Residual Claims in Co‐operatives: Design Issues

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.