When is it fair to say a small business is not one?

A recent program review by the US government’s Office of Inspector General focused on loans by the Small Business Administration made to poultry farmers. The report concluded that poultry farmers do not meet the regularly requirements of a small business and therefore are no longer eligible for small business loans. A nice article in Modern Farmer entitled “Should a poultry farm be considered a small business?” discusses this report.

In the US, most poultry growers have contracts with chicken companies, like Tyson and Pilgrim’s Pride, to raise chicks until they have grown large enough for slaughtering. These companies are known as “integrators” because so much of the poultry growing and processing operation is owned and controlled by the company (i.e., integrated into one business enterprise). The integrators own the chicks that poultry farmers raise; they determine the quality and quantity of chicks poultry farmers receive; they provide the chicken feed and dictate the operating procedures that poultry farmers must use in feeding and raising the chicks; they mandate the size and shape of the buildings poultry farmers grow the chicks in and can require growers to make changes in buildings at the grower’s expense; they can conduct surprise inspections of poultry farmer operations. Poultry farmers provide the labor in raising the chickens.

One reason why the Office of Inspector General concluded that poultry farmers were not small businesses is that they are “affiliated” with chicken companies and thus are not truly independent businesses. An entity is “affiliated” with a business operation when the business “controls or has the power to control the other” entity. According to the report, “integrators exercised comprehensive control over the growers through a series of contractual mandates and restrictions, management agreements, operating procedures, oversight, inspections, and market controls that overcame practically all of the grower’s ability to operate their businesses independent of integrator mandates.”

According to the report, 76 percent of all agricultural loans by the Small Business Administration in 2016 went to poultry farmers. The average size of loans in 2016 was $1.4 million.

If a poultry grower defaults on a small business loan, it is very difficult for the lender to recover losses through, for instance, the sale of business assets. The reason is that the value of grower facilities is strongly tied to the production contracts that growers make with integrators. If the integrator cancels a particular grower’s contract, the grower usually has no option but to exit the business. In most rural areas where poultry farming occurs, there is only one integrator with whom a grower can contract. The program review report notes “substantial loss in the value of a grower’s facility without the integrator contract.” Economists would say the salvage value of poultry barns is very low. I guess an interesting question to consider is why a lender would make a loan to a poultry grower if the risk of default is closely tied to integrator behavior and the salvage value of assets backing the loan is low. Loans guaranteed by the US government is a reasonable answer.

My colleague, Mary Hendrickson, and I have written about the unfairness of the poultry contracting and growing system. In a paper published in 2016 (here), we show how the relative dependency of poultry growers combined with a lack of contractual and other safeguards create an unfair system for them.

Is it fair to poultry growers that the Small Business Administration will not recognize them as small businesses? As stated in the Modern Farmer article, “There is an argument to be made that by not helping poultry farmers get loans, the SBA would be hurting poultry farmers.” Thus, I can see how poultry growers might assert that the change in designation–if upheld after further government review–is unfair to them. If growers can no longer expect to obtain small business loans, then a claim of unfairness might make sense. Dr. Hendrickson and I, along with two doctoral students, have a new paper, where we not only assess the validity of unfairness claims by poultry growers, but also provide a framework explaining why a violation of expectations is important when assessing claims of unfairness.

In the long-run, however, the change in designation of poultry growers might be a good thing. One could argue, as noted in Modern Farmer, that the ability of growers to obtain small business loans “is currently propping up a wildly damaging system.” If it becomes more difficult or even impossible for growers to obtain such loans, then maybe that will push the system to change more in favor of poultry growers.

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Author: Harvey James

Professor, Agricultural and Applied Economics, University of Missouri Editor-in-chief, Agriculture and Human Values

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