The Horizon Problem and New Generation Cooperatives: Another Look at Minnesota Corn Processors
Democratic governance
Voting Limits on Equity Ownership
A second characteristic is that the governance of the cooperative business is structured democratically, as in “one-member, one-vote”, so that voting power is not proportional to the stockholder’s equity investment. The allocation of voting power based NOT on equity ownership is intended to separate the control of the organization from the contribution of capital, the so-called “Principle of Preventing the Domination of Capital” in the cooperative. This diffusion of capital power however, raises the possibility that a majority of small contributing patrons could impose policies that exploit the minority of large contributing members.
Of greater concern is the possibility that the diffusion of political power may reduce the quali
ty of the board of directors’ decision making. When board members believe their reelection is dependent on a majority of patrons each with a relatively small stake in the cooperative, they may regard decisions more cavalierly than when voting rights are proportional to equity investment.
In an effort to insure “member control,” there are strict limitations on the number of nonmembers who may serve on the board of directors.
Board members of a farmer cooperative are users of the firm’s services and therefore, bring concerns to the board from an owner’s standpoint as well as that of a user. An owner’s concern is focused on the security and overall profitability of the stockholder’s investment. A user is concerned with issues which affect the profitability of the cooperative to the individual patron.
User concerns generally are given priority in a marketing cooperative because of the limitation of dividend payments and the inability to accrue capital gains. And as users of the co-op’s services, board members may bring an important technical understanding of t
he firm’s operations.
governanceHowever, when cooperative operations are complex and reach well up the marketing chain, a farmer-director is less likely to have the deep skills necessary to make sound business decisions and lead the co-op wisely. This leads us to Helmberger’s dilemma, “To the extent that farmers participate in leadership roles in the board, they may contribute to poor decisions and hamstring management; to the extent that they do not participate, ownership is separated from control.” (Helmberger)
Return on investment gained through patronage
No secondary market for stock
The stock certificates of an IOF confer to its holders a residual claim in perpetuity on the earnings of that firm. A secondary market values the stock in terms of its expected present value of the firm’s future net earnings. And the capitalized value of those future earnings may be realized any time its holder desires, simply by selling the stock.
In contrast, a stock certificate of a marketing cooperative grants the holder a residual claim on the firm’s earnings only so long as the holder continues patronage in the co-op. That certificate has no secondary market. And the future earnings of the cooperative have little effect on its stock value. Any equity retirement policies confer only a fixed claim to be paid in nominal terms over several years. As a consequence, the benefits of ownership in a marketing cooperative accrue to its shareholders through their current patronage.
Under-financing the Cooperative
Farmer-members therefore, invest in an agricultural cooperative to obtain the right to patronize the firm. And because no real dividend is paid on the amount of equity invested, as long as it is profitable for a farmer to patronize the cooperative, the return on investment can be raised by expanding participation relative to the investment. Left unchecked, members only contribute enough capital to gain entry and then expand patronage only so long as it is more profitable to do so.
To overcome this behavior, cooperatives have developed programs such as: ‘capital retai
ns’, ‘base capital plans’, and other ways of withholding (allocation) patronage refunds. These mechanisms basically force members to align their capital contributions with their patronage in the cooperative.
Limited Pool of Equity Capital
A fundamental consequence of tying stock ownership to patronage is that it severely constrains the potential pool of equity capital for the cooperative. Investor owned firms may raise additional equity capital by selling stock to the general public. But a marketing cooperative can only increase its equity base by conscripting additional capital from its existing shareholders or by recruiting new farmer-members.
Risk Aversion
Existing members of a marketing cooperative resist further subscription of capital for a number of reasons.

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