Contrasting Structures

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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
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Contrasting Structures

• Overview
• Problem
• Question
• Explore discretionary pricing
• Explore lender restrictions
• Model specification
• Information results
• Volatility results
• Conclude

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Contrasting Structures

• Problem
• Cooperatives are exiting
• Theory explores whys hows
• Discretionary forward pricing enables
  liquidation strategy
• Liquidation is rational under certain
  conditions

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Contrasting Structures

• Question
• Does coop bankruptcy signal improvement in
  external market efficiency?
• -or-
• Are we losing a valuable market mechanism a
  stabilizing economic force?

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Contrasting Structures

• Question
• Specifically, does the cooperatives
  discretionary forward pricing mechanism help
  farms and processors avoid bankruptcy?
• Yes.

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Contrasting Structures
Explore Discretionary Pricing
Raw product (cash) prices may not be readily
observable (illiquid)

• Thin cash market information
• Variable yields
• Seasonal production
• High transportation storage costs
• Geographic dispersion
• Diverse forward contract terms

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Contrasting Structures
Explore Discretionary Pricing
Investor-owned processors pay market forward
prices for agricultural products.
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Contrasting Structures
Explore Discretionary Pricing
Investor-owned processors pay market forward
prices for agricultural products.
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Contrasting Structures
Explore Discretionary Pricing
In contrast, cooperative processors may declare
forward prices above or below market.
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Contrasting Structures
Explore Discretionary Pricing
In contrast, cooperative processors may declare
forward prices above or below market.
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Contrasting Structures
Explore Financial Covenants
Lenders use a range of financial covenants to
manage risk

• Capital
• Collateral
• Capacity
• EBT (earnings before taxes)
• EBIT (earnings before interest and taxes)
• EBITDDA
• Interest coverage (EBITDDA/Interest)
• Fixed pmt. coverage (EBITDDA/(IntPrinDepr))

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Contrasting Structures
Explore Financial Covenants
Consider an earnings (EBT) floor
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Contrasting Structures
Model Specification

• Processor
• IOF structure
• Cooperative structure
• Farmer
• Supplies raw product to processor
• Sets cooperative forward pricing policy
• Lender
• Lends to both processor and farmer
• Utilizes a simple EBT floor
• Depends on cooperative for pricing information

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Contrasting Structures
Model Specification

• Bankruptcy
• Triggered when covenant violated
• Equity in bankrupt firm lost
• Sale under duress
• Foreclosure costs
• Default interest rates
• Raw product cash market prices not perfectly
  observable
• Data from Tri Valley Growers surrounding
  counties
• Assume continued farming and processing
  operation is preferred to shutting down

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Contrasting Structures
Results
Consider the processor impact of reduced
liquidity.
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Contrasting Structures
Results
Consider the farm impact of higher processing
earnings volatility.
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Contrasting Structures
Conclusions

• The cooperatives discretionary pricing policy
• Allows both farmer and processor to better
  satisfy capacity-related lending restrictions
• Lowers processor ruin probabilities (12
  percentage points lower over 15 years)
• Lowers expected farm equity losses (45 per acre
  per year, 1/3 of farm profit margin)

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Contrasting Structures
Questions? Thank You