A 

109.10 

84 Farmer Cooperative Theory: 

Recent Developments 

United States 

Department of 

Agriculture 

Agricultural 

Cooperative 

Services 

ACS Research 

Report 

Number 84 

WAITE MEMORIAL BOOK COLLECTION 

DEPT. OF AG. AND APPLIED ECONOMICS 

1994 BUFORD AVE. - 232 COB 

UNIVERSITY OF MINNESOTA 

ST. PAUL, MN 55108 U.SA. 
preface 

By the late 1970's, it had become clear to the cooperative community 

that existing theories of farmer cooperation had failed to address adequately 

many of the critical issues facing farmer cooperatives. The environment in 

which these organizations and their patron-members operated had grown 

much more complex than in the 1950's and 1960's, when most of the 

previous theories about the behavior of farmer cooperaUves were developed. 

Hence, there was a need for new theoretical work to guide empirical, 

problem-oriented research aimed at finding ways to improve performance of 

individual cooperatives, and the cooperative system as a whole. 

Beginning in 1980, the Agricultural Cooperative Service (ACS) in the 

U.S. Department of Agriculture played a critical role in fostering a new round 

of work on cooperative theory by funding research at several land-grant 

universities. Some results of that research have already appeared in the 

report, Cooperative Theory: New Approaches, edited by Jeffrey S. Royer 

(ACS Service Report No. 18). This report is companion to the earlier 

publication, and attempts to synthesize the results of the ACS-sponsored 

"Cooperative Theory Project" as well as other recent developments in the 

theory of farmer cooperation. 1 

Many people provided helpful reviews of this report, including James 

Shaffer, Larry Hamm, V. James Rhodes, Ronald Cotterill, Jeffrey Royer, 

Michael Turner, Hugh Moore, Kenneth Duft, David Cobia, and David Holder. 

Any remaining errors of fact or interpretation are solely those of the author. 

Ii' 
contents 

HIGHLIGHTS ................................................................................................... iv 

WHY STUDY COOPERATIVE THEORY? ........................................................ 1 

Organization of the Report .... : ................................................................... 1 

Role of Theories and Economic Models ................................................... 1 

DEVELOPMENTS IN COOPERATIVE THEORY THROUGH 1980 ................. 2 

The Cooperative as a Form of Vertical Integration ................................... 2 

The Cooperative as a Firm ....................................................................... 3 

The Cooperative as a Coalition ................................................................. 8 

RECENT DEVELOPMENTS IN COOPERATIVE THEORY ............................. 8 

Reasons for the Resurgence .................................................................... 8 

Approaches Used ..................................................................................... 9 

Extensions of the "Cooperative as a Firm" Approach ....................... 9 

Analyses of Cooperatives in the Planning Sector ........................... 12 

The Cooperative as a Nexus of Contracts ...................................... 14 

The Cooperative as a Coalition ....................................................... 19 

SUMMARY, CONCLUSIONS, AND IMPLICATIONS ...................................... 22 

Implications of Recent Theoretical Research ......................................... 22 

Cooperative Goals and Governance ............................................... 22 

Cooperative Finance ....................................................................... 22 

Improving System Coordination ...................................................... 23 

Public Policy Toward Cooperatives ................................................. 23 

Implications for Future Research ............................................................ 24 

NOTES ........................................................................................................... 25 

REFERENCES ............................................................................................... 28 

iii 

... 
iv 

The 1980's witnessed a resurgence of research by agricultural 

economists on the theory of agricultural cooperation. The renewed interest 

cooperative theory resulted from the recognition that existing theories failed . 

address many of the challenges facing agricultural cooperatives today. The 

challenges include the need for cooperatives to compete with very large, oft 

conglomerate, investor-owned firms (IOF's); the necessity of raising large 

amounts of equity capital to capture economies of size; the dilemmas in 

serving a highly heterogeneous group of members, whose interests 

sometimes conflict; and the difficulties of dealing in increasingly risky markets:

In addition, the growth and consolidation of cooperatives raised many ;

questions for public policy, such as whether large cooperatives posed antitru 

problems; whether cooperatives could improve market coordination, thereby 

substituting for Federal income- and price-support programs; and whether 

large, multi-division cooperatives really behaved any differently from IOF's. 

In attempting to address these issues, economists have extended 

previous models that viewed the cooperative as a firm; developed new 

approaches that model the behavior of cooperatives in highly concentrated 

industries (lithe planning sector"); analyzed the cooperative as a coalition of 

various participants, such as farmers, managers, board members, and input 

suppliers; and modeled the cooperative as a set of explicit and implicit 

contracts among these partiCipants. In carrying out these analyses, theorists 

have adapted many approaches originally developed for the analysis of 

investor-owned firms, such as applications of game theory, agency theory, 

behavioral theories of the firm, and the theory of contestable markets. 

The recent work has shown that the structure of cooperatives offers them 

opportunities and creates challenges for them different from those present in 

IOF's. Consequently, cooperatives may perform differently than IOF's, both a

individual economic entities and in their effect on the wider economy. Whethe

an individual cooperative realizes its potential for improving economic 

performance and farmer welfare, however, depends critically on the co-op's 

structure and practices. 

The theoretical work has also demonstrated that setting operational goals 

for a cooperative involves striking delicate balances. For example, a co-op 

needs to balance the goal of increasing its net margin with the goal of offering 

members attractive prices. Attempting simply to maximize the cooperative's 

net margin does not maximize members' welfare, nor does focusing solely on 

providing members with favorable prices. Similarly, when the cooperative has 

a heterogeneous membership, the co-op needs to balance benefits among 

various members to preserve the membership base. In some instances, 

differential pricing of goods and services to members is necessary to prevent 

those with better market opportunities from abandoning the cooperative, which 

could leave the remaining members worse off. Striking such delicate balance

is one of the key responsibilities of the board of directors. 

Another area of theoretical work has been the implications of the patronowner relationship for cooperative finance. The lack of ability to "float stock" 

constrains the equity base of cooperatives and prevents the emergence of a 

secondary market for cooperative equity certificates. The absence of such a 
brz 

market has a number of implications for cooperative investments and 

governance, including the reluctance of cooperatives to undertake projects 

with long gestation periods and the need for cooperatives' boards of directors 

to playa much more active role -in the governance of their organizations than 

do IOF boards of directors. 

Theory also suggests that potential exists for improving the performance 

of the entire cooperative system, not just individual cooperatives. For 

example, in some cases there is theoretical justification for more collaboration 

and less competition among cooperatives. Such collaboration could reduce 

total system costs and improve returns to farmers. But both theoretical work 

and common observation highlight several factors that can block such 

collaboration, such as the vested interests of current managers, patronowners, and board members, and the belief by some members that 

competition is the only way of ensuring control over management. Hence, any 

move to increase collaboration among cooperatives will have to address these 

issues. The theoretical work also shows that in some circumstances 

cooperative members would be better off taking collective action via the 

cooperative, but that incentives exist for them to behave independently, acting 

as free riders. An example is the lack of patron commitment to a cooperative 

that is acting as a competitive yardstick. To capture the potential for improved 

coordination, cooperatives need to develop mechanisms to increase member 

commitment, such as contracts with members that have significant penalties 

for nonperformance. The development of such mechanisms needs to be 

coupled with actions aimed at strengthening member control, however; 

otherwise, such actions might simply remove membership pressure on the 

management and the board to perform their duties effectively. 

The recent theoretical research also reaffirms that there are often valid 

justifications for public policies to support cooperatives, particularly because of 

their effects on competition in highly concentrated markets and their potential 

to improve market coordination. The recent work cautions, however, that the 

public should not grant carte blanche to cooperatives, as certain types of 

cooperative structures may behave similarly to an IOF conglomerate. In 

particular, theory suggests that cooperatives that follow a closed membership 

policy and make heavy use of unallocated retained earnings are more likely to 

pose antitrust problems. 

Areas warranting additional theoretical research include further analyses 

of cooperative-IOF joint ventures and analyses of how cooperatives can 

effectively collaborate to counterbalance increasing IOF concentration in 

certain segments of the agricultural economy. In addition, the theoretical work 

outlined in this report generates many new hypotheses that deserve empirical 

investigation. Testing these hypotheses may be one of the most fruitful areas 

for further cooperative research. 

v 
r Farmer Cooperative Theory: 

Recent Developments 

John M. Staatz, Associate Professor 

Department of Agricultural Economics 

Michigan State University 

WHY STUDY COOPERATIVE THEORY? 

Recently the CEO of a major California 

cooperative spoke on "Agricultural Cooperatives: Are 

They Still Relevant?" (Allewelt). The question is 

heretical to many in the cooperative community, yet it is 

one that is increasingly heard. The answer ultimately 

depends on what, if anything, is unique about farmer 

cooperatives, and what advantages they offer memberpatrons in dealing with today's complex and rapidly 

changing business environment. 

Cooperative advocates have discussed their unique 

features ever since the days of the Rochdale pioneers. 

In the 1920's, two schools of thought developed in the 

United States regarding the justification for, and 

function of, farmer cooPeratives. One school, identified 

with Aaron Sapiro, argued that the major function of 

farmer cooperatives was to unify farmers on a 

commoditywide basis so that they could exert market 

power and raise total returns to agriculture. By 

contrast, followers of Edwin Nourse contended that 

cooperatives should function as "competitive 

yardsticks." They should not try to monopolize 

commodity markets but simply add enough competition 

to the system to give farmers a basis on which to judge 

the performance of investor-owned agribusinesses. 

Since the 1940's, academicians, particularly economists, 

have drawn on Sapiro's and Nourse's ideas as well as 

general economic theory to develop formal models of 

cooperatives' behavior. These models highlight how 

the unique features of farmer cooperatives affect their 

business practices and examine the implications of 

those practices for patron-members and society at large. 

Between the mid-1940's and the mid-1960's, 

cooperative theorists focused particularly on the nature 

of the relationship between the cooperative and its 

member-patrons and the implications of that 

relationship for how the cooperative priced its goods 

and services, for how those pricing and output decisions 

affected market competition, and for the appropriate 

rules for governing the cooperative. After the mid1960's, research on cooperative theory fell off 

Notes and references carried at end of text. 

dramatically. The environment in which cooperatives 

and their members operated, however, continued to 

evolve rapidly, posing new problems and opportunities 

for cooperatives, many of which were not addressed by 

existing theories of farmer cooperation. In response to 

these new challenges, there has been a resurgence 

during the 1980's of theoretical work on farmer 

cooperatives. A key element in this resurgence has 

been financial and intellectual support offered by the 

Agricultural Cooperative Service (ACS). Since 1980, 

researchers have explored the basic nature of farmer 

cooperation, the theoretical benefits and limits to 

cooperative enterprise, and the implications of these for 

cooperative members, managers, and public policy. 

This report describes and evaluates the recent 

theoretical developments; examines some of their 

implications for cooperative decisionmaking, 

management practices, and public policy; outlines 

remaining areas of conflict and gaps in the theory of 

agricultural cooperation; and discusses topics for future 

research. 

Organization of the Report 

Although this report briefly mentions some recent 

work by European theorists, it focuses primarily on the 

North American agricultural economics literature since 

1980.2 It also concentrates almost exclusively on the 

literature concerning agricultural marketing and supply 

cooperatives. It does not review the voluminous, and in 

many ways parallel, literature on the theory of the 

labor-managed firm (including the agricultural 

production cooperative) or on the theory of agricultural 

bargaining cooperatives (which is similar to the theory 

of labor unions) and mentions only briefly work on the 

theory of consumer cooperatives.] 

Role of Theories and Economic Models 

Before proceeding, it is useful to say a few words 

about the nature and purpose of economic theories and 

models. All models and theories of behavior are by 

definition abstractions and simplifications of reality. 

The purpose of a theory is to simplify the complexity of 
the real world so that the key elements determining 

how something works can be identified and the 

interrelationships among those elements can be 

understood. 

The aim of cooperative theory is therefore to 

develop models that help us understand how 

cooperatives do or potentially could operate in the real 

world. Such models and theories have the ultimate 

purpose of aiding cooperative managers, directors, 

extension personnel, and those involved in establishing 

public policy toward cooperatives, in the process of 

problem solving. By outlining the relationships among 

key variables that help determine cooperative behavior 

and performance, theory can provide guidance in: 

1. Assessing problems and opportunities facing 

cooperatives; 

2. Developing and evaluating alternative 

strategies, such as different pricing arrangements; and 

3. Anticipating probable outcomes of alternative 

courses of action. 

Because all theories are by definition 

simplifications of reality, the test of the usefulness of a 

theory does not lie in whether the theory faithfully 

represents the real world, for no theory or model will or 

should. Rather, the tests of usefulness lie in whether 

the crucial elements of the behavior and relationships 

affecting the problem at hand have been correctly 

identified, whether important elements have not been 

assumed away, and whether extraneous elements have 

been ignored. (For more details, see Condon.) This 

implies that different models will assume different 

things away depending on what problem the model is 

built to address. Certain elements of reality may be 

crucial for particular problems but irrelevant to others. 

For example, models of a cooperative's pricing 

behavior are likely to differ depending on whether the 

cooperative has a dominant market share or whether it 

operates as a small firm in a large industry. Similarly, 

models may differ depending on whether the 

cooperative has a federated or centralized structure. 

Although conceptually one can imagine one grand 

theory of cooperation that would address all issues 

faced by all types of farmer cooperatives, such a theory 

would likely be so complex as to negate the main 

advantage of theory-the simplification of reality to 

facilitate analysis. Therefore, rather than to seek a 

single model of cooperatives' behavior, it is more 

realistic to seek several models, each addressing 

different aspects. In this perspective, the different 

2 

theoretical approaches outlined in this report should be; 

viewed as largely complementary rather than' 

competing. 

DEVELOPMENTS IN COOPERATIVE THEORY 

THROUGH 1980 

Economists studying cooperative theory through 

1980 tended to view the farmer cooperative in three 

distinct ways: (1) as a form of vertical integration by 

otherwise independent firms, (2) as an independent 

business enterprise, which could be analyzed as a 

variant of the investor-owned firm (IOF), and (3) as a 

coalition of firms, in which there was "a revocable 

substitution of collaboration for independent 

competition"(Sosnick, p. 2; Staatz, 1984). From the 

1940's through the early 1960's, much of the debate in 

cooperative theory focused on whether cooperatives 

represented purely a form of vertical integration by 

farmers, that is, simply an extension of the member 

firms, or whether cooperatives could legitimately be 

analyzed as organizations having scope for 

decisionmaking independent of their member firms. 

This debate was often phrased in terms of whether 

cooperatives were really "firms." While it may seem 

odd that economists would debate whether to call 

multimillion dollar organizations "firms," the real 

debate wasn't simply one of terminology. Rather, it 

was over whether management of the cooperative 

simply implemented the member-patrons' desires or 

whether it pursued goals of its own, causing the 

cooperative to act as a firm that was in some ways 

independent of the members. 

The CooperatIve as a Form of Vertical Integration 

As far back as 1922, advocates of farmer 

cooperatives such as Nourse were arguing that farmer 

cooperatives were simply extensions of the members' 

farm firms. Emelianoff, in 1942, was the first to 

analyze formally the cooperative as a form of vertical 

integration. He argued that because a cooperative 

operated at cost, it did not incur profits or losses itself; 

only its member firms incurred profits or losses. 

Therefore, the cooperative was not an acquisitive unit 

and hence not a firm. Emelianoff's views were further 

developed by Robotka and formalized into a model of 

cooperative output and pricing decisions by Phillips. 

Phillips argued that the cooperative simply 

represented a jointly owned plant operated by 
independent member firms. Throughout his analysis, 

Phillips assumed that member firms dealt exclusively 

with the cooperative. Therefore, he did not address the 

broader question of how a firm determines its degree of 

participation in the cooperative: 

"When a group of individual firms form a 

cooperative association, they agree mutually to set up a 

plant and operate it jointly as an integral part of each of 

their individual firms (or households in the case of a 

consumer cooperative). The cooperative has no more 

economic life or purpose apart from that of the 

participating economic units than one of the individual 

plants of a large multi-plant firm" (Phillips, pp. 74-75). 

Two separate issues need to be distinguished: 

Whom was the cooperative set up to serve and how 

does it make its output and pricing decisions? Phillips 

did not distinguish these issues as separate, concluding 

that since the cooperative was set up solely to serve its 

members, its decisions could be modeled as if the 

cooperative were one plant of a multiplant firm. Many 

years earlier economists had developed rules for how an 

IOF operating several different plants should set output 

levels in each plant to maximize profits, and Phillips 

argued that the optimal output and pricing rules for the 

members of a cooperative could be determined by 

simply extending this basic theory. 

Phillips' proposed pricing and output rule 

involved all the member firms producing at a point 

where their marginal costs of production were equal to 

the marginal revenue the cooperative received from an 

additional unit of output. Among the problems with this 

proposed solution is that members would not have an 

incentive to produce at that level if the cooperative 

plant faced either increasing or decreasing marginal 

costs. In those cases, the marginal cost faced by the 

member would diverge from that faced by the 

cooperative as a whole. For example, if a processing 

cooperative faced increasing marginal costs, the per-unit 

margin would fall for each additional unit of raw 

product the cooperative processed. The individual 

member would only take into account how this decrease 

in per-unit margins affected his or her profits, not those 

of the other members of the cooperative and hence 

would have an incentive to expand production beyond 

the optimum level for the cooperative as a whole. The 

member would therefore not bear the full marginal cost 

of his or her actions on the cooperative. (For details, 

see Sexton, 1984b, pp. 64-69.) Furthermore, following 

the Phillips rule requires that each member know the 

equilibrium outputs of all other members to determine 

how much to produce. 

Phillips argued that to achieve an optimum level 

of production, each member must share the benefits and 

costs of the joint plant in direct proportion to the 

member's share of the total business conducted through 

the cooperative. Similarly, the benefits and costs of 

individual departments should be allocated among the 

members in direct proportion to .1heir use of those 

departments (pp. 76-78). 

Such a view seems consistent with the 

cooperative principle of service at cost. It assumes, 

however, that: 

1. All costs of cooperative activity should be 

borne by members because they accrue all the benefits 

of that activity, 

2. All the benefits from one department of a 

cooperative accrue solely to the direct users of that 

department, 

3. All activities of the cooperative in one time 

period generate benefits only in that time period, and 

4. Overhead costs can be allocated among 

departments in a nonarbitrary manner. 

In raising the issue of sharing costs and benefits of 

the cooperative in proportion to use, Phillips helped 

spark the debate over "equal versus equitable treatment" 

of members of a cooperative. The issue has become 

more pointed in recent years with the growing diversity 

of cooperative members. Phillips clearly came down on 

the side of those who advocated differential treatment of 

members based on their degree of patronage. 

In keeping with his "theory of proportions," 

Phillips also advocated that voting in cooperatives be 

proportional to patronage. He argued that since costs 

and benefits in cooperatives should ideally be 

distributed proportionately, the rule of one-person, onevote in cooperatives "had no scientific basis" (pp. 86-

87). The argument over proportional voting continues 

today, with some contending that it is necessary to put 

control of the cooperative in the hands of those who 

, really use it. Others, however, see proportional voting 

as threatening the basic tenet of democratic control. 

The Cooperative as a Firm 

Stephen Enke, writing about consumer 

cooperatives in 1945, was the first to analyze the 

cooperative formally as a separate type of business firm. 

He pointed out that on a day-to-day basis the 

cooperative manager had to choose what to maximize 

(total sales, level of the patronage refund, profits, etc.). 

3 

II I 

1

'1' II! , , 
Enke traced the consequences for the cooperative and 

for society as a whole of choosing alternative goals. 

Enke's work represented the beginning of a long and 

often muddled debate about what cooperatives should 

or did seek to maximize.4 Often this debate confused 

what was desirable with what was feasible and did not 

distinguish shortrun outcomes from longrun outcomes. 

Enke analyzed the situation of a cooperative that 

was operating either as a monopolist or in monopolistic 

competition (fig. I). In other words, the cooperative 

had some influence over the price it could charge for its 

goods and services. (The cooperative's ability to vary 

its prices without losing all of its patrons is indicated 

by the downward-sloping demand curve in figure 1.) 

The cooperative also had some fixed investments, such 

as a store of a given size.' Enke concluded that in 

situation the welfare of both the cooperative mem 

and society as a whole was maximized if the 

cooperative manager sought to maximize the sum of 

cooperative's "profits" (producer surplus) and the 

members' benefits from lower prices (consumer 

surplus).6 This was achieved at the point where the 

cooperative's marginal cost curve intersected its ; 

demand curve (point B). At that point, the decrease i"*J 

member-patron benefits that would result from the f~ 

in the cooperative's "profits" from a unit increase in ,1:

outpu~ would be just offset by the increase in membe~ 

benefits (as measured by consumer surplus) that would;

result from the lower prices that accompanied expandcM

output (Cotterill, pp. 188-90).J~ 

Figure 1 - Alternative Shortrun Goals for a Supply or Consumer Cooperative Operating In 

Monopolistic Competition 

Price 

f>1 -... -_._-•...........•...••....•....•.... 

· lMARGINAL REVENUE 

· · 

Point A - Maximization of cooperative'S profit (analogous to IOF's goal of profit maximization) 

Point B - Maximization of sum of consumer and producer surpluses (Enke's solution) 

Quantity 

Point C - Minimization of member price consistent with covering costs ("zero surplus n solution - e.g., Helmberger-Hoos) 

Source: Enke, p. 149. Similar figures are also pr:esented in Kaarlehto (1956), p. 283; LeVay, p.12; and Cotterill, p. 189. 

4 
I 

r 

Enke's model emphasized that to maximize 

member benefits, the cooperative manager had to 

balance the benefits members received as owners of a 

profitable enterprise with the benefits they received as 

patrons of an establishment that offered favorable 

prices. Going too far in one direction or the other, that 

is, running the cooperative in a manner that simply 

maximized profits as a separate entity or running it in a 

way that simply minimized prices to members, would 

reduce total member benefits. Enke's work thus 

emphasized an important implication of the unique 

owner-patron relationship in cooperatives-the need to 

balance benefits derived as stockholders with those 

derived as patrons. 

There is a problem, however, with the managerial 

goal that Enke proposed: Under most circumstances 

members would not want to patronize the cooperative at 

the level that would maximize total member benefits. 

At point B in figure 1, the cooperative would generate a 

per-unit net margin equal to BO. If this were rebated to 

members in proportion to their patronage, they would 

likely interpret the refund as a reduction in the price, 

which would give them an incentive to expand their 

patronage beyond the welfare-maximizing point B. If 

the cooperative does not impose some limit on 

patronage, the only stable patronage point (equilibrium) 

is point C, at which point the cooperative earns no net 

margin. Point C, however, is not the welfaremaximizing point. Point B would be a stable 

equilibrium only if the members regarded the patronage 

refund as a windfall gain or if the cooperative faced 

constant marginal costs of production. In the latter 

case, the marginal cost and average cost curves would 

coincide, as would points B and C.' 

Enke's work initially was ignored by theorists 

working in the area of agricultural cooperatives. Most 

of the early work on the agricultural cooperative as a 

firm emerged in reaction to the writings of Emelianoff, 

Robotka, and Phillips, which generated much critical 

discussion in professional journals. Critics of the 

"cooperatives as vertical integration" approach attacked 

the narrow definition of the firm used by Emelianoff, 

Robotka, and Phillips, and hence the implied locus of 

decisionmaking within the cooperative, and the 

existence and stability of the cooperative equilibrium 

posited by Phillips. 

Emelianoff and his followers had argued that 

because cooperatives do not accumulate capital and 

seek profit for their own account, they did not meet the 

classical definition of a firm. The critics countered by 

describing the cooperative as a "going concern," an 

entity to which participants delegate entrepreneurial 

functions to gain the advantages of joint action. These 

authors argued that such revocable delegation of 

deci~ionmaking authority resulted in hired managers 

making most of the cooperative's day-to-day decisions. 

Managers pursued certain objectives (for example, 

maximizing the cooperative's net margins or sales), and 

the pricing and output decisions of the cooperative 

resulted from the pursuit of those objectives. 

HeImberger and Hoos, whose work became the standard 

model in cooperative theory for nearly 20 years, argued 

that the agricultural cooperative could be modeled as a 

separate firm, using tools from the standard neoclassical 

theory of the investor-owned firm. 

HeImberger and Hoos explained that the theory of 

the profit-maximizing firm needed to be modified 

before it was applied to cooperatives because, the 

authors argued, cooperatives did not try to maximize 

their own profits but rather those of their farmermembers. Cooperatives did this by operating on a zeroprofit basis and returning all their "surplus" (net 

margins) to the members. HeImberger and Hoos 

assumed that in an agricultural processing cooperative, 

the manager would try to maximize member benefits by 

maximizing the average per-unit cooperative surplus (or 

"pay price") to the farmer. For a supply cooperative, 

the analogous goal would be to minimize the price of 

the good or service sold by the cooperative, subject to 

meeting per-unit costs of production. This would be 

achieved by operating at point C in figure 1. 

HeImberger and Hoos developed models of both 

shortrun and longrun behavior by an agricultural 

processing cooperative. In the shortrun model, the 

cooperative took the amount of output supplied by the 

members as given. In the longrun model, output could 

be varied depending on whether the cooperative adopted 

an open- or closed-membership policy. Hence, unlike 

Phillips, HeImberger and Hoos addressed the question 

of when it would be in the interest of current members 

to limit further membership in the cooperative. The 

general conclusion was that it would be in the interest 

of existing members to expand membership whenever 

expansion would allow the cooperative to capture 

economies of size, thereby reducing per-unit processing 

costs' On the other hand, if the cooperative were 

facing increasing marginal costs, expanding the volume 

moving through the plant would increase per-unit costs, 

and it would be in the interest of existing members to 

restrict membership to prevent this from happening' 

Even if it were in the interest of existing members 

to limit membership, others might want to join the 

5 
cooperative if it offered better prices than alternative 

market outlets. Hence, there can exist a potential 

conflict of interest between existing members and 

potential members of the cooperative. Heimberger and 

Hoos claimed that how this conflict was resolved 

depended on who controlled the cooperative. A 

cooperative dominated by a manager intent on 

expanding the volume of business might opt for 

expanding membership, while an organization firmly in 

the hands of farmer members might restrict it. 

Although HeImberger and Hoos discussed this polen 

conflict, they did not attempt to model the bargainin " 

process among members, the board, and management; 

settle the matter. : 

Heimberger and Hoos assumed that farmermembers acted as price takers, that is, an individual 

member could not influence the price the cooperative' 

offered. Consequently, each farm-firm had a welldefined supply curve, which showed the amount of ra 

product the firm would be willing to sell to the ' 

Figure 2 - Heimberger and Hoos Model of Cooperative Price and Output Determination 

In the Long Run-Open and Closed Membership 

Raw product 

price, Pm 

Source: HeImberger and Hoos (1962), p. 289. 

Notes: Sc = Aggregate supply curve for closed-membership cooperative 

So = Aggregate supply curve for open-membership cooperative 

LRNR = Longrun net returns function 

Volume of raw 

product handled, M 

The net revenue function, as defined by HeImberger and Hoos, shows for each level of output of the cooperative the 

maximum per-unit amount (or 'Pay price") the cooperative can offer for the raw product and still cover all processing costs. The 

net revenue function is thus analogous to the cooperative's demand function for the raw product, based on the assumption that 

the cooperative strives to just break even. 

6 
cooperative at various prices. The individual firms' 

supply curves could be summed to yield an aggregate 

supply curve, showing how much raw product members 

would supply at different prices. The intersection of the 

cooperative's net revenue function with its supply 

function determined amount of output handled by the 

cooperative and the price paid to members for their raw 

product (fig. 2). In the long run, the equilibrium output 

and price depended on whether the cooperative 

followed an open- or closed-membership policy. A 

closed-membership cooperative would restrict 

membership so that the aggregate supply curve would 

intersect the longrun average net revenue curve at its 

maximum (P mc in figure 2). If the cooperative 

followed an open-membership policy, members would 

enter as long as they found it profitable to do so, 

shifting the aggregate supply curve outward (to, say, So 

in figure 2), resulting in a larger output and a lower 

raw-product price (P mo) than would obtain in a closedmembership cooperative. 

HeImberger and Hoos' assumption that farmermembers are price takers faces the same problem that 

arose with the Enke model, namely, whether a supply 

function for members of a marketing cooperative (or, 

equivalently, a demand function for members of a 

supply cooperative) can be unambiguously defined. If 

the initial price paid by the cooperative results in a net 

margin for the organization and if the margin is rebated 

to the members in proportion to their patronage, the 

members will probably interpret the rebate as part of the 

payment for their product. They will therefore have an 

incentive to expand their production further (Cotterill, 

p. 192). Only if the cooperative sets its prices in a way 

that results in a net margin equal to zero is the problem 

eliminated. HeImberger and Hoos assumed that the 

cooperative's manager knew its net revenue function, 

which specified the price the cooperative should pay for 

any given quantity of raw product to set the 

cooperative's net margin to zero and thus overcome the 

indeterminacy problem. It is highly questionable, 

however, whether cooperative managers really know in 

advance their firms' net revenue functions with such 

precision. 10 

The basic Helmberger-Hoos model was applied 

and extended in several ways during the 1960's and 

1970's. HeImberger used the model to analyze how the 

presence of cooperatives would affect market outcomes 

in different market structures. His general conclusion 

was that a monopsonistic processing cooperative that 

followed an open-membership policy would generate 

outputs and price levels closer to those that would 

prevail under perfect competition than would an IOF 

operating under the same conditions. This conclusion 

reinforced the view common in United States antitrust 

policy, at least through 1980, that cooperative 

"monopolies" did not threaten consumers if 

membership in the cooperative remained open because 

an open-membership cooperative cannot limit supply. 

Heimberger showed, however, that if the cooperative 

had a closed membership, the equilibrium output would 

be smaller and the equilibrium price would be higher 

than those obtained under an IOF. Hence, the question 

of open membership became critical in evaluating the 

impact of cooperative monopolies on the general public. 

Later, the basic Helmberger-Hoos model was extended 

to supply cooperatives (Youde, 1966, 1968), consumer 

cooperatives (Mather), and multiproduct processing 

cooperatives (see HeImberger, Campbell, and Dobson, 

pp. 558-59). A variant of the model served as a key 

part of Sunkist's successful defense against charges that 

the cooperative had illegally monopolized the California 

and Arizona citrus market in the late 1970's (Mueller, 

HeImberger, and Paterson). 

A distinguishing feature of the Helmberger-Hoos 

approach was its assumption that the cooperative 

pursued a single objective. The model did not address 

how that goal was set. Rather, it simply assumed that 

the goal had been set and that once set, all the 

cooperative's resources were devoted to achieving it. 

Hence, the model did not try to analyze conflict within 

the cooperative about what the goal(s) of the 

organization should be. 

Most theorists of the 1960's and early 1970's 

continued to base their models on this sort of 

centralized goal setting, although not all agreed with 

HeImberger and Hoos on what the cooperatives were 

trying to maximize. Most authors also continued to 

assume, as did both Phillips and Helmberger-Hoos, that 

all members faced similar if not identical cost functions, 

and hence there would be little conflict among the 

members about what goals the cooperative ought to 

pursue. The most ambitious attempt to build a general 

model of the cooperative as a firm that maximizes a 

single objective was the work of Carson, who presented 

a model of a "generalized welfare-maximizing firm" (or 

"G-firm"). This firm maximized a "generalized welfare 

function," which is basically a weighted sum of the 

"utility" (well-being) of the firm's stockholders. 

Because stockholders were free to buy and sell goods 

and services to and from the firm, farmer cooperatives, 

consumer cooperatives, the investor-owned firm, and 

7 
the worker-managed firm each represented a special 

case of the G-firm. 

The Cooperative as a Coalition 

Early models of the farmer cooperative as a form 

of vertical integration portrayed a very diffuse 

decisionmaking process within the organization. The 

cooperative as such made no decisions; only the 

individual member-firms made decisions. In contrast, 

most models of the "cooperative as a firm" developed 

in the 1960's and early 1970's saw decisionmaking in 

the cooperative as being completely centralized, 

presumably in the hands of the manager. Both types of 

models generally assumed a homogeneous membership 

and thus abstracted from intraorganizational goal 

conflicts. By doing so, these models could show that 

the maximizing activities of the individual farmermembers or of the cooperative's manager led to a 

unique and optimum (in terms of member welfare) set 

of prices and outputs for the cooperative. 

As early as the 1950's, however, several authors 

(for example, Kaarlehto, Ohm, Trifon) pointed out that 

heterogeneity of the membership, differences of 

opinion between the membership and the management 

over the appropriate goals for the organization, 

information costs, and the nature of the collective 

action itself could each prevent such a stable outcome. 

In these situations, the cooperative's behavior would 

result from a bargaining process that reflected the 

r~lative power of the different participants. These 

authors argued that the cooperative should be viewed as 

a coalition of participants (different groups of farmers, 

management, board members, input suppliers, lenders, 

and nonmember customers), each of whom had its own 

objectives and who participated in the organization as 

long as it felt its objectives were being met. 

Authors who have viewed the cooperative as a 

coalition have focused on situations in which conflicts 

could arise (1) among farmer-members of the 

cooperative and (2) between the farmer-members and 

the other participants in the cooperative, such as 

management. Authors who addressed interfarmer 

conflicts (such as Kaarlehto, Ohm, Trifon, and Pichette) 

focused primarily on situations in which individual 

members did not bear the full marginal cost or receive 

the full marginal return for their actions and hence had 

an incentive to act in ways that were inconsistent with 

the longrun welfare of the cooperative or of some of its 

members. This was often reflected in conflicts between 

current and potential members over whether to expand 

8 

n membership in the cooperative, an issue also touched ii 

upon by HeImberger and Hoos. Conflicts between :~ 

farmer-members and other cooperative participants, 'rl 

such as management, have be~n more widely discussed~ 

by European theorists (see Eschenburg and Ollila) thari:~ 

by their North American counterparts (an exception is' 

Perrault). Both groups of authors have focused on the d_: 

types of outcomes likely to be generated by the 

bargaining processes necessary to maintain the 

cooperative coalition. Their work presaged some of the' 

more recent theoretical work discussed below. 

RECENT DEVELOPMENTS IN 

COOPERATIVE THEORY 

Renewed interest in North America in the theory 

of farmer cooperation grew out of the perceived 

inadequacy of existing theory to address many of the 

issues facing cooperatives. These issues arose largely 

because of changes in the market environment facing 

cooperatives and in the structure of the cooperatives 

themselves. 

Reasons for the Resurgence 

Growth in the size of major entities in the 

economy (firms, labor unions, etc.) led to renewed 

interest in the role that cooperatives play in 

concentrated markets, particularly when the 

cooperatives themselves are very large. Some of the 

questions that arose included whether farmer 

cooperatives could effectively compete with 

multinational conglomerates, especially given 

cooperatives' constraints on raising equity capital; 

whether large cooperatives themselves posed antitrust 

problems; whether large cooperatives could improve 

systemwide coordination in the economy, including 

possibly replacing expensive government income- and 

price-support programs; and whether, with the 

increased integration of rural markets, cooperatives had 

lost their main reason for existence. 

As cooperatives became larger lmd more diverse 

in their operations, often through mergers, the 

membership of individual cooperatives became 

increasingly heterogeneous. This raised questions 

about whether one cooperative could serve a highly 

diverse group of members, each of whom had differing 

expectations of the organization. The issue was often 

phrased in terms of whether one cooperative could 

serve both large and small farmers. For example, 
should a cooperative price its services differentially 

aJ1long its members based on their volume of 

patronage? The issue applied equally well, however, to 

a cooperative whose members produced competing 

products, such as butterfat and vegetable oil, or whose 

members produced the same product in competing 

regions of the country (for example, dairy farmers in 

Wisconsin and Texas, both producing cheese for the 

national market). 

Growth in the average size of cooperatives also 

implied increased reliance on hired management to 

handle many of the major decisions facing the 

cooperative and raised issues of member control. 

Increasingly, researchers felt uncomfortable with 

models that assumed that all decisionmaking power 

resided with the members or that management 

altrUistically sought to maximize members' well-being 

with no concern for its own welfare. Furthermore, as 

large, increasingly conglomerate cooperatives began 

recruiting more managerial personnel from investorowned firms and business schools, questions arose as to 

whether cooperatives' practices were really any 

different from those of IOF's. 

During the 1970's, the shift to floating exchange 

rates, the integration of financial and agricultural 

commodity markets, and changes in the agricultural 

trade policies of several major countries, such as the 

EEC and the USSR, all contributed to much greater 

instability in agricultural markets. This instability 

further drew into question previous models of 

cooperative decisionmaking, which were all variants of 

the theory of firm decisiorunaking under certainty. 

While researchers increasingly recognized that 

existing theories of farmer cooperation did not 

adequately address these questions, they also 

recognized that over the previous 20 years there had 

been impressive advances in several areas related to the 

theory of the investor-owned firm that possibly could be 

extended to the theory of the farmer cooperative. These 

included theories of decisiorunaking under uncertainty, 

behavioral theories of the firm (for example, Simon, 

Cyert and March), agency theory (Jensen and 

Meckling), transaction-cost economics (Williamson), 

the theory of contestable markets (Baumol, Panzar, and 

Willig), and applications of game theory to firm 

decisiorunaking (Shubik). Research to investigate these 

areas gained increasing support, particularly from 

USDA's ACS.lI 

Approaches Used 

Recent work in cooperative theory falls into four 

categories: (1) extensions of the traditional work on 

the cooperative as a firm, including analysis of the 

impact of cooperatives on price and output levels in 

highly concentrated industries; (2) analyses of 

cooperatives in what Galbraith has termed "the planning 

sector," including investigation of the behavior of large, 

conglomerate cooperatives; (3) models that analyze the 

cooperative as a special set of implicit and explicit 

contracts between farmer-members, managers, and 

other employees; and (4) further work on the 

cooperative as a coalition. The approaches, particularly 

the last three, are highly complementary, often 

addressing the same issue from different perspectives. 

Indeed, many of the researchers whose work is 

described in this part of the report analyze cooperatives 

using more than one approach. 

Extensions of the "Cooperative as a Finn" 

Approach 

Several authors have continued to extend the 

"cooperative as a firm" approach, building models that 

assume that the cooperative seeks to maximize a single 

objective. These models trace the consequences of 

choosing different objectives (net margins, "pay price," 

etc.) for the cooperative's market behavior, focusing 

particularly on the implications of this behavior for 

cooperative finance and antitrust issues. In general, the 

findings of recent work on the cooperative as a firm 

reinforce those of earlier theoreticians such as Enke, 

HeImberger and Hoos, and Kaarlehto. For example, 

Royer (1982) argues that ideally the goal of a 

cooperative firm should be to maximize total members' 

welfare, which is achieved when the sum of members' 

profits from their farm operations plus cooperative net 

margins are at a maximum. This is the same goal that 

Enke posited for consumer cooperatives, and while 

desirable as a goal for the cooperative, it faces the 

problem outlined above of not being a stable shortrun 

outcome unless a quota is imposed on the members' 

purchases from or sales to the cooperative. 

Analyses of Firm-Level Decisions. Cotterill 

focuses on developing a theory that links cooperatives' 

product pricing and finance decisions. His approach 

differs from some of the earlier theoretical work in that 

he does not focus on what goals the cooperative should 

ideally pursue, but rather on what types of goals it can 

achieve and sustain given how its members and 

9 

'Ii :i '!I 
competitors react to various pricing and financing rules. 

For example, Cotterill examines how different rules for 

allocation of joint costs among products in a 

multiproduct cooperative can affect the competitive 

position of the cooperative in the various markets in 

which it operates (pp. 200-201). By allocating a lower 

percent of joint costs to products in more competitive 

markets, the cooperative might be able to expand 

market share in that market at the expense of only small 

losses in a less competitive market whose products now 

have to bear a higher proportion of the joint costs. The 

final outcome depends, of course, on how the 

cooperative's competitors react to its pricing and costallocation decisions. Cotterill's emphasis on 

identifying sustainable or stable outcomes is similar to 

some of the game-theoretic approaches to cooperative 

theory discussed below. 

Cotterill stresses that the financial performance of 

a "competitive yardstick" cooperative cannot be 

evaluated independently of its performance in the 

product market because the return to the cooperative's 

investments accrues to members (and nonmembers) 

largely through more favorable product prices, not 

improved cash-flow to the cooperative itself . 

. Therefore, the worth of an investment by a competitive 

yardstick cooperative must be evaluated in terms of the 

consumer and producer surpluses it generates to both 

members and nonmembers through more favorable 

prices (from both the cooperative and its competitors), 

not just by increased net earnings of the cooperative. 

Cotterill's work thus reinforces the basic finding of 

Enke, namely the need to balance the returns members 

receive from their cooperative as owners of a profitable 

enterprise with the benefits derived as patrons of an 

organization that offers favorable prices and forces its 

competitors to do so as well. 

An implication of this work is that cooperatives 

that act as competitive yardsticks should not evaluate 

potential investments simply using measures, such as 

the internal rate of return, based on how the investment 

affects the cooperative's cash-flow. The evaluation of 

cooperative investments is more complex due to the 

organization's integrated nature. Cotterill defines the 

"global value" of a cooperative as the amount of money 

members would pay rather than do without the 

cooperative (p. 216). The effect of an investment on 

the cooperative's global value has two components: (1) 

the return on investment as measured by the 

cooperative's net margin and (2) the increased cashflow to members that results from the more favorable 

prices they payor receive as a result of the 

10 

cooperative's activities. The first component includes 4 

benefits members may receive when the cooperative '1 

dominates a particular market and is thereby able to il

earn substantial net margins through strength in '~ 

purchasing and seIling and ability to develop new .. ~ 

products and services. The second component, which .'

Cotterill calls the "security value" of the cooperative, "~ 

includes benefits members derive from more favorable 

prices offered both by the cooperative and by IOF's thatt

are forced to compete. Evaluating cooperative 

investments solely on the basis of their impact on the 

cooperative's net margin ignores the security value of 

the cooperative and may lead either to underinvestment 

in the cooperative or to a choice of investments that do 

not maximize member benefits. This suggests that in 

evaluating prospective investments, cooperative 

managers and board members should look not only at

how the investment will affect the cooperative's net 

margins but also how it will affect competition in the 

industry. Only when the cooperative has no 

"competitive yardstick" effect on the economy does the

cooperative's cash-flow alone provide an unbiased 

measure of the worth of an investment to the 

cooperative (Cotterill, pp. 216-17).12 

Some of the "cooperative as a firm" analyses 

(Cotterill, Lopez and Spreen) also examine what 

constitutes "optimum" output and pricing levels for a 

cooperative and reach a familiar conclusion: If the 

cooperative faces a U-shaped average cost curve, such 

as shown in figure 1, and if members take the patronage 

refund into account when making their sales or 

purchase decisions, only the "zero-surplus" solution 

(point C) emerges as a stable equilibrium. I' Lopez and 

Spreen label this point the "myopic equilibrium," 

arguing that if members could, through some 

mechanism such as member quotas, limit demand for 

the cooperative's services to Q2, their welfare would 

increase. They argue that the failure to achieve such an 

equilibrium voluntarily represents a prisoner's 

diIemma. 14 If the longrun average cost curve is Lshaped, however, marginal cost equals average cost, 

and consequently the welfare-maximizing solution 

corresponds with the zero-surplus solution, leading to a 

stable welfare-maximizing solution. 

Cotterill (p. 195) goes on to analyze the 

conditions under which it would be in the current 

members' interest to restrict membership, again 

reaching conclusions similar to those of HeImberger 

and Hoos. His work verifies that when average costs of 

production for the cooperative are rising, it pays current 
members to restrict membership, but such restrictions 

come at the expense of nonmembers, including the 

publiC at large.15 If, in this situation, nonmembers want 

to join the cooperative, it is because they perceive a 

benefit from doing so. But because increased volume in 

the cooperative would raise its average cost of 

production, per-unit net margins would fall, hurting 

current members. 16 If, on the other hand, the 

cooperative is operating in a range where its average 

costs of production fall with increasing volume (that is, 

where there are economies of size), both new and old 

members would benefit from expanding the 

membership. 

Lopez and Spreen, who build a model of a 

processing cooperative, address a similar issue, namely 

when it makes sense from the point of view of current 

members to buy raw product from nonmembers. They 

conclude that so long as the cooperative can earn an 

after-tax net margin on nonmember business (after 

having served all the members) and does not rebate the 

net margin to nonmembers, members are better off if the 

cooperative expands its nonmember business. For 

example, the cooperative might buy from nonmembers 

in order to expand volume enough to capture economies 

of size in processing. This can be particularly important 

when the cooperative is competing with large-volume 

IOF's. There is a danger, however, in relying too 

heavily on nonmember trade. If left unchecked, the 

cooperative members may have an incentive to rely 

increasingly on nonmember trade, retaining the 

cooperative surplus earned on that trade as profits for 

the original members. As original members retire, the 

remaining members have an incentive to restrict new 

membership, as an expansion of membership would 

dilute each remaining member's share of the profits 

earned on nonmember business. As this attrition 

continues, the organization is gradually converted from 

a cooperative into an investor-owned firm. McGregor 

discusses theoretically how this process can occur and 

documents how it has occurred in production 

cooperatives for plywood in the United States and for 

agricultural products in the South Pacific. There is thus 

a theoretical justification for placing limits on the 

amount of nonmember business all cooperatives (not 

just Capper-Volstead cooperatives) can conduct as well 

as restrictions on the terms under which it is conducted. 

Unrestricted nonmember business can threaten the 

cooperative nature of the enterprise. 

Analyses of the Impact of Cooperatives on 

Market Performance. Cotterill uses his firm-level 

models to analyze the impact of cooperatives on 

industrywide performance in various market structures. 

He concludes, as did HeImberger, that in monopoly and 

oligopoly situations, openmembership cooperatives that 

pay aU refunds in cash play an important competitive 

yardstick role in moving price and output levels closer 

to those that would obtain under perfect competition. 

Cotterill argues that if the cooperative, on the other 

hand, has a closed membership, retains all net margins 

as unallocated reserves, or issues an allocated patronage 

refund that is only redeemed after a long period, it will 

not enhance competition. His analysis shows that such 

a cooperative, operating in an oligopolistic market in 

which the other firms are restricting output to jointly 

maximize profits, will price its goods and services at the 

same level as the other oligopolists. Hence, the 

presence of the cooperative in the market will not 

change the behavior of the other firms at all. 

Why won't such a cooperative enhance 

competition? If the cooperative retains all net margins 

as unallocated reserves (perhaps investing them in 

activities outside the particular subsector in which they 

are earned), then the farmer-members whose business 

generates those margins will not have any incentive to 

expand their patronage with the cooperative. (See the 

discussion of the "hunter cooperative" in the next 

section.) Similarly, if all patronage refunds are 

redeemed as cash only after many years, the members 

are likely to ignore the patronage refunds in making 

their current patronage decisions, basing those decisions 

almost entirely on the cooperative's cash price. 

Cotterill argues that even if the cooperative does rebate 

net margins to members in cash, if the cooperative 

follows a closed-membership policy, the rebate will not 

induce much more production and hence will not 

threaten the competing firms' market shares. 

These conclusions are based on the assumption 

that the main way in which the market share of the 

cooperative increases is through attracting new 

members. If the market share does not change, then the 

other firms in the market have no incentive to change 

their pricing behavior. Under some circumstances, 

however, cooperatives' ,market share may increase even 

if the existing cooperative has a closed membership. 

The most obvious way is if farmers who are currently 

nonmembers organize another cooperative to try to 

duplicate the original cooperative's success. 

Even if a second cooperative is not formed, the 

original cooperative may increase its market share. If, 

for example, members of the cooperative, in response to 

their share of supernormal profits, expand their 

production of products handled by the cooperative by 

11 

I 

I 
reallocating resources from other activities or by 

buying out their neighbors who currently patronize the 

competing IOF's, the market shares of the other firms 

in the industry will be threatened. Consequently, they 

are likely to offer more attractive prices to farmers to 

win back their patronage. The analysis also assumes 

that unallocated retained earnings are used only in ways 

that competitors view as nonthreatening. If the 

unallocated retained earnings simply substitute in the 

cooperative's financial structure for allocated equities, 

the cooperative may be able to retire existing allocated 

equities earlier than would otherwise be possible. Such 

retirement would increase current returns to members, 

thereby inducing them to increase their patronage. If 

one relaxes the assumption that the output of the 

cooperative is sold in perfectly competitive markets, 

Cotterill's conclusions also may not hold. If the 

cooperative has a significant share of the output market 

and members are free to expand output in response to 

higher prices, an oligopolistic cooperative may "break 

the market" for the processed product, causing its IOF 

competitors to withdraw. This appears to have 

occurred in the United States processed fruit and 

vegetable markets during the late 1970's (Staatz, 1984, 

pp. 294-96). 

Despite these caveats, Cotterill's work represents 

an important theoretical advance in that it provides a 

framework to analyze the impact of large cooperatives' 

membership policies and financing practices have on 

market performance. Viewing cooperatives' pricing 

and financing decisions together also sheds new light 

on the alleged tax advantages of cooperatives (Cotterill, 

pp.222-23). Because of the patron-owner relationship, 

the benefits of cooperative ownership are distributed to 

the members via patronage, in the form of lower prices 

or as patronage refunds. Such benefits are taxed as 

ordinary income. In contrast, many of the benefits of 

IOF ownership take the form of capital gains in the 

value the stock, which, prior to the 1986 tax reform in 

the U.S., were taxed at a substantially lower rate than 

ordinary income. Cotterill shows that under quite 

plausible tax rate assumptions, cooperatives were 

actually disadvantaged relative to IOF's prior to the 

1986 reform. 

Cotterill also addresses why cooperatives may 

want to use unallocated retained earnings when they 

face a risky market environment (pp. 250-51). When 

the market is risky, the cooperative's returns will 

fluctuate from year to year. Management can draw on 

unallocated reserves to smooth out patronage refunds 

over time. This gives a steadier return to members, 

12 

makes investment in the cooperative appear less risky 

to them, and hence increases their willingness to invest

in the organization. The increased willingness to inves

in the cooperative for a given interest rate reduces the 

cost of capital to the cooperative, thereby allowing it to

expand more rapidly.17 

Competition Among Cooperatives. Another issue

theorists have investigated recently is competition 

among cooperatives (Cotterill; Rhodes, 1983, 1987a). 

Such competition is common, even when the 

cooperatives involved are owned by the same farmers, 

resulting in the farmer-owners' competing against 

themselves. Cotterill and Rhodes show that in 

industries where diseconomies of scale are not 

significant and where the minimum efficient scale of 

operation is large relative to the size of the market, 

farmers would often be better served if their 

cooperatives colluded or merged rather than engaged in 

head-to-head competition. Such collusion or 

consolidation would allow more efficient use of 

facilities and the capturing of scale economies, which 

could be passed on to the farmer-members. As Rhodes 

(1987a) points out, however, there are often pressures 

from within the competing cooperatives that encourage 

such competition. These include a desire to "keep 

management on its toes," the vested interests of 

management and board members who might lose their 

positions if a merger occurred, the vested interests of 

farmers whose handling costs to the cooperative might 

increase dramatically if operations were consolidated 

(particularly important for bulky items like milk), and 

support for competition by those farmers who reside in 

the overlapping areas of the competing cooperatives. 

These farmers, for whose patronage the rivals are 

competing, often benefit from cutrate prices, etc., that 

result from the competition, while members in 

nonoverlapping areas bear the costs. Rhodes suggests 

that such situations may be amenable to analysis using 

bargaining models such as those discussed below. 

Analyses of Cooperatives In the Planning Sector 

John Kenneth Galbraith, in his book The New 

Industrial State, divides the economy into a "planning 

sector," composed of large firms that possess market 

power, and a "market sector," composed of smaller 

firms that operate as price takers in competitive 

markets. Galbraith argues that planning-sector firms 

are forced by the "technological imperatives" of 

modem large-scale production to make huge fixed 

investments in plant and equipment. These make the 
firms extremely vulnerable to economic fluctuations. 

To protect themselves, the planning-sector firms try to 

control their environment by administering prices, 

influencing the political system to ensure favorable 

regulatory treatment and macroeconomic stability, and 

SO on. Three authors (Rhodes, Sexton, and Shaffer) 

have attempted to extend earlier theoretical work on the 

effects of cooperatives on concentrated markets to 

include discussion of the role of large cooperatives in 

the planning sector. 

Theory o/Contestable Markets. Previous 

analyses, such as that of Heimberger, compared the 

price and output levels that cooperatives would generate 

in concentrated markets with those that would prevail 

under perfect competition. Rhodes (1983, 1987b) and 

Sexton (1984a) extend this type of analysis by using 

concepts from the recently developed theory of 

contestable markets (Baumol, Panzar, and Willig). This 

theory stresses that it is not the degree of market 

concentration per se that determines market 

performance, but the nature of the costs in the industry 

and the barriers to entry and exit. Hence, an industry 

with a high degree of market concentration may 

perform well if it is "contestable," that is, if barriers to 

entry are low enough that the threat of entry from 

competing firms disciplines the behavior of firms 

presently in the industry. 

Rhodes and Sexton show that cooperative entry or 

the threat of entry into a broad range of concentrated 

market structures can playa powerful role in forcing 

IOF's to behave more competitively. They point out 

that the threat of entry by a cooperative may be more 

effective in improving the market performance of 

incumbent firms than the threat of entry by an IOE A 

potential IOF entrant decides whether to enter the 

market based on an evaluation of the likely post-entry 

market conditions, for example, whether the incumbent 

firms will retaliate by offering farmers more favorable 

prices. A farmer cooperative, on the other hand, bases 

its decision on pre-entry conditions. If the incumbent 

firms do not retaliate, the cooperative captures a 

substantial net margin, which it rebates to members. If 

the incumbents do react 'by offering farmers more 

favorable prices, the cooperative's members benefit 

directly. Either way, the farmer-members gain. The 

incumbent firms can deter cooperative entry by offering 

farmers more favorable prices and cutting profit 

margins, but this simply means that these firms are 

forced to act in a more competitive manner, which 

obviates the need for a cooperative (Sexton, 1984a, pp. 

283-356). Hence, the mere threat of cooperative entry 

may serve an important competitive yardstick function. 

Rhodes (1987b, p. 110) states that historically this effect 

has "been greatest in those markets of moderate 

barriers-where the rewards have been worth seeking 

and have not been so protected that cooperatives could 

not achieve them." 

Rhodes (1983) argues that because cooperatives 

rebate net margins to members, in certain oligopolistic 

industries, large regional cooperatives may eventually 

tend to dominate the market. Concentrated industries 

often are characterized by high profit margins. If lOP 

competitors do not cut their prices in response to the 

entry of a cooperative, the cooperative earns a 

substantial net margin, which it rebates to members. 

The rebates attract new members, increasing the 

cooperative's market share. Faced with the option of 

cutting their prices substantially to compete with the 

cooperative, the IOF's may simply prefer to withdraw 

gradually from the industry and redeploy their capital in 

other, higher return sectors of the economy. Rhodes 

suggests that this phenomenon explains the expansion 

of several large midwestern supply cooperatives during 

the 1970's, when the petroleum and agrochemical 

industries in the United States were operating under the 

price umbrella of the oil oligopoly. 

The Hunter Cooperative. While cooperatives 

may often reinforce competition, Rhodes (1987c) argues 

that in some large cooperatives the relationship between 

the members and management is very similar to that 

which exists between an IOF and its customers. In such 

cooperatives, the preceding arguments may not hold. 

He describes what he calls the "hunter cooperative," an 

organization that aggressively seeks new activities 

based solely on the criterion of relative profitability, 

with little attention to members' current activities. It is 

an organization that, in Enke's terms, focuses purely on 

the maximization of producer surplus rather than on 

striking a balance between the benefits derived from 

producer surplus and those derived from consumer 

surplus. In other words, the hunter cooperative seeks 

profit simply at the level of the cooperative rather than 

attempting to improve vertical coordination between the 

farm and the rest of the marketing chain. While there 

are probably no cooperatives that operate continuously 

as pure hunter cooperatives, many cooperatives may 

exhibit hunter behavior from time to time. 

Rhodes argues that such organizations are often 

disloyal to their members in the sense that the capital 

contributed by current members is used to finance entry 

into new activities from which the current members do 

not benefit. For example, retained earnings from cherry 

13 

I 

I' 
marketing might be used to finance entry into beef 

processing. "Even the classic defense of the 

cooperative monopoly-that it doesn't really 

monopolize because the flow-through to members 

encourages producer supply response rather than supply 

restriction-would not apply to a cooperative 

management that diverts its earnings into developing 

new enterprises and markets" (p. 163). 

Cooperatives do, however, need flexibility to 

modify their mix of activities as economic conditions 

change, and Rhodes argues that the challenge for 

cooperatives is to find a middle ground: "A member 

whose cooperative can abandon him at any time does 

not have much incentive to be a member. But a 

cooperative that can never turn away from old members 

is likely a firm condemned to eventual insolvency" 

(ibid.). 

Shaffer's analyses of the role of the cooperative in 

the planning sector focuses on the role that large 

cooperatives (or federations of smaller cooperatives) 

could play in improving economic coordination in the 

context of pervasive uncertainty. His work emphasizes 

the explicit and implicit contracts between the 

cooperative and its members and is discussed in the 

following section. 

The Cooperative as a Nexus of Contracts 

The debate over whether to model the cooperative 

primarily as an independent firm or as a form of 

vertical integration by its member firms is far from 

resolved. As outlined above, some authors continue to 

view the cooperative as a separate firm pursuing a 

single objective. On the other hand, Sexton (1984a, p. 

15) argues that cooperation represents "horizontal 

coordination to achieve mutual vertical integration," 

and Shaffer (p. 61) contends that cooperatives represent 

neither market relationships nor vertical integration, but 

"a third general mode of organizing coordination, 

combining characteristics of markets and internal 

(integrated) coordination in ways which are different 

from either." There are, of course, elements of truth in 

each of these views. The cooperative is a legal entity 

separate from its member firms, having its own 

bureaucracy and its own decisionmaking apparatus. ' 

This apparatus, however, is at least nominally 

controlled by the members, via the board of directors, 

and members join the cooperative to gain the 

advantages of vertical integration. In the final analysis, 

what is crucial is not how we label the cooperative but 

the nature of the business relationships among the 

14 

various participants in the organization (farmer- d 

members, managers, other employees, board members.,j 

etc.). These relationships can be viewed aSj~ 

representing a set of explicit and implicit contracts. ';j 

For example, when a farmer joins a cooperative, that :1 

person implicitly contracts with the other members of ' .. ~ 

the organization for a share of the net earnings of the . ,i 

organization (distributed in proportion to patronage) in \ 

exchange for an initial membership fee, other capital 

contributions to the cooperative (that is, per-unit 

retains), and meeting the other conditions of 

membership. This implicit contract is different from 

that which exists between a stockholder and an 10F, 

and hence one would expect the two types of 

organizations to behave differently. It is the nature of 

the implicit and explicit contracts among participants in 

a cooperative that determines the degree of member or 

managerial control, the degree to which the cooperative 

achieves goals similar to those of a vertically integrated 

firm, and so on. 

Since 1980, several authors have examined the 

nature of these contracts, in part out of concern for 

whether members really "control"large cooperatives 

and whether the behavior of these cooperatives is really 

any different from that of large 10F's. These authors 

have used two related theoretical tools, originally 

developed for the analysis of ownership and control 

issues in 10F's: applications of agency theory and 

analyses based on concepts from transaction-cost 

economics. Both approaches have then been used to 

analyze potential opportunities for and barriers to using 

cooperatives to improve economic coordination. 

Agency Theory Approaches. Agency theory 

views an economic organization as a collection (or 

nexus) of contracts among various participants who 

provide the organization inputs, including labor, 

managerial talent, and capital, and purchase its outputs. 

For example, stockholders of an 10F hire (contract 

with) management to carry out the day-to-day running 

of the firm in a way that will maximize the 

stockholders' return on investment. In exchange, 

management receives certain benefits, such as salary 

and stock options. Agency theory posits that each 

participant (or "agent") in an organization seeks to 

maximize his or her own welfare. There is no 

automatic presumption, for example, that managers of 

10F's selflessly promote the interests of stockholders. 

To ensure that management acts in the interest of the 

stockholders, the stockholders must incur the costs of 

monitoring the performance of management. The 

higher the costs of keeping tabs on management, the 
more latitude management has to pursue its own goals. 

Agency theory analyzes the types of mechanisms 

available to agents for monitoring others' compliance 

with the implicit and explicit contracts within an 

organization, the costs that each monitoring mechanism 

involves, and the implications of these for the 

organization's performance. 

Two contracts that agency theorists particularly 

stress are those that specify the nature of the "residual 

claims" in the organization and the allocation of the 

decision process among agents (Vitaliano, 1983). When 

agents contract to perform services in an organization, 

they promise to do so in exchange for either a fixed 

claim or a residual claim on the cash-flow of the 

organization. A fixed claim is a fixed amount of 

money, such as a salary or an input price, received for a 

good or service provided to the organization. A residual 

claim is a claim on the amount of money left over from 

the cash-flow after all the fixed claims (wages, input 

payments, etc.) have been met. Hence, residual 

claimants are those agents who contract for a share of 

the difference between the organization's gross revenue 

and the payments promised under fixed-claim contracts. 

In an IOF, the residual claimants are the owners of 

common stock, who share the after-tax profits of the 

firm in proportion to their capital investment. In a 

cooperative, the residual claimants are the patronmembers, who share the net margins of the cooperative 

in proportion to patronage. 

Agency theorists separate decisionmaking 

authority in the organization into decision control and 

decision management. Decision control involves 

setting policies for the organization and monitoring 

their implementation, and is handled by representatives 

of the residual claimants, such as the board of directors. 

Decision management involves actually implementing 

those policies, and is handled by managers. Using this 

framework, Condon summarizes the key difference 

between a cooperative and an IOF as follows: 

"In an IOF, control over how resources are used 

and the rights to residuals ultimately rest in the hands of 

the owners of common stock in the organization. 

Decision control is based on the share of capital 

invested, and decisions are presumed to be judged on 

the merits of the returns generated by that capital. In a 

cooperative, the basic property rights governing 

ownership and control are structured so that decision 

control and the rights to residuals rest solely in the 

hands of those who patronize the firm as 

members .... Ancillary to this restructuring of rights is the 

fact that cooperative firm control is generally based on 

I-man, I-vote terms and not by share of capital 

invested. In addition, because membership and control 

in such organizations is restricted, these rights have 

value'only so long as the member firm or individual 

remains an active patron." 

Condon and Vitaliano ar8}le that a very important 

result of this structure of residual claims in a 

cooperative is that it results in a very limited or 

nonexistent secondary market for cooperative equity 

certificates, such as common stock. Because there is no 

secondary market, cooperative equity certificates 

typically do not have a market-determined value that 

fluctuates in response to changes in the earnings 

potential of the organization. The equity certificates' 

only cash value is their par value at the time they are 

redeemed, which does not necessarily reflect the value 

of the cooperative to the member. II 

The lack of a secondary market for cooperative 

stock may have several significant consequences 

(Condon and Vitaliano; Staatz, 1984, pp. 94-114; Stutz, 

1987a, pp. 44-50; Shaffer, pp. 63-65). First, it restricts 

member-owners from diversifying their portfolios to 

spread risk. Owners of farmer cooperatives typically 

have invested most of their assets in their farms and 

cooperatives, that is, in one or two particular lines of 

agriculture. In contrast, IOF stockholders often have 

highly diversified portfolios (particularly since the rapid 

growth of mutual funds), which reduces investment 

risk. Because the owners of a cooperative have "all 

their eggs in one basket," they may pressure 

cooperative managers to be more risk averse in their 

strategies than their IOF counterparts. 

Second, the lack of a secondary market for 

cooperative stock denies the cooperative's stockholders 

the possibility of using the market price of the stock as 

an indicator of management performance or as a way of 

rewarding better managers. Managers of IOF's 

recognize that poor performance on their part will affect 

the stock price, which may lead to either proxy fights 

aimed at replacing management or attempts at hostile 

takeovers. I, Indeed, a whole industry, typified by The 

Wall Street Journal and various investment counseling 

services, has emerged to convey information to current 

and potential stockholders of IOF's about the 

performance of managers, based in part on how their 

actions have affected stock prices. IOF's have also tried 

to strengthen managers' incentives to perform well by 

offering them stock options. If the firm does well 

financially, boosting the stock price, the manager 

benefits directly. Because cooperatives lack a 

fluctuating stock price, members cannot use the stock 

15 

ii
price as an indicator of management performance, the 

board cannot offer managers stock options as an 

incentive to perform better, and there is no threat of 

hostile takeovers to discipline management. 

Consequently, cooperative boards of directors are 

forced to playa much more activist role than their IOF 

counterparts in directly monitoring the performance of 

the management. Failure to do so can leave 

management with considerable scope to pursue its own 

objectives. 

A third consequence of the lack of a secondary 

market for cooperative stock is that members of the 

cooperative may have an incentive to underinvest in the 

cooperative, particularly with respect to long-term 

investments. Members may even push for 

decapitalization of the firm. Decapitalization can take 

several forms short of outright liquidation. For 

example, patron-owners may encourage management to 

enter into price wars with competitors, which generate 

short-term benefits in the form of more favorable prices 

for the patrons, but at the cost of the long-term viability 

of the cooperative. This tendency in cooperatives to 

favor short-term gains at the expense of long-term 

losses has been dubbed "the horizon problem." It 

arises because equity certificates of a cooperative 

confer a residual claim on the earnings of the 

organization only so long as the member remains a 

patron. Therefore, a stockholder of a cooperative has 

an incentive to underfund investments that would be 

profitable for the cooperative as a whole but whose 

benefits accrue largely after the member has retired. 

The tendency is likely to be most acute among 

members nearing retirement, as they are eager to 

recuperate their equity from the cooperative before 

retiring. The theory also suggests the problem will be 

more severe in cooperatives lacking mechanisms, such 

as viable equity retirement programs that permit 

members to recover their accumulated investment in 

the organization by means other than decapitalizing the 

co-op. The problem is also likely to be more acute in 

local cooperatives, where the members are individual 

farmers who have a limited lifetime, than in regionals, 

where the members are local cooperatives that are 

likely to remain members of the regional for an 

indefinitely long period (Haydu, pp. 76-78).20 

Several factors may attenuate the horizon 

problem. If farmers can transfer their membership 

intergenerationallyor if the cooperative membership is 

salable with the farm, then the current member has an 

interest in the long-term viability of the cooperative and 

the horizon problem can be overcome.21 Similarly, if 

16 

the cooperative follows a completely openmember 

policy, then the value of the cooperative will be 

capitalized into the farms of the cooperative's servO 

area, and the farmers will have an incentive to mai 

the organization. The problem will also be redUced 

members gain nonmonetary benefits from bequeath· ; 

a viable cooperative to their heirs or if the cooperati 

runs a pension program for retired members, whose . 

value depends on the future financial performance of ". 

the cooperative. 

Although it may be in the interest of some of 

older members to try to decapitalize the firm, it is 

in the interest of the management. Ironically, .. , 

management, in pursuing its own interest, may end uP 

defending the cooperative from some of its members,\ 

(Murray, 1983a, p. 57). .~~ 

The impossibility of benefiting from capital gaO • 

of cooperative stock may also reduce the incentive to,;, 

found a cooperative even when the net social benefits'i 

of doing so exceed the net social cost (Shaffer, p. 66k 

Whereas an entrepreneur who founds a successful 10 . 

is rewarded with substantial capital gains as the net' l 

worth of the firm increases, no such reward exists for'.: 

the founder of a cooperative. Rather, the motivation 

found a cooperative sometimes may be more a sense 

social injustice than immediate personal gain. Beca 

individual material incentives to start a cooperative 

may be lacking even when ample social justification Ii 

the cooperative exists, there may be a legitimate role 

for governmental support to encourage the formation

cooperatives. 

Transaction-Cost Approaches. The transactioncost approach to cooperative theory builds on earlier 

theoretical work on the IOF by Ronald Coase and morO

recently by Oliver Williamson. A transaction occurs

whenever a good or service is transferred between two

stages of a production system or subsector that 

potentially could be run by separate firms. (Williamson

refers to such stages as "technologically separable 

activities.") For example, when processing apples are 

transferred from grower to processor a transaction has 

occurred, as growing and processing can be carried ou

by two separate firms. There is no technical reason 

why the growing of the apples and their processing 

need to be carried out by the same firm. There may, 

however, be good economic reasons why the two 

activities should be integrated within one firm, and 

transaction-cost economics attempts to explain what' 

those reasons are. More generally, the transaction-cos

approach focuses on how the characteristics of a 

transaction affect the costs of handling it through 
markets, through bureaucracies (for example, a 

vertically integrated firm), or through other forms of 

organization, such as cooperatives. The basic idea is 

that each type of good or service has a set of 

characteristics that affect whether it is cheaper to 

produce and distribute the good or service through 

markets, integrated firms, cooperatives, or some other 

means. 

The costs of carrying out a transaction include 

gathering and processing the necessary information, 

reaching decisions within the organization, negotiating 

contracts with other parties, and policing and enforcing 

the contracts. Transaction costs arise largely because 

the pervasive uncertainty in the world prevents 

contracts from specifying all possible future 

contingencies and because when unforeseen 

circumstances arise, people may act opportunistically, 

taking advantage of their trading partners. Por example, 

if a firm buys a highly specialized piece of equipment 

and later experiences an unanticipated problem with it 

that is not covered by an explicit warranty, the seller of 

the equipment may charga an exorbitant amount to 

repair it. Because it is impossible, when drafting a 

contract, to foresee all possible future events and design 

the contract to deal with each of them explicitly, it is 

necessary to design the contract in a general way that 

protects each party if unforeseen occurrences arise. Por 

example, a contract may specify an arbitration 

procedure to settle any dispute not explicitly covered 

elsewhere in the contract. Each form of business 

organization, such as an lOP or a cooperative, embodies 

different types of such explicit and implicit contracts. 

The transaction-cost approach argues that the 

organizational form or "governance structure" that 

minimizes the sum of production and transaction costs 

for a given activity will have a competitive advantage 

and tend to dominate that activity. Transaction-cost 

economists would argue, for example, that it is no 

accident that the collection and processing of milk in 

many countries is organized on a cooperative basis but 

that automobile dealerships are not. Certain 

characteristics of milk production (for example, 

perishability of the product and the high level of 

specialized investment by the farmer) give cooperatives 

a particular advantage in this domain, while such 

characteristics do not exist in auto retailing. 

Each governance structure embodies a different 

set of explicit and implicit contracts among the 

participants in the transaction. Shaffer and Staatz 

(1984, 1987b) analyze how these contracts among 

participants in a cooperative, particularly between the 

cooperative "firm" and the member-patrons, affect the 

performance of the organization compared with that of 

an lOP. The contract linking the farmer-members with 

the cooperative differs from the links within a vertically 

integrated firm because the cooperative usually cannot 

dictate the production decisions of its farmer members. 

The contract also differs from coordination that relies 

on the spot market, in that the contract between the 

cooperative and the member is always a contingent 

contract, with the final price adjusted, via the patronage 

refund, depending on the cooperative's performance. 

Although lOP's sometimes also practice contingent 

pricing, cooperatives may have an advantage in this 

form of risk sharing because farmers may be more 

willing to trust that their own organization will not use 

this practice dishonestly. In many ways, the 

cooperative-patron relationship resembles two types of 

contracting that sometimes occur among lOP's, called 

"neoclassical contracting" and "relational contracting" 

(Williamson, pp. 70-72). In neoclassical contracting, 

the contracting parties make no attempt to specify all 

possible future contingencies, but simply specify a 

process, such as binding arbitration, to resolve 

unforeseen disputes. Relational contracting involves a 

more general understanding among the contracting 

parties that disputes will be settled amicably to preserve 

fl valued long-term relationship. 

The level of trust among the contracting parties is 

particularly important when the contract leads to 

investment in highly site- or use-specific assets, such as 

a fruit orchard. Once made, the value of these assets in 

use greatly exceeds their salvage value (that is, the 

investment in the assets becomes a sunk cost), which 

makes the asset owner potentially liable to exploitation 

by its trading partner (for example, a processor). By 

acting opportunistically, for example, by promising a 

remunerative price for the output produced by the asset 

and then reneging on the agreement once the investment 

in the highly specific asset has been made, a trading 

partner who has other market alternatives can capture 

the returns that would have otherwise accrued to the 

highly specific asset (Staatz, 1984, pp. 164-70). In such 

situations, there are incentives to integrate vertically 

(for example, for the orchard owner to buy the 

processing plant to escape this type of exploitation), and 

in many situations cooperatives represent a superior 

form of vertical integration to lOP's (Shaffer, pp. 77-78; 

Staatz, 1984, pp. 164-67; Staatz, 1987b, pp. 88-90). 

Pailure to deal with the trust issue may lead to missed 

economic opportunities, as potentially profitable 

investments are foregone because of the potential risk 

17 

I I, 

III 

II 

I, 

I 

I ' 
arising from opportunistic behavior (Shaffer, pp. 77-

78). 

Cooperatives and Economic Coordination. As 

economies move away from subsistence agriculture to 

more complex forms of organization, the task of 

coordinating the activities at various levels of the 

economy becomes more crucial. Because cooperatives 

involve elements of vertical integration and because of 

the way the explicit and implicit contracts linking 

participants in cooperatives are structured, cooperatives 

potentially offer advantages in coordinating certain 

types of activities (Shaffer; Shaffer and Staatz). One 

area of theoretical work has focused on these potential 

advantages and the barriers to achieving them. 

Economic coordination can be formally defined as 

the process whereby productive activities in various 

parts of the economy are harmonized so that goods and 

services are produced without major bottlenecks. 

Shaffer (p. 61) describes the coordination problem as 

follows: 

"In the modern economy, the activities of 

thousands of people and resources scattered over 

thousands of miles contribute to producing and 

distributing a single product such as a loaf of bread. 

The contributions are made over a period of many 

years, past contributions being embedded in capital 

goods, knowledge, institutional structure (including 

firm organization), and inventories. How to coordinate 

these contributions when at each step of the productiondistribution sequence information and mechanisms of 

control are imperfect is a central economic problem. 

Production decisions must be made under conditions of 

uncertainty as to future supplies of inputs and demand 

for products. The future is inherently uncertain. If 

information about future input supplies, product 

demands, and transformation functions were perfect, 

resources were perfectly mobile and divisible, contracts 

were perfectly drawn and enforceable, and no firm had 

power to influence its prices, coordination would be 

simple. But none of these conditions exist in the real 

world." 

Coordination problems exist at four levels: 

1. Coordination within the firm, which Shaffer 

calls micro-micro coordination; 

2. Coordination between individual firms (for 

example, between farmers and processors), or micro 

coordination; 

3. Coordination of total supply with total demand 

for individual commodities or industries at each step of 

the production-distribution process (macro 

18 

coordination); and ~ 

4. Coordination of aggregate demand with 

aggregate supply for the economy as a whole (mac~ 

macro coordination). ~

-\

Although coordination at these different levels ~ 

aggregation is interrelated, most of the theoretical ~ 

has focused on the potential roles of cooperatives in 

improving vertical coordination among firms in a giv

subsector (micro coordination) and in helping to 

~chiev~ a better supply-~e~and balance withi~ entire

mdustnes (macro coordmatIOn). The emphasIs has 

been on those characteristics of cooperatives that c0u

improve the functioning of the entire cooperative 

system rather than just the performance of individual 

cooperatives. 

The analysis of micro coordination stresses the

potential for greater use of forward contracts-for 

example, between farmers, input distributors, and in

manufacturers. Such contracts could allow farmers a

their cooperatives to capture many of the advantages 

vertically integrated firms, such as reduced inventory 

and delivery costs, while maintaining advantages of 

decentralized decisionmaking. The analysis of macro

coordination harkens back to the work of Sapiro

focusing on ways that cooperatives can help "match 

productive capacity with ultimate consumer demand 

prices consistent with costs" (Shaffer and Staatz, p. S

This research focuses on issues such as competitio

among cooperatives and the potential to use 

cooperatives to replace elements of current governme

support programs. Shaffer suggests that a system of 

forward deliverable contracts, administered by 

openmembership cooperatives, could provide 

participants in the economy with more reliable 

information on future supply, demand, and prices pri

to important production decisions, thereby improving 

macro coordination. Such a system might also provi

a more stable environment for farmers, thereby 

contributing to a more orderly and less painful 

adjustment out of agriculture. 

The work on cooperatives and coordination 

generates numerous hypotheses regarding how 

cooperatives could take additional actions to improve 

economic coordination and increase member benefits

An obvious question is why they do not. Three 

possible answers come immediately to mind: (1) 

members and managers are unaware of the potential 

benefits; (2) while there would be positive net benefi

to undertaking these actions, the distribution of costs 

and benefits among participants is such that key acto
do not have an incentive to participate (in particular, 

!bere may be free-rider problems); (3) the theory is 

y,rrong. Obviously, one avenue for future research is to 

sort out these alternatives.22 

The cooperative as a Coslnlon 

Recent theoretical work has also built on earlier 

work that viewed the cooperative as a coalition. The 

basic notion of this approach is that the cooperative is 

composed of several kinds of participants (farmers of 

different types, managers, other employees, board 

lIlembers, input suppliers, and lenders), each of whom 

seeks to maximize his or her own well-being. They 

lIlay not all have the same objectives for the 

cooperative, so the participants bargain among 

themselves to agree on courses of action that enable 

each participant to achieve at least some of his or her 

objectives. For example, to qualify for a loan, a 

cooperative's board and management may have to 

bargain with the lender over what the appropriate 

performance criteria should be for the cooperative. The 

coalitional analyses focus.on the types of stable 

outcomes (equilibria) that are likely to emerge from 

such bargaining processes and whether common 

cooperative practices, such as one-member, one-vote 

and patronage-based financing, generate stable 

equilibria, that is, situations in which no participant has 

an incentive to change his or her behavior. 

Voting Within Cooperatives. Initial attempts by 

economists to analyze how the various participants 

within a cooperative came to agree on rules, for 

example, for cost allocation and financing, tried to 

model the bargaining as a voting process (Zusman, 

Knoeber and Baumer). These analyses concluded that 

several of the common financing and cost-allocation 

practices of cooperatives are likely to lead to stable 

equilibria. The models assumed, however, that the 

members decided each issue entirely on its own merits 

(no vote swapping occurred), that the membership was 

not split into two widely divergent camps on the issue, 

and that all issues were decided by a simple majorityrule vote.23 If these assumptions are met, modeling the 

cooperative's decision process reduces to modeling the 

preferences of the median or "typical" member. It soon 

became apparent, however, that in most agricultural 

cooperatives, policy decisions involve several 

interrelated issues, about which members may have 

quite diverse preferences. In such situations, simple 

majority-rule voting models need to be replaced with 

bargaining models (Zusman). 

Bargaining Within Cooperatives: GameTheoretic Approaches. Murray (1983a, 1983b) 

analy~es decisionmaking in British agricultural 

cooperatives, particularly concerning financing, as a 

bargaining process between farmer-members and 

managers. He argues that because of the imperative 

facing farmer-members to invest heavily in their own 

farm operations, members have an incentive to 

underfinance their cooperatives. Managers, on the other 

hand, favor capital accumulation, as this increases 

managerial flexibility and growth of the cooperative, 

which is strongly correlated with managerial rewards. 

Managers, therefore, push for unallocated reserves. 

Ironically, if management is successful in pursuing its 

own goal of growth rather than the goals of the 

membership, the manager may act as guardian of the 

cooperative's long-term viability by ensuring its 

adequate capitalization, albeit at the cost of some loss of 

member control. Murray argues that the financing 

arrangements that finally emerge depend on the_relative 

bargaining strengths of the parties involved, but he does 

not formalize the bargaining process in an explicit 

mathematical model. 

In recent years, a few researchers have attempted 

to model group choice in cooperatives using game 

theory (Sexton 1984, 1986; Staatz 1984, 1987b). Game 

theory is a technique developed to analyze group choice 

when the preferences of the members of the group 

regarding an issue are at least partially conflicting and 

when the welfare of each member (or "player," to use 

the game-theory term) depends on the actions of the 

other members.24 These are conditions that often hold in 

cooperatives. For example, members may disagree 

about whether to offer volume discounts to large 

patrons, and the welfare of small-volume members 

depends on how large-volume members behave-for 

example, whether they abandon the cooperative if no 

discounts are offered .. 

Sexton and Staatz argue that many decisions in 

cooperatives, such as the pricing of goods and services, 

the allocation of joint costs and pool receipts among 

producers of different products, and whether to merge 

competing cooperatives, can be modeled using the 

theory of cooperative games. Cooperative games are 

those in which players communicate and make binding 

commitments, such as contracts. The theory of 

cooperative games is commonly used to model 

situations in which there are gains from joint action by a 

potential coalition of players, but where the players 

must bargain among themselves about how the net 

benefits of the joint action are to be shared. Failure to 

19 
agree on an allocation of net benefits among players 

prevents the coalition from forming. In other words, in 

order for the players to cooperate with one another, it is 

not enough for them to know that by working together 

they can bake a bigger pie. They must agree on a way 

of slicing the pie so that each piece is at least as big as 

that which the player could get by working 

independently or with some other coalition. The 

essence of the argument is that individuals will not join 

in the cooperative's activities unless they are better off 

under that arrangement than under any other alternative 

open to them. Game theorists label the set of 

allocations of benefits among players that makes 

everyone better off by remaining in the coalition 

(cooperative), the core of the game. 

Sexton and Staatz apply game-theoretic models to 

a number of different situations facing cooperatives, 

including the pricing of goods and services to members. 

They show that in many situations, charging the same 

price to all members does not generate a stable 

equilibrium; some members (those with better market 

alternatives) have an incentive to defect from the 

cooperative. The analysis also shows that average-cost 

pricing, such as advocated by HeImberger and Hoos 

(fig. 1), does not generate a stable coalition when 

average costs are rising, as some subgroup of members 

always has an incentive to break away and produce the 

good for itself at a lower average cost. The optimal 

way of financing a cooperative, in terms of always 

generating a core solution, involves two-part pricing, 

that is, charging all members the marginal cost of 

producing the good or service and levying fixed 

charges (for example, required stock purchases) to 

cover the fixed costs. To generate a core solution, the 

fixed charges need to vary by member in proportion to 

how much the member's profits are enhanced by 

membership in the cooperative (Sexton, 1986). 

Hence, the game-theoretic analysis shows that in 

certain circumstances, differential pricing of goods and 

services is necessary to prevent certain members from 

leaving the cooperative. To prevent defection, the 

differential pricing must reflect both how a member's 

patronage affects the cooperative's costs of operation 

(this is just an extension of the service-at-cost 

principle) and the member's strategic opportunities for 

obtaining the good or service outside the cooperative. 

Furthermore, the analysis shows that in situations 

where a cooperative's average cost of providing a good 

or service to the membership first decreases then 

increases, there may be no way of pricing the service, 

other than Sexton's proposed two-part pricing, that 

20 

' ..j' 

i 

. ~ 

gives everyone an incentive to stay in the organizati~ 

This situation suggests that cooperatives need to be '~ 

very careful in deciding when to expand their . "4 

membership and/or mix of activities, expanding Only~ when there are clear synergies that allow the" i' organization to hold down its average costs. The ~.4., 

impossibility of finding a stable way of pricing the· ~ 

services among a heterogeneous membership may 

prevent cooperatives from "doing all things for all r<. 

people." II 

While the game-theoretic analysis shows that " 

many of the current pricing practices of cooperative$ J 

are theoretically unstable, it implicitly assumes that ~ members of the cooperative possess perfect informatj, 

about their market alternatives and can establish new' 

contracts with alternative buyers and suppliers at no ,~ 

cost. Obviously, neither condition holds in reality.' 

Incorporating into the analysis these, other transactioq 

costs, and the nonmonetary benefits that some mem~ 

may derive from belonging to a cooperative broadenS:1 

the set of potentially stable solutions (Staatz, 1984, pp, 

279-314; Staatz, 1987b, pp. 132-39). 

Nonetheless, the basic concept underlying the 

"cooperative game" analysis remains valid: to preve~ a proposed allocation of costs and benefits in a farmer.; 

cooperative from inducing defection, careful attention 

has to be given to the payoffs facing individual . 

members. The increasing tendency of large local 

supply cooperatives ("super-locals" or "miniregionals") in the Midwest to bypass their regionals an 

contract directly with input manufacturers is an 

example of the type of breakdown in a cooperative 

coalition that may occur when the allocation of costs 

and benefits among members lies outside the core. 

Cooperative Loyalty: Theory of Noncooperativ4 

Games. Certain types of situations in agricultural 

cooperatives, such as how to ensure member loyalty il1 

a "competitive yardstick" cooperative, are more 

appropriately modeled using another branch of game 

theory, the theory of noncooperative games (Staatz, 

1984, pp. 263-75; Staatz, 1987b, pp. 127-31). In 

noncooperative games, high communication costs, 

unenforceability of contracts, or lack of trust lead 

players to eschew joint strategies and act 

independently. A particularly well-known form of 

noncooperative game is called "the prisoner's 

dilemma," which describes a situation in which all the 

players face individual incentives to act independently 

even though the group as a whole, as well as each 

individual member, would be better off if they 

cooperated.25 
The prisoner's dilemma has been used by 

. onornists to describe free-rider situations, that is, 

~uatiOns in which group action can make everyone 

~tter off but in which individuals can share in the 

benefits of the group action without paying a portion of 

the costs. If enough people act as "free riders" in this 

way, the group action doesn't occur. An example of 

"free riding" in cooperatives is a group of dairy farmers 

breaking away from a dominant dairy cooperative that 

provides market-balancing services. These farmers 

form a limited-service cooperative, serve their members 

at a lower cost, and still benefit from the larger co-op's 

market-balancing actions. If enough farmers form such 

breakaway cooperatives, the large cooperative will 

collapse or have to abandon its market-balancing 

services, making all dairy farmers worse off. A more 

general example of free riding is the failure of farmers 

to patronize their cooperative adequately even though 

they recognize that the "competitive yardstick" 

activities of the cooperative are responsible for the 

favorable prices offered by the IOF's. 

If such situations truly represent prisoner's 

dilemmas, then game theory predicts that cooperatives' 

provision of services like these will ultimately break 

down due to pervasive free riding. However, two 

characteristics of the classical prisoner's dilemma that 

ensure this dismal outcome need to be examined. First, 

the players are unable to make binding commitments 

with each other. Second, the game is played only once, 

and the players have no concerns about cooperating in 

subsequent periods, developing reputations as reliable 

partners, and so on. If they do, a simple prisoner's 

dilemma may not be an appropriate modeP6 For 

example, farmers don't simply face a one-time decision 

of whether to join and support a cooperative; that choice 

is continually before them. Reputations clearly do 

matter. Cooperatives may expel habitually 

"noncooperative" members even if doing so imposes 

some short-term cost on the remaining members. 

If players face recurrent prisoner's dilemmas, 

patterns of cooperation among the players may evolve. 

If a single-period game (called a constituent game) is 

infinitely repeated, a new gaine is defined (called a 

Supergame ) in which the payoffs are the net present 

values of the stream of benefits from the constituent 

game. Game theorists have shown that even if the 

constituent game is a prisoner's dilemma, the resulting 

SUpergame need not be. Staatz (1984, pp. 265-69; 

1987b, pp. 129-31) uses the theory of supergames to 

derive suggestions for attenuating freeriding in 

cooperatives. His analysis suggests: 

(1) Cooperative loyalty will be greater among 

those who will be farming for an indefinite period 

compared to those who are close to leaving farming, 

provided' there is no way for the individual leaving 

farming to continue to benefit from the existence of the 

cooperative, such as through capitalization of the value 

of the cooperative into the value of the member's land, 

through a "pension" provided by the retirement of the 

member's accrued equity in the cooperative, or through 

non-monetary (psychic) benefits from supporting the 

cooperative.27 If those leaving farming will have no 

further payoffs from the cooperative once they leave, 

theoretically they have no incentive to remain loyal to it 

as they near retirement. 

(2) Cooperative loyalty increases as the penalties 

(both monetary and psychic) for disloyalty increase. 

Although this is hardly a surprising finding, it is 

sometimes ignored by cooperative practitioners. 

Although managers sometimes express astonishment 

that members who have substantial investments in a 

cooperative are not more loyal to the organization; in 

many instances the benefits a member receives from 

investment in a cooperative is only weakly conditional 

on continued patronage (Staatz, 1987a, pp. 40-41). 

(3) A farmer's cooperative loyalty decreases as he 

or she increasingly discounts future returns compared 

with current returns. For example, highly leveraged 

farmers are likely at times to face severe cash-flow 

constraints and therefore have a high discount rate. The 

widespread notion that young farmers as a group 

display less cooperative loyalty than older farmers may 

in part be attributable to younger farmers being more 

highly leveraged than their older counterparts. In a 

cash-flow bind, many young farmers may not be able to 

afford cooperative loyalty if more favorable prices or 

credit terms are available elsewhere. 

Conclusions. The game-theoretic analysis 

stresses that farmer cooperatives cannot always singlemindedly pursue the simple objectives posited in earlier 

models of cooperative behavior, such as maximization 

of per-unit surplus. Doing so may result in a 

distribution of member benefits that creates incentives 

for certain members to leave the organization. 

Similarly, given a heterogeneous membership, rules 

such as "equal treatment for all" may in certain 

circumstances lead to no service for anyone, as they 

precipitate the disintegration of the organization. 

Furthermore, because of the free-rider problems 

inherent in many of the activities undertaken by 

cooperatives, in some circumstances what is good for 

the individual cooperative participant may not be good 

21 

I 

i, 

I 

I 

i I 

J 

" 

,i 

I, " 

II 
for the cooperative as a whole. Therefore, if 

cooperatives are to succeed in fulfilling important 

social roles such as acting as competitive yardsticks, 

they may need to develop rules that increase the cost of 

exiting from cooperatives. Developing such rules 

involves striking a delicate balance, as retaining some 

threat of member exit may be necessary to ensure good 

performance by the board and management. 

SUMMARY, CONCLUSIONS, AND 

IMPLICATIONS 

Cooperative theory has nearly come full circle. 

The early models of the cooperative as a form of 

vertical integration viewed decisionmaking in 

cooperatives as being entirely decentralized, residing 

solely with the farmer-members. 1 he "cooperative as a 

firm" models, on the other hand, saw the cooperative as 

maximizing a single objective, presumably set for it by 

the manager. Much of the recent theoretical work 

reviewed above has reintroduced a degree of pluralism 

into models of cooperative decisionmaking, but has 

done so in a broadened and institutionally richer 

framework than that of the early models. Not only has 

the list of potential participants been broadened to 

include managers, other personnel, competitors, 

nonmember customers, input suppliers, and the state, 

but the complexity of the decisionmaking process itself 

has been more fully portrayed. 

Implications of Recent Theoretical Research 

The recent theoretical work has shown that the 

structure of cooperatives offers them opportunities and 

creates challenges for them different from those present 

in IOF's. Consequently, cooperatives may perform 

differently than IOF's, both as individual economic 

entities and in their effect on the wider economy. 

Theory suggests that whether an individual cooperative 

realizes its potential for improving economic 

performance and farmer welfare depends critically on 

the cooperative's structure and practices. To answer the 

question posed at the beginning of this report, 

cooperatives can be still relevant, but whether they are 

is largely up to them. 

Cooperative Goals and Governance 

The recent theoretical research suggests that 

setting operational goals for individual cooperatives 

involves striking delicate balances. For example, 

22 

"! 

unfettered pursuit of "the bottom line" in the sense oil 

maximizing the cooperative's net margin is subopti . 

as is the sole pursuit of more favorable prices to 

farmers. Hence, the evaluation of investments is m 

complex for a cooperative than for an IOF, as one 

to take into account the investments' effects both on 

cooperative's net margins and on market prices. 1be' 

cooperative also needs to strike a balance between 

serving members in their current activities and 

branching out into new activities if that is necessary , 

preserve the cooperative's ability to continue serving l

' 

the majority of its patron-owners.' 

When the membership of the cooperative is 

heterogeneous, the cooperative also needs to balance 

benefits among the various members to preserve the . 

stability of the organization. For example, the game- , 

theoretic analyses demonstrate that in some instances '; 

differential pricing of goods and services to members: 

necessary to prevent those with better market 

opportunities from abandoning the cooperative, whicb;

could leave the remaining members worse off. Game ,;

theory also offers some guidelines on how such" 

differential pricing ought to be structured. ,J

Exactly where the balance should be struck J 

between these various objectives will vary by 

cooperative, depending on its structure, the type of ~ 

membership it serves, the goods and services it ~ 

provides, and the market environment in which it 

operates. Striking such balances is one of the key 

responsibilities of the board of directors in settingij 

policy for the cooperative.J. 

Cooperative Finance 

The nature of the patron-owner relationship has 

important implications for cooperative finance. 

Restricting ownership to patrons limits the potential 

pool of equity capital for cooperatives as well as 

management's options for tapping it. The patron-own~ 

relationship also restricts the emergence of secondary 

markets for cooperative stock, which may lead to more 

risk-averse behavior on the part of cooperatives, a 

tendency for members to underinvest in the 

organization, and more scope for management to 

pursue its own goals. To attenuate these problems, 

theory suggests that cooperatives need to establish 

reliable equity retirement programs and explore new 

financing options. Such options need to be examined 

carefully, however, as there is a danger that some may 

compromise the basic cooperative nature of the 

organization. 
Theory also suggests that because cooperatives 

lack a fluctuating price on their equity certificates, 

which in IOF's serves as an important indicator of 

management performance, the boards of directors of 

cooperatives need to be more attentive than their IOF 

counterparts in monitoring the performance of 

management. In this sense, the tradition of member 

control in cooperatives represents a structural necessity, 

not just an ideological preference. Ensuring member 

control presents a challenge, particularly in large 

cooperatives, where the complexity of the cooperative's 

business and the transaction costs to individual 

members of interacting with the board and management 

may insulate management from effective member 

control. Hence, there is a theoretical justification for 

greater use in such cooperatives of member committees 

and strong education programs for board members and 

owner-patrons. 

Improving System Coordination 

The recent theoreti~al work also suggests that 

potential exists for improving the performance of the 

entire cooperative system, not just of individual 

cooperatives. For example, in some cases there is 

theoretical justification for more collaboration and less 

competition among cooperatives. Such collaboration, 

which could take the form of joint ventures, 

consolidations, or mergers, could reduce total system 

costs and improve returns to farmers. Both gametheoretic analysis and common observation, however, 

indicate that several factors may work to block such 

collaboration, such as the vested interests of current 

managers, patron-owners, and board members and the 

belief by some members that competition is the only 

effective means of ensuring some control over 

management. Hence, any movement toward greater 

collaboration among cooperatives will have to address 

these issues. 

The game-theoretic analysis suggests that in some 

circumstances cooperative members would be better off 

taking collective action via the cooperative, but that 

incentives exist for them to behave independently, 

acting as free riders. Examples include the reluctance 

of members to enter into binding contracts that would 

lead to economies in input supply and the lack of patron 

commitment to a cooperative that is acting as a 

competitive yardstick. Theory suggests that to capture 

the potential for improved coordination, cooperatives 

need to develop mechanisms to increase commitment, 

such as contracts between cooperatives and their 

members (including contracts between locals and 

regionals) that have significant penalties for 

nonperformance. The need for increased commitment 

is likely to be particularly important in federated 

systems, where locals may act independently of their 

regionals. The danger, however, in increasing the costs 

to members of not patronizing their cooperatives is that 

such action may remove the threat of competition (the 

loss of patronage) as a tool for ensuring good 

performance by management and the board. Therefore, 

theory also suggests that the development of 

mechanisms to increase member commitment needs to 

be coupled with actions aimed at strengthening member 

control. The current discussion in several federated 

cooperatives of moving toward more of a hybrid 

system, combining the commitment of a centralized 

cooperative with the grassroots control of a federated 

structure, represents an attempt to strike such a balance. 

Public Polley Toward Cooperatives 

The recent theoretical research reaffirms that there 

are often valid justifications for public policies to 

support farmer cooperatives, particularly because of 

their effects on competition in highly concentrated 

markets and their potential to improve economic 

coordination. This work thus reinforces the earlier 

analyses by authors such as HeImberger, but does so for 

a broader range of market structures than the previous 

analyses. The recent work, however, also cautions that 

the public should not grant carle blanche to 

cooperatives. Certain types of cooperative structures 

(for example, Rhodes' "hunter cooperative") may 

behave similarly to an IOF conglomerate. There is also 

theoretical justification for restrictions on the volume of 

business cooperatives may conduct with nonmembers 

and still legally qualify as a cooperative. Unrestricted 

member business can undermine the basic nature of a 

cooperative. 

Theory suggests that two structural characteristics 

of a cooperative may be particularly important when 

evaluating its impact on market performance. First, 

does the cooperative follow an open- or closedmembership policy? All theoretical analyses since the 

1950's have shown that it is extremely difficult for even 

very large cooperatives to exert monopoly power if they 

do not restrict membership. Second, how extensively 

does the cooperative rely on unallocated retained 

earnings? Unallocated reserves represent a pool of 

"unowned" capital that management can use for its own 

ends, and heavy reliance on them could allow even an 

23 

1

. 
openmembership cooperative to exert market power. 

Such market power would arise because net margins 

earned in one activity would not necessarily flow back 

to members engaged in that activity to encourage 

greater supply response. While some use of 

unallocated reserves may be necessary to give the 

cooperative flexibility in financing its operations, 

heavy reliance on such reserves may undermine the 

cooperative nature of the organization. 

Implications for Future Research 

Conflicts remain in the theory of farmer 

cooperation. The most obvious is between the work of 

those authors who continue to model the cooperative as 

a firm that maximizes a single objective and much of 

the other recent theoretical writings that view 

cooperatives as organizations composed of many 

individuals, each pursuing his or her own goals. The 

"cooperative as a firm" models have proved useful for 

certain types of market structure analyses and have the 

advantage of generating determinate outcomes. 

However, they are of little use in addressing many of 

the issues of group choice facing cooperative 

participants, and to date they have usually continued to 

assume perfect knowledge, although Cotterill has 

begun to incorporate decisionmaking under uncertainty 

into his analysis of cooperative finance. 

Recent theoretical work that pictures the 

cooperative as a nexus of contracts or as a coalition 

yields a number of new conclusions and hypotheses 

about the behavior and performance of farmer 

cooperatives, but often the conclusions are not fully 

determinate. For example, the game-theoretic work 

concludes that to avoid inducing defections from the 

cooperative, financing rules must lie within the "core" 

of the game, but often several rules meet this criterion. 

The models cannot predict which of these rules will be 

chosen. Similarly, the work based on transaction-cost 

economics suggests that cooperatives can improve 

economic coordination in a number of situations; 

whether cooperatives do in fact improve coordination 

depends on the specific operating procedures adopted 

by the cooperatives, which the theory does not predict. 

At least two specific areas in cooperative theory 

merit further analysis. The first involves modeling the 

behavior of various forms of joint ventures between 

cooperatives and IOF's. In response to the difficulties 

cooperatives face in raising equity capital, cooperatives 

are increasingly exploring joint ventures with IOF's or 

creating IOF subsidiaries that are partially or wholly 

24 

owned by the cooperatives. Many in the cooperative 

community are concerned that such undertakings 

violate the very nature of cooperatives and raise 

important public policy questions. For example, sho 

a cooperative operating a joint venture with an lOP be 

able to finance those activities with loans from the 

Bank for Cooperatives? To address these questions, 

analysts need models and theories that predict how 

such cooperative-IOF joint ventures and for-profit 

subsidiaries owned by cooperatives are likely to beha 

in the market. For example, how is the behavior of a .

for-profit subsidiary of a cooperative likely to differ '. 

from that of a cooperative directly involved in the sam~ activities? .. 

American industry is facing increasing levels of .

concentration and conglomeration. Because of these, a 

second area that warrants further theoretical work is .

how to arrange greater cooperation among cooperative~ 

and between cooperatives and their patrons tOl 

counterbalance the market power of large IOF's in; 

certain segments of the economy. In some areas, it is 

not clear that cooperatives, as presently structured, can 

compete in the shortrun with the "deep pockets" of 

conglomerate firms. Yet the long-term consequences o

having no cooperatives in these markets might be 

severe. 

Theoretical work is by its nature hypothesisgenerating rather than hypothesis-testing. While there 

are still many fruitful areas for further work in 

cooperative theory in addition to those outlined above, 

such as more fully incorporating uncertainty into the 

"cooperative as a firm" models, perhaps the most 

promising current area for researchers is to begin 

testing some of the hypotheses flowing out of the recen

theoretical work. For example, does evidence suggest 

that the "horizon problem" predicted by agency theory 

is in fact a serious problem? Why are some of the 

seemingly large opportunities for cooperatives to 

improve economic coordination that are predicted by 

theory being missed? There are ample opportunities to 

keep cooperative researchers busy for some time to 

come. 
Notes 

1. Some of the material presented here appeared in 

abbreviated fashion in Staatz (1987c). 

2. For more comprehensive surveys of the 

theoretical literature on cooperatives prior to 1980 see 

Vitaliano (1976); HeImberger, Campbell, and Dobson 

(pp. 556-62); LeVay; Staatz (1984, pp. 9-57); and 

Sexton (1984a, pp. 50-103). 

3. For an introduction to the theory of consumer 

cooperatives, see Enke. Classic works on the theory of 

the labor-managed firm include Domar, Vanek, and 

Ward. Domar's model is almost completely analogous 

to HeImberger and Hoos' model of an agricultural 

marketing cooperative. For recent analyses of the 

theory of agricultural production cooperatives, see 

McGregor; Guttman and Haruvi; and the references 

contained in those works. 

4. This became known as the debate over the 

"cooperative maximand." For a detailed discussion, see 

Cotterill, pp. 182-212; Baleman, Edwards, and LeVay; 

and Rhodes (1983), pp. 1092-93. 

5. The fixed investments are indicated by the Ushaped average cost curve in figure 1. (In economic 

jargon, the cooperative is operating in the "short run.") 

In the long run, all factors of production can be varied, 

leading to an average cost curve that is horizontal. 

6. Economists define producer surplus as the total 

returns a producer receives for a good or service minus 

the variable costs of production. In the figure, producer 

surplus is represented as the area above the firm's 

supply curve but below the price. Consumer surplus is 

defined as the well-being (utility) a consumer receives 

from a good or service minus the value to the consumer 

(in terms of well-being) of the money spent on the good 

or service. Hence, if a consumer would be willing to 

pay more for a good than the actual market price, that 

person receives a positive amount of consumer surplus 

when buying the good. In the figure below, consumer 

surplus is represented by the area below the demand 

curve but above the price. 

Price 

Quantity 

7. Rhodes (1983, pp. 1092-93) has expressed 

doubt that in reality a cooperative earning a substantial 

unit net margin, as would occur at point B, would allow 

members to expand patronage to point C. He points out 

that expanding beyond point B involves "overloading" 

the cooperative's facilities-that is, accepting so much 

patronage that the cooperative IS operating well beyond 

its point of minimum unit cost. Rhodes argues that 

while the problem of overloading may arise in 

marketing cooperatives that contract to accept all that 

their members deliver, "many marketing cooperatives 

and presumably all supply cooperatives have no such 

obligations. It is difficult to imagine a modem regional 

cooperative that would allow shortrun overloading to 

eliminate its earnings, given that the cooperative has no 

such contractual obligation and there are alternative 

market outlets or supply sources for producers" (p. 

1092). The ability to resist overloading requires, of 

course, that the management and the board refuse 

member demands for increased patronage in the short 

run, possibly expanding plant size in the long run to 

accommodate more business. Such overloading would 

also be less likely if patronage refunds are issued 

primarily in the form of allocated equities that are 

redeemed only after a long period. In this situation, the 

patron is likely to regard the patronage refund, when it 

is finally redeemed for cash, as a windfall gain rather 

than part of the original price. 

8. Assuming that the expanded production by the 

cooperative did not lead to a lower price for its 

processed product. 

9. HeImberger and Hoos' analysis assumed that 

each member-firm was currently producing at its profitmaximizing point and hence had no incentive to 

increase its individual patronage with the cooperative. 

If this were not the case, the argument would also apply 

to the question of when it would be in the collective 

interest of the cooperative's members to allow 

individual members to expand their patronage with the 

cooperative. If such expansion led to increasing 

marginal costs for the cooperative, the membership as a 

whole would have an economic interest in limiting the 

amount of business individuals could carry out with the 

cooperative (for example, by establishing tonnage 

contracts). The problem in establishing such limits is 

that it is often politically impossible in the cooperative, 

for while it may be in the collective interest to limit 

patronage, many individual members have incentives to 

expand their patronage, and hence they pressure the 

25 

I
board to oppose any such limits. 

10. An alternative interpretation is that the rawproduct price shown in figure 2 is the price net of the 

patronage refund. In this case, the manager would not 

have to know the cooperative's net revenue function in 

advance. But for the members to have a well-defined 

supply curve in terms of this net price, they would have 

to know in advance what their patronage refund would 

be, which is equivalent to saying that the members 

would have to know in advance the cooperative's net 

revenue function. 

11. Particularly significant was an ACS-supported 

"Cooperative Theory Project," which funded research 

at the University of Missouri, Virginia Polytechnic 

Institute and State University, the University of 

Connecticut, and Michigan State University. The 

research by Rhodes, Condon, Vitaliano, Cotterill, 

Shaffer, and Staatz discussed in this report was 

supported by this project. 

12. A potential problem arises, however, if the 

cooperative makes an investment that simply leads all 

firms in the market to offer farmers more favorable 

prices but does not increase the cooperative's net 

margins. Farmers then have an incentive to act as "free 

riders," benefiting from the lower prices offered by the 

cooperative's competitors but not bearing any of the 

cost of supporting the cooperative that made those 

lower prices possible. This type of free-rider problem 

and how to address it have been analyzed by theorists 

who view the cooperative as a coalition. 

13. An equilibrium is a situation in which no 

member has an incentive to change his or her level of 

patronage with the cooperative. Cotterill presents his 

analysis for both a supply cooperative, such as shown 

in figure 1, and a marketing cooperative, while Lopez 

and Spreen present graphical analysis only for a 

marketing cooperative. The issues discussed for the 

marketing cooperative are completely analogous to 

those raised for the supply cooperative, although the 

graphs differ. Due to space limitations, only the graph 

for the supply cooperative is presented here. One can 

apply figure 1 to the case of a marketing cooperative by 

simply interpreting it as showing the demand for and 

costs of supplying marketing services to members. For 

a critique of the argument presented here, see the 

discussion of Rhodes' work in note 7. 

26 

14. A prisoner's dilemma is a situation in which 

group of people's "rational" pursuit of individual self; 

interest leaves every member of the group worse off 

than they would have had been had they worked 

together. This particular prisoner's dilemma in 

cooperatives was first discussed by Kaarlehto in 1955; 

A more general discussion of prisoner's dilemmas in 

cooperatives appears in the section on the cooperative' 

as a coalition. For more details, see Shubik or Staatz, 

1987b. 

15. Assuming that the market for the final prod~ 

is effectively competitive. . 

16. In this situation, potential new members 

would be better off forming their own cooperative if 

they could operate it at an average unit cost lower than 

that which the old cooperative would experience with 

an expanded membership. 

17. Murray (1983b) has analyzed other reasons 

why managers may prefer to use unallocated reserves. 

Such reserves give managers considerable flexibility in 

dealing with unforeseen financial crises and in keeping 

disaffected groups of members within the cooperative. 

When a group of members threatens to leave because it 

feels it is being treated poorly relative to other 

members, managers may use unallocated reserves to 

offer them incentives (for example, in terms of better 

prices) to stay in the organization. 

18. Even in those instances where cooperatives 

allow equity certificates to be traded among members, 

the potential market for voting stock is very limited 

compared with that for the common stock of publicly 

held corporations because in a cooperative ownership i: 

restricted to patrons. Furthermore, within cooperatives 

there are generally strict limitations on sales of equitie~ 

that carry voting rights, such as common stock and 

membership certificates, compared with equities that dl 

not carry voting rights (Cobia et aI., pp. 57 -63). 

19. The threat of a hostile takeover arises when a 

group of outside investors believe that poor 

performance by the current management has lowered 

the firm's stock price below that which is justified by 

the firm's long-term earnings potential. The outside 

investors therefore bid for a controlling share of the 

firm, with the aim of installing a more able 

management team and thereby benefiting from the 

appreciation in the value of the stock. 
r 

20. The horizon problem does not arise in IOF's 

because IOF stock confers a residual claim on the 

earnings of that firm in perpetuity. A well-functioning 

secondary market for the IOF stock will therefore value 

it in terms of the expected present value of the firm's 

future earnings. Stockholders can realize the 

capitalized value of those future earnings at any time 

by selling the stock. 

21. Intergenerational transfer of ownership can be 

faciliated if the member-farm firms are legally 

incorporated and the corporation, rather than the 

individual proprietors, are the members of the 

cooperative. 

22. ACS is currently funding empirical research 

on these issues at Michigan State University. For 

example, see Haydu. 

23. Technically, the models assume that the 

frequency distribution of the members' preferences 

regarding a particular issue has a single peak, as in a 

bell-shaped curve. 

24. Basic introductions to game theory include 

Shubik and Luce and Raiffa. Howard Raiffa, in The 

Art and Science of Negotiation, presents an insightful 

and extremely readable account of how ideas from 

game theory can help in everyday decisionmaking. 

Staatz (1984, Appendix B) presents basic elements of 

game theory useful in modeling cooperatives' behavior. 

25. The prisoner's dilemma was first described by 

Luce and Raiffa (pp. 94-102), who developed the 

following story to illustrate the situation. The police 

arrest two men suspected of burglarizing a home, but 

lack the evidence to convict them without one of them 

confessing. The district attorney puts the prisoners in 

two separate rooms and offers each the following deal, 

letting each know that his accomplice has been offered 

the same proposition. If neither confesses, the DA has 

enough evidence to convict them both on a trumped-up 

charge of disturbing the peace, for which they will each 

be sentenced to a year in jail. If one confesses and turns 

state's evidence while his compatriot does not, the one 

who confesses will go free while his partner will have 

the book thrown at him and will likely be sentenced to 6 

years in prison. If both conf~ss, the prosecution will be 

more lenient and ask that each be sentenced to 4 years. 

The payoffs to the two prisoners from following 

different strategies are summarized in the matrix, which 

shows the number of years each player can expect to 

spend in jail depending on what both he and his partner 

do. For example, if prisoner A does not confess while 

prisoner B does, prisoner A will spend 6 years in jail 

while prisoner B goes free. This is indicated by the 

ordered pair (6,O) in the northeast comer of the matrix. 

Payoft's (years in jail) in a Prisoner'S Dilemma 

Not Confess 

Prisoner A 

Confess 

PrisonerB 

Not Confess 

(1,1) 

(O,6) 

Confess 

(6,O) 

(4,4) 

No matter what strategy prisoner B follows, 

prisoner A is always better off confessing. If B refuses 

to confess, A can escape all punishment by confessing 

and turning state's evidence. If B confesses, A will be 

jailed for 6 years if he doesn't confess but only 4 years 

if he does. The same logic applies to prisoner B. If the 

prisoners could communicate and make binding 

commitments to each other, than the best mutual 

strategy would be for them both not to confess. 

Lacking the ability to make such deals, each has an 

individual incentive to confess, even though he realizes 

that his partner has the same incentive and that if both 

confess, they will both be worse off than if they both 

refused to deal with the DA. This dilemma illustrates 

the occasional difficulty in game-theoretic situations of 

unambiguously defining "rational behavior." Here, 

rational individual behavior leads to a mutually less 

preferred outcome. 

26. For example, the behavior of the prisoners 

described in the previous footnote would likely be 

different if they believed their behavior in the current 

"game" would affect not only the amount of time they 

would spend in jail but also their payoffs from 

subsequent games (for example, the possibility of being 

gunned down by their partner's brother for "being a 

rat"). 

27. See the discussion of the "horizon problem" 

earlier in this paper. 

27 

i; 

I 
References 

Allewelt, William E, Jr. "Agricultural Cooperatives: 

Are They Still Relevant?" Davis: University of 

California, Agricultural Issues Center Paper No. 

87-2, October 1987. 

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"u. s. CoVtRNIII(NT PRINT INC orr ICt :1989-241 -862,03100/41
i 

I 

I : t 

u.s. pepartment of AgrIculture 

Agricultural Cooperative Service 

P.O; Box 96576 

Washington, D.C. 20090-6576 

Agricultural Cooperative Service (ACS) proVides research, management, and 

educational assistance to cooperatives to strengthen the economic pOsition of farmers 

and other rural residents. It works 'directly with cooperative leaders and Federaland 

State agencies to improve organization, leadership, and operation of cooperatives and 

to give guidance to further development. 

"¥.i 

The agency (1 ) helps farmers and other rural residents develop' coofjera~vestQ obtain 

supplies and services at lower cost and to get better prices for products tb.eysel1; (2) 

advises rural r~sidents on deV'elopinge)xistingreS()urces through coope~\1:ea<1tion to 

enhance rural living; (3) helps cooperatives improve services and operating'eftiCi~ncy; 

(4) informs me~bers, directors, employees, and the public on how ~~rati-y:eswork 

and ,benefit their members and their communities; alid (5) encourages intemational . , cooperativeptogr~. ' . . , 

I 

AOS publishes research and educational materials and iS$ue~ Farmer Coo~rativ,es 

magazhte. All programs and activiti~,are conducted on a Bondi~Iimin~tbri·.b3sis, \ ":" ' . " ", . . ' " ,': '.' \-:\. ~ " J';'> .. ,\" .),) ,'.1, 1',.. '''-'' 

without ~gardto race, creed, color, sex, age, marital statUSl;h~~~,ot~~_8J;; 

origin. . , 

'!, "