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Contrasting Structures

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.

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Contrasting Structures

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  1. 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

  2. Contrasting Structures Overview • Problem • Question • Explore discretionary pricing • Explore lender restrictions • Model specification • Information results • Volatility results • Conclude

  3. Contrasting Structures Problem • Cooperatives are exiting • Theory explores why’s & how’s • Discretionary forward pricing enables liquidation strategy • Liquidation is rational under certain conditions

  4. Contrasting Structures Question • Does coop bankruptcy signal improvement in external market efficiency? -or- • Are we losing a valuable market mechanism – a stabilizing economic force?

  5. Contrasting Structures Question • Specifically, does the cooperative’s discretionary forward pricing mechanism help farms and processors avoid bankruptcy? Yes.

  6. Contrasting Structures Explore Discretionary Pricing • 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):

  7. Contrasting Structures Fwd Prices Mkt Liquidity Decreasing Explore Discretionary Pricing Investor-owned processors pay market forward prices for agricultural products.

  8. Contrasting Structures Fwd Prices Market Price Mkt Liquidity Decreasing Explore Discretionary Pricing Investor-owned processors pay market forward prices for agricultural products.

  9. Contrasting Structures Fwd Prices Market Price Mkt Liquidity Decreasing Explore Discretionary Pricing In contrast, cooperative processors may declare forward prices above or below “market.”

  10. Contrasting Structures Fwd Prices Price Max Market Price Price Min Mkt Liquidity Decreasing Explore Discretionary Pricing In contrast, cooperative processors may declare forward prices above or below “market.”

  11. Contrasting Structures Explore Financial Covenants • 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:

  12. Contrasting Structures Explore Financial Covenants Consider an earnings (EBT) floor:

  13. Contrasting Structures Model Specification • 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 information

  14. Contrasting Structures Model Specification • 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

  15. Contrasting Structures Results Consider the processor impact of reduced liquidity.

  16. Contrasting Structures Results Consider the farm impact of higher processing earnings volatility.

  17. Contrasting Structures Conclusions The cooperative’s 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)

  18. Contrasting Structures Questions? Thank You

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