CHS is the most dominant farm supply, grain, food and petroleum co-op in rural America today. But CHS is unlikely to convert to a corporation because it is a co-op through and through. In fact, the CHS Board of Directors is doing exactly what successful, profitable co-ops are supposed to do with patronage earnings: allocate every dollar of patronage earnings . . . redeem the allocated equity when you can.
Scholarly opinion and tradition hold that all patronage earnings belong to patrons and should be allocated and distributed to patrons. The law is that at least 20% of the distribution must be in cash and the other up to 80% is distributed with QNAs (If NQNAs are used, then all patronage earnings are distributed to patrons with NQNAs and no cash). Further, tradition and academic lore hold that the QNAs should be revolved at the earliest possible time, as and when the Co-op has surplus working capital.
Scholars and tradition are incredibly unsophisticated on the issue of co-op equity management. Allocate everything. Redeem the allocated equity as and when the co-op can. That's the extent of it, called "balance sheet management" by some scholars. I have never seen a farm supply and grain cooperative whose redemption "budget" was anything other than "we'll redeem what we can, when we can". That's not "control" in a finance sense; it is "we have no idea when we can redeem your allocated equity, but we promise we'll do it as fast as we can". This is not how CoBank's approach to equity management works.
Balance sheet management" does not account for the time value of cash distributions between a CoBank approach and a CHS approach, the finance principle of matching the life of assets with the life of liabilities, conserving capital with a CoBank approach, members' redemption expectations or how to manage those expectations, the diversity of financial metrics from one industry to the next and what those metrics mean for the financial capability of individual co-ops to redeem equity, nor does it explain why appreciable equity interests are a detriment and not a benefit to co-ops with significant capital requirements (appreciable equity interests abate the pressure to redeem equity by providing a mutual benefit to the co-op and members when the co-op cannot reasonably spend money on PPE.
Moreover, those scholars who seem to contend that redemptions of equity are within the reasonable control (that are not in substance "we will do what we can, when we can") of Boards of Directors use financial models that are disconnected from reality and do not explain what we see every day all around us. For example, the one serious financial model that I've seen built for a farm supply and grain co-op is seriously flawed (for several reasons, but this one is most pronounced) because it assumes that member co-ops do not make investments in federated cooperatives. This assumption is important: the cooperative's redemption "budget" in this financial model is reduced by a third or more if cooperatives do make investments into federated cooperatives. Fortunately for federated cooperatives, but unfortunately for the financial model, member co-ops do make investments - significant investments - into federated co-ops.
To test the validity of that assumption, you need only review slide 7 http://www.blackdogcooplaw.com/case-study-managing-allocated-equity-1
The point of slide #7 is that a direct correlation exists between a federated co-ops allocated equity and the investments that member co-ops hold in the federated co-op. And as the federated co-op's allocated equity grows, a mirror image of that growth in reflected in the member co-ops' investments in other cooperatives. Any financial model that holds investments in federated co-ops static is seriously flawed. Assuming the federated co-op is allocating its patronage earnings, the member co-ops' investments in the federated co-op must be growing as well.
But every boat needs cadence drummers so that all oarsmen row in sync with each other. And in the co-op community, our cadence drummers are the professors in agricultural economics departments across the country. These are all smart and eloquent people and their work reflects well on their universities and the co-op community. They have written eloquently about free rider, horizon and portfolio issues that hinder co-ops from redeeming equity on time. I get the feeling though that CoBank's approach with its incorporation of finance principles has literally passed them by, unnoticed.
And why not apply finance theory to co-op theory and co-op equity management? CoBank's approach incorporates finance principles into CoBank's interpretation of co-op theory. Sizing one's obligations to their ability to pay, honoring the expectations of members, creating a strong capital structure and value proposition, and distributing cash to maximize the bang for the buck are finance concepts that strengthen the co-op theory of finance and equity management. They strengthen co-op theory unless you are wed to the idea that every dollar of patronage earnings must be allocated and then redeemed "as and when the co-op can", in which case these finance principles are described as the "worst ideas" by our cadence drummers.
It would be fascinating to give the "balance sheet management" issues identified above - along with other finance issues that co-ops face - to a business school's graduate finance gurus for evaluation and analysis. The only limitation would have to be that they not deviate from the principle that financial benefits of owners must flow to patrons in proportion to use rather than to investors in proportion to ownership.
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