Retained Earnings and Membership Stability in Cooperatives, a Relational Contracting Perspective

Abstract: An important decision for the members of a cooperative is the annual decision regarding the retained earnings percentage. This paper studies from a relational contracting perspective whether the members of the cooperative or the professional management holds the decision right about the distribution of profit. The decision needs to balance the member interest on the one hand, and the cooperative enterprise development on the other hand. Our findings show that the allocation of decision right to distribute cooperative profit affects parties’ reneging temptations and thus the stability of the relational contract between the members and the management. The set of feasible relational contracts shrinks when farmers’ outside options increase, when the value added at the downstream stage decreases, and when the discount rate rises. The cooperative retained earnings percentage is lower when the variability of farmers’ outside options decreases, for example, when market price for farm produce is generally increasing. Finally, our results show that the set of feasible relational contracts between the cooperative management and membership is the largest when the variability of prices is high.