Financing agricultural cooperatives with retained earnings

Abstract

Purpose

The purpose of this paper is to explore the advantages equity capitalization programs based on retained earnings from patronage sources may provide cooperatives and their patrons that traditional equity financing methods do not offer.

Design/methodology/approach

The analysis is based on a model used to assess patron benefits from a cooperative that is financed by a combination of allocated equity acquired from noncash patronage refunds and unallocated equity acquired from retained earnings. The level of patron benefits is represented by the present value of the after-tax cash flow patrons receive from the cooperative, and the model is used to determine the combination of noncash patronage refunds and retained earnings that provides the greatest present value given the levels of those parameters that affect capitalization of the cooperative and the distribution of cash benefits to patrons.

Findings

The analysis demonstrates that only pure plans, i.e., plans based entirely on retained patronage refunds or entirely on retained earnings, will be associated with the greatest present value for any particular set of parameter values. Cooperatives that are characterized by low marginal tax rates and growth rates and whose patrons are characterized by high marginal tax rates and discount rates are those most likely to benefit from equity capitalization programs based on retained earnings.

Research limitations/implications

The model is based on the assumption of constant parameter values and does not account for the existence of nonpatronage income.

Practical implications

A useful extension of this work would be the development of a decision aid capable of generating basic operating statement and balance sheet data and enabling cooperative decision makers to conduct experiments concerning alternative financing strategies based on retained earnings.

Originality/value

The analysis contained in this paper is based on an explicit model and extends across a broad range of values for various parameters that affect the level, timing, and present value of cash distributions from cooperatives. Because the cash flow received by patrons is determined after the cooperative’s planned equity growth is met, cash flow comparisons are equivalent with respect to the capital provided the cooperative. In addition, the revolving period is endogenously determined.

Citation

Royer, J. (2017), "Financing agricultural cooperatives with retained earnings", Agricultural Finance Review, Vol. 77 No. 3, pp. 393-411. https://doi.org/10.1108/AFR-06-2016-0060