Wednesday, 23 July 2014

Investor-owned firms as cooperatives

Having written a couple of posts recently on cooperatives, see here and here, I thought to compare cooperatives with investor-owned firms, the main form of firm in the economy. While investor-owned firms dominate the economy what is not often realised is that they can be seen as a form of producer cooperative. This argument is due to Henry Hansmann, "Ownership of the Firm", Journal of Law, Economics, & Organization, Vol. 4, No. 2. (Autumn, 1988), pp. 267-304.

Hansmann begins by noting that
In the discussion that follows it will be helpful to have a term to comprise all persons who transact with a firm, either as purchasers of the firm's products or as suppliers to the firm of some factor of production, including capital. Such persons—whether they are individuals or other firms—will be referred to here collectively as the firm's "patrons."

Most firms are owned by persons who are also patrons. This is conspicuously true of producer and consumer cooperatives.
He then notes that this is also true of the standard business firm, which is owned by persons who lend capital to the firm. In fact, Hansmann argues, the standard investor-owned firm is in a sense nothing more than a special type of producer cooperative—a lenders' cooperative, or capital cooperative.

To show this Hansmann starts by looking at the structure of a typical producer cooperative.
A representative example is a dairy farmers' cheese cooperative, in which a cheese factory is owned by the farmers who provide the raw milk for the cheese. The firm pays the members a predetermined price for their milk on the occasion of each sale. (In keeping with conventional usage, the term "member" will be used here to refer to the patron-owners of cooperatives.) This price is usually set low enough so that the cooperative is almost certain to make a profit from its operations. Then, at the end of the year, profits that have been earned from the manufacture and sale of the cheese are distributed pro rata among the members according to the amount of milk they have sold to the cooperative during the year. Voting rights are held only by those who sell milk to the firm, either on the basis of one-member-one-vote or with votes apportioned according to the volume of milk each member sells to the firm. Some or all of the members may have capital invested in the firm. In principle, however, this is unnecessary: the firm could borrow all of the capital it needs. In any case, even where members invest in the firm, those investments typically take the form of preferred stock that carries no voting rights and is limited to a stated maximum rate of dividends. Upon liquidation of the firm, the net asset value—which may derive from retained earnings or from increases in the value of rights held by the firm—is divided pro rata among the members, usually according to some measure of the relative value of their cumulative patronage.

In short, ownership rights are held exclusively by virtue of the fact, and to the extent, that one sells milk to the firm. On the other hand, not all farmers who sell milk to the firm need be owners; the firm may purchase some portion of its milk from nonmembers, who are simply paid a fixed price and do not participate in net earnings or control. (Consumer cooperatives are set up similarly, with net earnings and votes apportioned according to the amounts that a member purchases from the firm.)
Now what of the standard business firm?
A business corporation is also organized in this fashion, except that it is owned not by persons who supply the firm with some commodity, such as milk, but rather by some or all of the persons who lend capital to the firm. To see the analogy clearly, it helps to characterize the transactions in a business corporation in somewhat stylized terms: The members each lend the firm a given sum. For this they are paid a fixed interest rate, set low enough so that the firm has a reasonable likelihood of running at a profit. Then at regular intervals, or upon liquidation, the firm's net earnings (after all contractual expenses, including wages and the cost of materials as well as the fixed interest rate on the capital borrowed from the members, have been paid) are distributed pro rata among the lender-members according to the amount they have lent. The firm may also have lenders who are not members. These lenders, commonly banks or bondholders, simply receive a fixed market interest rate and have no share in profits or participation in control.

As it is, in a business corporation the interest rate that is paid to lender- members (that is, shareholders) is generally set at zero for the sake of convenience. Moreover, the loans from members are not arranged annually or for other fixed periods, but rather are perpetual; the principal can generally be withdrawn only upon dissolution of the firm. In the typical cooperative, by contrast, members generally remain free to vary their volume of transactions with the firm over time, and even to terminate their patronage altogether. This distinction is not, however, fundamental. Investor-owned firms can be, and sometimes are, structured so that the amount of capital invested by each member can be redeemed at specified intervals or even (as in a simple partnership) at will. Conversely, cooperatives can be, and often are, structured so that members have a long-term commitment to remain patrons. Electricity generation and transmission cooperatives, for example, commonly insist that their members (which are local electricity distribution cooperatives) enter into requirements contracts that run for thirty-five years.

Indeed, we can view business corporation statutes as simply specialized versions of the more general cooperative corporation statutes. In principle, there is no need to have separate business corporation statutes at all; business corporations could just as well be organized under a well-drafted general cooperative corporation statute. Presumably we have separate statutes for business corporations simply because it is convenient to have a form that is specialized for the most common form of cooperative—the lenders' cooperative—and to signal more clearly to interested parties just what type of cooperative they are dealing with. (All quotes, Hansmann 1988: 270-2. Footnotes deleted.)
So the standard business firm can be seen as a form of cooperative, a capital cooperative. Not that it is often thought of in this way.


Brett said...

Rather interesting stuff. I suppose the response would be that in an "ideal" cooperative economy, being an "owner" would require some deep legal connection to the firm beyond simply lending it money, although the boundaries get blurry there as well (if you lend the firm money for 30 years, are you not deeply connected, as with the electricity coops you mention?).

I suppose it ultimately depends on what you define as an "employee" vs an "investor", which is going to be arbitrary legal definition as well if the employees are also supposed to be owner-investors in the firm.

Paul Walker said...

You can think of an owner as someone who has residual control rights over the non-human assets of the firm and an employee as someone with an employment contract.