Agents Monitoring Their Manager: A Hard‐Times Theory of Producer Cooperation

• Author: Brent Hueth,Philippe Marcoul
• Published date: 01 March 2015
• DOI: http://doi.org/10.1111/jems.12083
• Date: 01 March 2015

Agents Monitoring Their Manager: A Hard-Times

Theory of Producer Cooperation

BRENT HUETH

Department of Agricultural and Applied Economics

University of Wisconsin-Madison

Madison, WI

hueth@wisc.edu

PHILIPPE MARCOUL

Department of Resource Economics and Environmental Sociology

University of Alberta

Edmonton, Canada

marcoul@ualberta.ca

We model the producer cooperative as a firm where a single class of individuals supplies an

essential input and monitors managerial behavior. We show how this contractual structure

reduces the incidence of equilibrium credit rationing, even assuming a cost disadvantage relative

to a firm where these roles are specialized. Our model provides an explanation for producer and

worker buyouts in the face of exit by investor owners, and, more generally, for cooperative entry

in low-return economic environments not serviced by investor-financed firms. Further,our model

predicts that a cooperative firm is less prone to monitor-manager collusion, and that it monitors

excessively in high-return environments.

1. Introduction

Producer cooperatives often persist under economic conditions that do not support

private investment. Hetherington (1991, pp. 182–186) sums up his cross-sectoral inves-

tigation of cooperative activity by concluding that, “Proprietary firms tend to be more

aggressive, innovative, and flexible competitors, while mutuals, particularly coopera-

tives, continue to serve markets at rates of return at which proprietary firms would

withdraw from business.” Buyouts of financially distressed investor owned firms are

a common source of formation for worker and farm marketing cooperatives (Nourse,

1922; Ben-Ner and Jun, 1996). This buyout and market-extending behavior is puzzling

because cooperatives are thought to face higher governance, risk bearing, and capital

costs than investor owned firms.

In a partial answer to this puzzle, Ben-Ner and Jun (1996) argue that employee

buyouts act as a screening mechanism with respect to the private information of firm

managers. In their model, workers can get a “good deal” in bad return states in part

because they can bargain simultaneously over wages and a possible buyout. Knowing

We thank Philippe Bontems, Jacques Cremer, Lutz Hendricks, David Hennessy,Bob Jolly, Roberto Mosheim,

Cheng Wang, and Patrick Gonzalez for helpful comments on earlier drafts. We also thank seminar audiences

at the University of Wisconsin-Madison, Iowa State University, Ryerson University,University of Nebraska-

Lincoln, University of Grenoble, and IDEI-INRA workshop (University of Toulouse), University of Alberta,

University of Ottawa, University of Cergy-Pontoise, Bank of Canada, and University of Waterloo for useful

discussions.

C2015 Wiley Periodicals, Inc.

Journal of Economics & Management Strategy, Volume24, Number 1, Spring 2015, 92–109

Agents Monitoring Their Manager 93

privately that future prospects are good, management is willing to pay relatively high

wages, but unwilling to negotiate much on a buyout price. The reverse is true when

managers know privately that future prospects are relatively weak. This argument is

appealing, but it ignores changes in the financial and organizational makeup of the

firm pre- and post-buyout. That is, while it may be true that a buyout offer by workers

provides a means of eliciting information from firm managers, it remains to be explained

why employees (or input suppliers) should control the firm after the buyout.

In an agricultural context, Hansmann (2000, p. 124) argues that farmers may invest

in a marginally profitable processing facility if the alternative is one or a small number

of oligopsony buyers. However, in many of the examples cited by Hetherington (1991),

it has been the threat of no buyer that has motivated farmers, rather than the threat of

a small number of oligopsony buyers. A considerable body of literature suggests that

cooperatives do play a pro-competitive role in agricultural markets (e.g., Refsell, 1914;

Sexton, 1990; Cook and Chaddad, 2004), but cooperatives also seem to extend markets

into low-return economic environments. These two effects are qualitatively distinct.

The purpose of this paper is to explain the buyout and market-extending behavior

of producer cooperatives within a model that is descriptive of their unique organiza-

tional structure.1The model we develop focuses on the provision of finance as the factor

potentially constraining firm activity. Relative to investor owned firms, there are sharp

contrasts with respect to the information and incentive that members have to monitor

managerial behavior. As workers or suppliers, members transact regularly with the firm

they collectively own. As owners, members also are residual claimants on annual earn-

ings and net firm assets in case of liquidation. It seems natural to assume that residual

claimancy can motivate effort toward production, and similarly that a member’s eco-

nomic stake as producer or employee can motivate effort toward managerial oversight.

This interaction between incentives for direct production and managerial oversight,

and its effect on the equilibrium provision of firm finance, is the central focus of our

model. Unlike previous analyses where the cooperative firm is modeled as a distinctive

objective function, we are explicit about its unique contractual nexus among suppliers,

managers, and financiers.2

From here on out, we use the term “producer” to reference workers and suppliers.

We assume that monitoring by producers is costly relative to monitoring by specialists,

but show how bundling producer and monitoring tasks can lower agency rents. Com-

bining the incentive and cost aspects of member ownership expands the set of feasible

financial contracts, but only by shrinking total economic surplus relative to investor own-

ership. As a result, this expansion is only desirable when there is insufficient expected

total surplus generated by the firm to motivate adequately all the relevant parties. We

show how a cooperative firm can operate in such an environment, so long as the dead-

weight cost associated with cooperation is sufficiently small. Paradoxically, cooperatives

are limited in scale and scope of operations because they cannot access equity markets,

but they can secure capital to undertake activities where investor capital will not go. This

1. Our model does not distinguish between cooperatives of workers and input suppliers. We label the

cooperative in our model a producer cooperative because its members contribute a productive action to the firm.

Wedo believe that there are interesting and important differences between worker and supplier cooperatives,

but these differences have yet to be articulated in an economic model (and ours is no exception).

2. There are other ways to define what it means to be a “cooperative” firm. We do not model demo-

cratic decision making by producer owners, residual control rights by suppliers (rather than investors), or

restrictions on outside equity finance. Admittedly these each also are interesting features of cooperative firm

organization. But producer monitoring is among the interesting and important structural distinctions that

define cooperatives, and it seems one good place to begin modeling the contents of this particular black box.