Residual Claims in Co-operatives: Design Issues

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Abstract

This paper examines issues in the design of a co-operative member's contractual relationship with the other agents (including the remaining members) using organizational economics. The paper assumes that the central defining characteristic of a co-op is the residual claim specification. Agency theory identifies certain inherent problems of the co-op form, the horizon problem, common property problem, and non-transferability. Non-transferability both reduces the incentive to monitor and imposes limits on portfolio diversification. This paper argues that features such as claim incompleteness and non-transferability are not inherent to the co-op but may be transaction-cost economizing. The paper also argues that the pre-emptive payoff feature by which the residual claimants (the co-op members) also become fixed payoff agents can affect the risk of other agents, and is an important determinant of co-op risk. A co-op may have more than one potential residual claim base. Five generic design choices are available for handling possible multiple claim bases: battleground, pre-specified allocation, limited return, alignment, and fixed payoff. The paper uses the design of residual claims in sugar co-ops to show how a co-op can partly overcome some of the problems identified by agency theory. This illustration ties together the issues of claim incompleteness and non-transferability, pre-emptive payoff, and multiple claim bases.

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