Challenges of User-Owned Firms
Phil Kenkel
Bill Fitzwater Cooperative Chair
In my last newsletter I discussed the comparative advantages of user-owned firms that were
consistent across all business sectors. User-owner firms also have some inherent challenges. The
members of user-owned firms have weak incentives to invest in the firm. An implication of
this challenge is that member investment is often low. USDA research indicates that cooperative
stock represents 1-2% of the total assets for most members. This is part of the second challenge
which is that user-owned firms are owned by a large number of members, each with a small
holding, and a single vote. The individual members have a weak financial incentive to take part
in governance. The final challenge is that when reserves become too large members have an
incentive to unlock the value by selling the firm or converting to an investor owned business.
Cooperatives can and do use a number of strategies to address those challenges. New generation
cooperatives address the member investment issue by linking usage rights to investment. Open
membership cooperatives address it through a system of profit retention and equity revolvement.
This is not a complete solution since the individual members are often not cognitive of the need
to invest in the cooperative. When the revolving period is short, investment is closely linked to
use and it achieves a result close to the NGC model. When the period becomes extended
investment is often disproportional to use and the active users are under invested.
This structure of diluted voting rights is actually a two edged sword. A user-owned firm does
not have a large shareholder with proportionally large voting rights that can be counted on to
actively monitor the board and management. On the other hand, members with small equity
holdings are not disenfranchised from governance since they have equal voting power.
Cooperatives can increase owner participation in governance through communication and
through processes. Cooperatives that are successful in this area create a culture of member
participation and continue to tweak there voting procedures, director recruitment process and use
of focus groups and member meetings. Member control may never be a mass participation
activity. A small portion of members that are regularly involved in governance can keep the
cooperative aligned with member needs.
The issue of excess unallocated reserves (retained earnings) is unique to user-owned firm. It is a
result of the structure of redeeming equity at face value. In investor-owned firms, equity trades
in the market place and an owner can realize their full share of the value of the firm by selling
their shares. Cooperatives lack that vehicle and profits channeled to unallocated equity are never
returned to the individual member. Excessive reserves have not been a major problem for
agricultural cooperatives (just like excessive rainfall has not been a recent problem for Oklahoma
producers) but this phenomenon termed “demutualization” has been a major issue in some
sectors. Cooperative can address the demutualization issue through balance sheet management
(carefully considering their ratio of allocated/unallocated equity) and by communicating the
member’s value in having access to the cooperative’s infrastructure. Remind your members that
the cooperative is worth more alive than dead and/or manage your equity so that the question
does not arise.
The advantages of the cooperative business form outweigh the challenges. We need to continue
to communicate our advantages and make decisions which offset our challenges.
12-12-12