Download - Contrasting Structures
Contrasting StructuresCooperative advantage in illiquid markets
Steve Buccola and Robin CrossOregon State University, Agricultural & Resource EconomicsAgricultural Cooperatives in Rural Development Workshop
Economic Research Service, Washington DC, June 2004
Contrasting StructuresOverview
o Problemo Questiono Explore discretionary
pricingo Explore lender restrictionso Model specificationo Information resultso Volatility resultso Conclude
Contrasting StructuresProblem
o Cooperatives are exitingo Theory explores why’s & how’s
o Discretionary forward pricing enables liquidation
strategyo Liquidation is rational under certain conditions
Contrasting StructuresQuestion
o Does coop bankruptcy signal improvement in external market efficiency?
-or-
o Are we losing a valuable market mechanism – a stabilizing economic force?
Contrasting StructuresQuestion
o Specifically, does the cooperative’s discretionary
forward pricing mechanism help farms and processors avoid bankruptcy?
Yes.
Contrasting Structures
Raw product (cash) prices may not be readily observable (illiquid):
Explore Discretionary Pricing
o Thin cash market informationo Variable yieldso Seasonal productiono High transportation & storage costso Geographic dispersion
o Diverse forward contract terms
Contrasting Structures
Fwd Prices
Mkt Liquidity Decreasing
Explore Discretionary PricingInvestor-owned processors pay market
forward prices for agricultural products.
Contrasting Structures
Investor-owned processors pay market forward prices for agricultural products.
Fwd Prices
Mkt Liquidity Decreasing
Market Price
Explore Discretionary Pricing
Contrasting Structures
In contrast, cooperative processors may declare forward prices above
or below “market.”Fwd Prices
Mkt Liquidity Decreasing
Market Price
Explore Discretionary Pricing
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
Contrasting Structures
Lenders use a range of financial covenants to manage risk:
Explore Financial Covenants
o Capitalo Collateralo Capacity
o EBT (earnings before taxes)o EBIT (earnings before interest and taxes)o EBITDDAo Interest coverage (EBITDDA/Interest)o Fixed pmt. coverage (EBITDDA/(Int+Prin+Depr))
5 10 15 20 25 30 35 40 45 50-600
-400
-200
0
200
400
600
800Earnings Before Taxes (EBT)
Year
Farm
Ear
ning
s Be
fore
Tax
es
Farm EarningsEarnings Floor
Contrasting Structures
Consider an earnings (EBT) floor:Explore Financial Covenants
Contrasting StructuresModel Specification
o Processoro IOF structureo Cooperative structure
o Farmero Supplies raw product to processoro Sets cooperative forward pricing policy
o Lendero Lends to both processor and farmero Utilizes a simple EBT flooro Depends on cooperative for pricing information
Contrasting StructuresModel Specification
o Bankruptcyo Triggered when covenant violatedo Equity in bankrupt firm lost
o Sale under duresso Foreclosure costso 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
Contrasting Structures
Consider the processor impact of reduced liquidity.
Results
0 0.1 0.2 0.3 0.40
20
40
60
80Expected Processor Equity Losses
Mkt Liquidity Decreasing
Equi
ty L
oss
Per A
cre
Per Y
ear
0 0.1 0.2 0.3 0.40
0.05
0.1
0.15
0.2Probability of Processor Financial Ruin
Mkt Liquidity Decreasing
Prob
abili
ty o
ver 1
5 Ye
ars
IOF StructureCoop Structure
IOF StructureCoop Structure
Contrasting StructuresConsider the farm impact of
higher processing earnings volatility.
Results
0.5 1 1.5 2 2.50
100
200
300
400Expected Farm Equity Losses
Earnings Volatility
Equi
ty L
oss
Per A
cre
Per Y
ear
0.5 1 1.5 2 2.50
0.2
0.4
0.6
0.8
1Probability of Farm Financial Ruin
Earnings Volatility
Prob
abili
ty o
ver 1
5 Ye
ars
IOF StructureCoop Structure
IOF StructureCoop Structure
Contrasting StructuresConclusions
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)
Contrasting Structures
Questions?
Thank You
