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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. Contrasting Structures. - PowerPoint PPT Presentation

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  • Contrasting StructuresCooperative advantage in illiquid marketsSteve Buccola and Robin CrossOregon State University, Agricultural & Resource EconomicsAgricultural Cooperatives in Rural Development WorkshopEconomic Research Service, Washington DC, June 2004

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

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

  • Contrasting StructuresQuestion Does coop bankruptcy signal improvement in external market efficiency?

    -or-

    Are we losing a valuable market mechanism a stabilizing economic force?

  • Contrasting StructuresQuestion

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

    Yes.

  • Contrasting Structures Thin cash market information Variable yields Seasonal production High transportation & storage costs Geographic dispersion

    Diverse forward contract terms

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

  • Contrasting StructuresExplore Discretionary PricingInvestor-owned processors pay market forward prices for agricultural products.

  • Contrasting StructuresInvestor-owned processors pay market forward prices for agricultural products.Explore Discretionary Pricing

  • Contrasting StructuresIn contrast, cooperative processors may declare forward prices aboveor below market.Explore Discretionary Pricing

  • Contrasting StructuresIn contrast, cooperative processors may declare forward prices aboveor below market.Explore Discretionary Pricing

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

  • Contrasting StructuresConsider an earnings (EBT) floor:Explore Financial Covenants

  • Contrasting Structures 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 informationModel Specification

  • Contrasting Structures 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

    Model Specification

  • Contrasting StructuresConsider the processor impact of reduced liquidity.Results

  • Contrasting StructuresConsider the farm impact of higher processing earnings volatility.Results

  • Contrasting StructuresConclusionsThe 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)

  • Contrasting Structures

    Questions?

    Thank You

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