The Advantage of Cooperatives under Asymmetric Cost Information

hand, it is well known also that ordinary hold-up problems can be handled
effectively by using long term contracts, cf. e.g. Tirole(1988). By negoti-
ating the transaction terms before production decisions are made, i.e. by
using ex-ante rather than ex-post negotiations, the production costs will be
honored and the producers will not be forced to under-produce. Hence, the
traditional hold up problem is solved by a cooperative - but not only by a
cooperative.

The aim of this paper is to show that certain incentive problems can be
handled effectively using a cooperative - and a cooperative only. We suggest
an economic rationale for cooperatives by providing a framework where a
cooperative is the unique optimal organization form.

The idea is simple. If farmers have private information about their pro-
duction costs, ex-ante negotiations may not be efficient. The more efficient
farmers will try to extract informational rents by imitating the less efficient
ones. The rational response of a buyer is to reduce transactions below the
first best level. This leads to an ex post in-efficient situation. As we shall
show, the only way to eliminate the associated economic loss is to have the
farmers integrate forward, i.e. take over the processing, and to do so on a
cooperative basis where the processing surplus is shared among farmers in
proportion to patronage.

The outline of the paper is as follows. We first present the set-up and
a useful reformulation of the incentive ∞mpatibility constraints. In Section
3, we characterize the socially optimal production structure and the profit
sharing principles that may support it. The similarities with cooperative pro-
cessing is explored in Section 4, and the effects of investor owned processing
is investigated in Section 5. Some examples are given in Section 6, extensions
are discussed in Section 7, and conclusions are given in Section 8.

2 The Model

We consider n farmers producing the same (homogenous) product. For
farmer г ∈ I — {1,..., n}, we let q_i be his production level, C^f_i(¾) := c_i ∙ q_i his
production costs and q^ his capacity. The farmers maximize expected profit.

We assume that information about production costs are asymmetric and
incomplete. The marginal cost <⅛ at farmer г is known by him only. The other
farmers as well as the processor only hold beliefs about his cost. Specifically,
we assume that the costs are independent and that c⅛ ^,s density ∕<(c⅛) =

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