role of credit constraints and government subsidies in farmland valuations in the US: an options pricing model approach

The Modigliani-Miller (M-M) theorem of financial asset theory concludes that asset values are independent of financing. In other words, debt-solvency (credit constraints) does not affect asset values. Therefore, using the M-M theorem one can argue that credit constraints in the farm sector (where land is the most important asset) do not affect the value of farmland. However, this proof relies on several arbitrage assumptions that are violated in the case of agricultural assets. This paper examines the effect of debt-solvency and government payments on changes in annual farmland values by state in the United States. Using panel cointergration method, results indicate that farmland values are significantly affected by both solvency and government payments. In addition, the results imply that government payments may affect agricultural asset values beyond the direct effect hypothesized in the literature.