1. 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

2. Contrasting Structures Overview o Problem o Question o Explore discretionary pricing o Explore lender restrictions o Model specification o Information results o Volatility results o Conclude

3. Contrasting Structures Problem o Cooperatives are exiting o Theory explores why’s & how’s o Discretionary forward pricing enables liquidation strategy o Liquidation is rational under certain conditions

4. Contrasting Structures Question o Does coop bankruptcy signal improvement in external market efficiency? -or- o Are we losing a valuable market mechanism – a stabilizing economic force?

5. Contrasting Structures Question o Specifically, does the cooperative’s discretionary forward pricing mechanism help farms and processors avoid bankruptcy? Yes.

6. Contrasting Structures Raw product (cash) prices may not be readily observable (illiquid): Explore Discretionary Pricing o Thin cash market information o Variable yields o Seasonal production o High transportation & storage costs o Geographic dispersion o Diverse forward contract terms

7. Contrasting Structures Fwd Prices Mkt Liquidity Decreasing Explore Discretionary Pricing Investor-owned processors pay market forward prices for agricultural products.

8. Contrasting Structures Investor-owned processors pay market forward prices for agricultural products. Fwd Prices Mkt Liquidity Decreasing Market Price Explore Discretionary Pricing

9. Contrasting Structures In contrast, cooperative processors may declare forward prices above or below “market.” Fwd Prices Mkt Liquidity Decreasing Market Price Explore Discretionary Pricing

10. Contrasting Structures In contrast, cooperative processors may declare forward prices above or below “market.” Fwd Prices Mkt Liquidity Decreasing Market Price Price Min Price Max Explore Discretionary Pricing

11. Contrasting Structures Lenders use a range of financial covenants to manage risk: Explore Financial Covenants o Capital o Collateral o Capacity o EBT (earnings before taxes) o EBIT (earnings before interest and taxes) o EBITDDA o Interest coverage (EBITDDA/Interest) o Fixed pmt. coverage (EBITDDA/(Int+Prin+Depr))

12. Contrasting Structures Consider an earnings (EBT) floor: Explore Financial Covenants

13. Contrasting Structures Model Specification o Processor o IOF structure o Cooperative structure o Farmer o Supplies raw product to processor o Sets cooperative forward pricing policy o Lender o Lends to both processor and farmer o Utilizes a simple EBT floor o Depends on cooperative for pricing information

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

15. Contrasting Structures Consider the processor impact of reduced liquidity. Results

16. Contrasting Structures Consider the farm impact of higher processing earnings volatility. Results

17. Contrasting Structures Conclusions The cooperative’s discretionary pricing policy: o Allows both farmer and processor to better satisfy capacity-related lending restrictions o Lowers processor ruin probabilities (12 percentage points lower over 15 years) o Lowers expected farm equity losses ($45 per acre per year, ~1/3 of farm profit margin)

18. Contrasting Structures Questions? Thank You