Investment in farming under uncertainty and decoupled support: a real options approach

Under the current version of the Common Agricultural Policy (CAP), payments to EU farmers are decoupled from the production of agricultural commodities. In fact, farmers qualify for CAP support as soon as their land is maintained in good agricultural and environmental condition. In this paper, we study how decoupled payments influence the decision to invest in farming. We show that decoupling is implicitly providing a costless hedge against volatile farming profits. Consequently, a higher decoupled payment leads the potential farmer to hasten its investment but also results in a farm with lower productive capacity