Retained Earnings and Membership Stability in Cooperatives, a Relational Contracting Perspective

TOPIC 7-STAGE 3-MICRO This paper focuses on the delegation of real authority from the upstream to the downstream party in a cooperative. Each period a decision is made about which share of profits is returned to the... [ view full abstract ]

TOPIC 7-STAGE 3-MICRO
This paper focuses on the delegation of real authority from the upstream to the downstream party in a cooperative. Each period a decision is made about which share of profits is returned to the cooperative members and therefore which share is reinvested in the cooperative. We study from a relational contracting perspective whether the members or the professional management formulates the proposal about the distribution of profits.
In the Dutch farmer cheese cooperative, De Producent, the members delegate to the manager the real authority to decide on the distribution of profits. This right is informally delegated to the management because the farmers formally own the cooperative enterprise and have the right to reject manager’s proposal. So, farmers’ decision rights are loaned to the manager, rather than owned by him. The delegation of authority from the upstream to the downstream party is not formally contracted upon but is rather sustained through relational contracts. Such contracts represent a type of collaboration sustained by the “shadow of the future” rather than through formally enforced agreements.
Research questions to be addressed by the paper are the following:
• How does the delegation of real authority to the downstream party affect its incentives to invest?
• When is the delegation of real authority from the upstream to the downstream party efficient?
• Under which conditions is the delegation feasible?
To address these questions, an infinitely repeated game between a principal (upstream party) and an agent (downstream party) is specified and solved to determine the equilibrium. The relational contract is defined as a bilateral agreement between the agent, who promises to choose a sufficiently high level of marketing intensity and the principal, who promises to always accept agent’s proposal. We find that the relational contract becomes less stable when the farmers become impatient, and when the value added at the downstream stage decreases, and when the variability of the outside options of the upstream party increases.
From the managerial perspective, the current paper emphasizes the importance of relational contracts in cooperatives. Through informal delegation of real authority to the downstream party, the cooperative is able to improve the level of marketing intensity at the downstream level and to gain efficiency when compared to the traditional forward integration model.