Contrasting Structures
Cooperative advantage in illiquid markets
Steve Buccola and Robin Cross
Oregon State University, Agricultural & Resource Economics
Agricultural Cooperatives in Rural Development Workshop
Economic Research Service, Washington DC, June 2004
Contrasting Structures
Overview
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Problem
Question
Explore discretionary pricing
Explore lender restrictions
Model specification
Information results
Volatility results
Conclude
Contrasting Structures
Problem
o Cooperatives are exiting
o Theory explores why’s & how’s
o Discretionary forward pricing
enables liquidation strategy
o Liquidation is rational under
certain conditions
Contrasting Structures
Question
o Does coop bankruptcy signal
improvement in external
market efficiency?
-oro Are we losing a valuable market
mechanism – a stabilizing
economic force?
Contrasting Structures
Question
o Specifically, does the
cooperative’s discretionary
forward pricing mechanism
help farms and processors
avoid bankruptcy?
Yes.
Contrasting Structures
Explore Discretionary Pricing
Raw product (cash) prices may not be
readily observable (illiquid):
o Thin cash market information
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Variable yields
Seasonal production
High transportation & storage costs
Geographic dispersion
o Diverse forward contract terms
Contrasting Structures
Explore Discretionary Pricing
Investor-owned processors pay market
forward prices for agricultural products.
Fwd
Prices
Mkt Liquidity Decreasing
Contrasting Structures
Explore Discretionary Pricing
Investor-owned processors pay market
forward prices for agricultural products.
Fwd
Prices
Market Price
Mkt Liquidity Decreasing
Contrasting Structures
Explore Discretionary Pricing
In contrast, cooperative processors
may declare forward prices above
or below “market.”
Fwd
Prices
Market Price
Mkt Liquidity Decreasing
Contrasting Structures
Explore Discretionary Pricing
In contrast, cooperative processors
may declare forward prices above
or below “market.”
Fwd
Prices
Price Max
Market Price
Price Min
Mkt Liquidity Decreasing
Contrasting Structures
Explore Financial Covenants
Lenders use a range of financial
covenants to manage risk:
o Capital
o Collateral
o Capacity
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EBT (earnings before taxes)
EBIT (earnings before interest and taxes)
EBITDDA
Interest coverage (EBITDDA/Interest)
Fixed pmt. coverage (EBITDDA/(Int+Prin+Depr))
Contrasting Structures
Explore Financial Covenants
Consider an earnings (EBT) floor:
Earnings Before Taxes (EBT)
800
Farm Earnings
Earnings Floor
Farm Earnings Before Taxes
600
400
200
0
-200
-400
-600
5
10
15
20
25
Year
30
35
40
45
50
Contrasting Structures
Model Specification
o Processor
o IOF structure
o Cooperative structure
o Farmer
o Supplies raw product to processor
o Sets cooperative forward pricing policy
o Lender
o Lends to both processor and farmer
o Utilizes a simple EBT floor
o Depends on cooperative for pricing information
Contrasting Structures
Model Specification
o Bankruptcy
o Triggered when covenant violated
o Equity in bankrupt firm lost
o Sale under duress
o Foreclosure costs
o Default interest rates
o Raw product cash market prices not perfectly
observable
o Data from Tri Valley Growers & surrounding counties
o Assume continued farming and processing
operation is preferred to shutting down
Contrasting Structures
Results
Expected Processor Equity Losses
80
60
IOF Structure
Coop Structure
40
20
0
0
0.1 0.2 0.3 0.4
Mkt Liquidity Decreasing
Probability of Processor Financial Ruin
0.2
Probability over 15 Years
Equity Loss Per Acre Per Year
Consider the processor impact of
reduced liquidity.
0.15
0.1
IOF Structure
Coop Structure
0.05
0
0
0.1 0.2 0.3 0.4
Mkt Liquidity Decreasing
Contrasting Structures
Results
Expected Farm Equity Losses
400
300
IOF Structure
Coop Structure
200
100
0
0.5 1 1.5 2 2.5
Earnings Volatility
Probability of Farm Financial Ruin
1
Probability over 15 Years
Equity Loss Per Acre Per Year
Consider the farm impact of
higher processing earnings volatility.
0.8
IOF Structure
Coop Structure
0.6
0.4
0.2
0
0.5 1 1.5 2 2.5
Earnings Volatility
Contrasting Structures
Conclusions
The cooperative’s discretionary pricing policy:
o Allows both farmer and processor to better satisfy
capacity-related lending restrictions
o Lowers processor ruin probabilities (12 percentage
points lower over 15 years)
o Lowers expected farm equity losses ($45 per acre
per year, ~1/3 of farm profit margin)
Contrasting Structures
Questions?
Thank You