This document has been made available in electronic format by the International Co-operative Alliance (ICA)

March, 1998
(Source: ICA Review, Vol. 91 No. 1, 1998, pp.48-54)

Individual Equity Capital of Agricultural Co-operatives
by Karin Hakelius*

Introduction --------------- Today, many farmer co-operative organizations face comprehensive necessary changes (van Bekkum & van Dijk 1997). First, the new external situation, with increasingly flexible markets and a possibility to act on larger markets, requires new skills within the organizations, as well as new financial resources. Second, younger farmers have a different attitude towards what the co-operative organization should do for them (Hakelius 1996), i.e. the internal situation of the co-operatives has changed. Another way of expressing this is to say that what has happened is that the overlap between (1) the characteristics and way of working of the farmer co-operatives and the requirements from (2) members, and (3) the market, has decreased (Figure 1).

(Figure 1 - The overlap between the goals of co-ops, the requirements of members and markets, respectively, in a graph form in the original printed version)

These three factors overlapped each other in the beginning of the era of co-operatives. Today, on the other hand, the overlap has shrunk. This implies that parties involved in co-operatives seem to have difficulties in seeing their common goal, and how a co-operative could help them reach it. This paper is focused on how to increase the overlap and, more precisely, how to change the way co-operatives are financed.

Why has the overlap shrunk? Using Figure 1 as a starting-point, this development can be described as follows: Generally speaking, farmer co-operatives were formed a century ago and they adapted themselves to the prevailing situation. In many countries, the agricultural sector has been protected from competition and subsidized for long periods and hence the co-operatives have not been exposed to fierce competition and strong market signals. Today, the environment surrounding co-operatives has changed, but co-operatives have not changed as much as markets and their owners have. For example, many co-operatives in Europe practice a financial system that worked well during the era when the overlap in Figure 1 still was large. With the expansion of the EU and the development of the world market as a whole, co-operatives having these old models of financing their activities no longer fit smoothly into their environment. Hence, these co-operatives are experiencing problems on the market.

In Figure 1, it is shown that members' requirements have changed. As mentioned, farmers view co-operative activity in a different way, from the view fifty years ago. One could say that farmers have changed with the society as a whole, and have acquired different value-sets from those of earlier generations of farmers. Hence, modern farmers have a different view on co-operative activity and what the co-operative membership is all about. The co-operatives' characteristics, however, have not followed the changes in member requirements.

Finally, the changes in markets also play an important role. The small, domestic markets have been replaced and co-operatives are now facing large, European or even global markets that demand new things of all actors.

What can be done about this development, i.e. how can the overlap between the three increase, making it possible for an economically effective co-operative sector throughout Europe? There is little that can be done about changing the European market, at least in the short run and solely by people involved in co-operative business. What have to change are, first, the characteristics of the co-operatives. If these change to better match the market requirements, the second step will occur more or less automatically, namely that the requirements from the members will be better fulfilled, which will lead to a higher degree of overlap and more effective co-operative organizations.

This paper will address the process of changing the way co-operatives are financed to better fit into the European market. One possible source of inspiration is to study the so-called New Generation Co-operatives (NGCs) and other new financial solutions for co-operatives to see if these may give rise to any ideas of how to change farmer co-ops.

New Generation Co-ops (NGCs) ---------------------------------------- The NGC-movement started on the North American prairies in the beginning of the 1990's. The two major differences between a traditional co-operative and a NGC are that a NGC has a closed membership and practices a system based on binding contracts between the members and the co-operative (see Nilsson 1997).

The basic idea behind forming a NGC is to allow members to take part of the value-added in late steps in the food chain. With this basic goal at hand, it follows that the quantity of products handled each year has to be known (limited) and fit into the existing plants etc, managed by the co-operative.

Some NGCs allow non-members (both juridical persons and natural persons) to invest money in the co-operative organization, through so-called preferred shares. The holders of such shares has no right to vote, but they get a certain amount of returns each year.

Member involvement in NGCs has proven to be high. Members are capable of seeing the connection between the way in which the co-operative is making out on the market and how it is managed and they do not tolerate mismanagement of the organization by the management. In addition, the price of the shares reflects the future expectations of profits etc., which gives direct signals between members and the co-operative organization.

North American Bison Co-operative (NABC) ------------------------------------------------------ This NGC is a good example of a successful new generation co-operative founded on the prairie in North Dakota. It was established in 1993 by some farmers who had bisons on their grounds. The goal has been to reach both the internal market and the external markets. This has lead to NABC obtaining an export permit to the European Union (EU). Today, around 20% of the total production is exported to the EU and a minor part of the production is also exported to Asia.

In the first offering to buy shares in NABC the process of forming the NABC is described: (1) In the beginning of 1992 the North Dakota Bison Association was formed. This organization examined the possibilities of opening a plant for processing bison meat. (2) Nine bison producers were selected to form the co-operative organization and to develop a business plan. (3) NABC was registered on December 16, 1992, under the name North Dakota Co-operative Association. (4) It was decided that the organization should be owned by producers and that each member should only have one vote, irrespective of the number of shares each member owned. In addition, the requirement that only members could own equity stock (with a voting right) and that no single member was allowed to own more than 10% of these shares. (5) Finally, the purpose of the co-operative organization was formulated (Offering Circular of the NABC, 1996, p 1):

"The Co-operative's purpose is to process bison meat products in facilities in North Dakota so that members may participate in the economic benefits of value-added processing."

The development of the NABC accelerated during 1995. The current prognosis is that members of NABC will have 60% of the market for bison meat by 1998, and that by then they will export 10-25% of the total production to Europe (Agweek, March 31, 1997, p 13)

Conclusions --------------- There are many new models of financing co-operatives other than those which have been dealt with here. However, there are other "old-fashioned" co-operatives in North America that have changed their financial structure, for example Saskatchewan Wheat Pool (see Hakelius 1997, Saskatchewan Wheat Pool and You and Saskatchewan Wheat Pool's Amended and Restated Prospectus). Nevertheless, by analysing the NABC-case, it is easy to see that there are other new ways of thinking about co-operative activity.

The new co-operative organizations that have emerged, mainly in sparsely populated areas in Northern USA and in Canada, have been started because people wanted to adjust the co-operative activity to today's situation, not only at the markets but also in order to better fit the demands of younger farmers on the co-operatives. In other words, these new co-operative ways of financing and organizing increase the overlap in Figure 1, making the entire system function better as a whole.

The NGC-model practices the dual commitment, through tying a certain amount of products to each share. Today, a rapidly increasing number of co-operatives in Europe have introduced contracts to be written between one member and the co-operative. This is, naturally, a step closer to having a general commitment to deliver to the co-operative and receive from members, respectively, making it easier for the co-operative to plan its activity. However, it is more costly to have to write one contract with each member, rather than having one contract and one set of rules for all members (like in a NGC).

What is needed is a higher degree of freedom for each co-operative to develop its way of financing its activities, etc, according to what its members want, as well as a openness towards new structural solutions, making it possible for non-members to support the co-operative, for instance.

Agency Theory ------------------- When working with restructuring and adjusting the farmer co-operatives, agency theory can be used as a helping tool. This theoretical framework is based on the relationship between a principal and an agent. In the case of co-operatives, members are principals and people working in the management of co-operatives are agents.

Looking upon co-operative activity through the eyes of an agency theorist, co-operatives have a number of problems, for example the horizon problem, the portfolio problem, the common property problem, the decision making problem, and the follow-up problem.

Many of these problems are discussed in the current co-operative debate: Members want to have as much money from their co-operative as soon as possible (the horizon problem); they have different opinions about what business deals their co-operative should be involved in and to what extent the co-operative should be involved (the portfolio problem); they do not want to invest more money than necessary into their co-operative (the problem with common property); and as a consequence of all this, they experience their co-operative as organizations difficult to take stock of, understand and govern (the follow-up problem). Judging from this, it could be relevant to assert that the agency theory's criticism on co-operative organizations is often correct.

Often, co-operators assert that the way co-operatives are structured and run today is the only "true co-operative way". However, if the ICA-definition of a co-operative is studied, it is difficult to see that this opinion is correct (1995, p 10). The definition of co-operatives is so broad that it includes a much wider variety of organizational models than the ones currently dominating the world of co-operation.

"A co-operative is an autonomous association of persons united voluntarily to meet their common economic, social and cultural needs and aspirations through a jointly-owned and democratically-controlled enterprise."

If this definition is further scrutinized, three central aspects of a co-operative enterprise are distinguished: (1) Members have intentionally joined together to form an independent organization; (2) The organization has been formed in order to solve some kind of need; and (3) it is jointly owned and democratically governed by members. These three aspects recur in most definitions of co-operative activity.

If the starting-point is the ICA-definition of co-operative activity, used above, it is difficult to see that the agency theory's criticism of co-operatives holds. Due to the fact that to a large extent the criticism describes the current situation for farmer co-operatives, it can, on the contrary, be looked upon as an analysis of what is wrong in the prevalent situation, rather than what is wrong about the co-operative idea as such. This leads to the conclusion that the ICA-definition should be combined with the agency theory in order to get a fruitful result from the analysis of what has to be done in order for the co-operative organizations to be more effective for their members.

Concluding Remarks ------------------------- The agency theory can be used to show what has to be changed in the financial system of farmer co-operatives today. By using this theory, it is easy to show the importance of individual ownership and clear marked signals in an organization: In a NGC, due to his role as a principal, the member is capable of influencing and monitoring the agent in a much more effective manner, compared to a traditional co-operative. Simultaneously, he can send clearer signals to the management (the agent) through the size and development of his possession of shares over time. If, for example, the management of a NGC would like to expand the capacity, they also have to find individuals (either existing members or presumptive ones) willing to invest into the expansion. This situation can be compared with the current way of expanding co-operatives: In many cases such decisions are more or less pure management decisions. The management simply uses a certain amount of the collective capital, borrows some more money and expands the enterprise, often using persuasion-tactics to make members agree to the expansion.

The important aspect in all this is that by implementing for example NGC ideas on co-operatives, an increased member commitment is achieved. Since a written contract exists between the member (the principal) and the co-operative (the agent), combined with the co-operative's possibility to give the member lower TRCs and returns on the invested capital, the member commitment is likely to increase. When the member commitment increases, the likelihood for the management (the agent) to be capable of acting fraudulently towards the members (the principal) decreases, and hereby the risk of increasing transaction costs for members become less. The member no longer has only two possible ways to express his opinions about how the co-operative is run: Exit and voice (Hirschman 1970). A system of tradable shares gives the exit-choice a much broader meaning.

Bibliography ---------------- Van Bekkum, Onno-Frank & Gert van Dijk (eds). 1997. Agricultural Co-operatives in the European Union. Trends and Issues on the Eve of the 21st Century. Assen, The Netherlands: Van Gorcum.

Hakelius, Karin. 1996. Co-operative Values. Farmers' Co-operatives in the Minds of the Farmers. Doctoral Thesis # 23. Uppsala: Swedish University of Agricultural Sciences.

Hakelius, Karin. 1997. Equity Capital of Co-operative Organizations. How to Finance (and Manage) Farmer Co-operatives. Paper to the ICA- conference in Bertinori, Italy.

Hirschman, Albert O. 1970. Exit, Voice, and Loyalty. Responses to Decline in Firms, Organizations, and States. Cambridge, Massachusetts: Harvard University Press.

International Co-operative Alliance (ICA). 1995. Making Membership Meaningful.

Participatory Democracy in Co-operatives. Saskatoon, Saskatchewan: Centre for the Study of Co-operatives, University of Saskatchewan.

Nilsson, Jerker. 1997. New Generation Farmer Co-ops. In: Review of International Co-operation, pp 32-38.

Brochures, Articles and Printed Matter Agweek, March 31, 1997. North American Bison Co-operative, Offering Circular dated January 12, 1996.

Saskatchewan Wheat Pool and You. Without date or year.

Saskatchewan Wheat Pool. Amended and Restaded Prospectus February 28, 1996 and March 22, 1996.

---------------------------------- * Dr. Hakelius is a researcher of co-operative business at the Swedish University of Agricultural Sciences. Her doctoral thesis treated farmers' values, compared to the co-operative values. Her present research project deals with how farmer co-operatives can be financed.