularly relevant for food supply chains that constantly face exogenous shocks from varying sources and play a primary role in preventing major social losses from food insecurity. We build a theoretical model in the context of US agri-food supply chains, where intermediary firms choose the quantity of output and the investment in reducing operational risk. The model allows for flexible market structures and interdependence of risk investments among firms. We show that private firms invest in risk management less than the socially optimal level under perfect competition, but market power introduces competing risk management incentives and have critical implications for the social efficiency of policy interventions.