Myth Buster: Cooperative Stock is Debt

By Phil Kenkel
Bill Fitzwater Cooperative Chair
Oklahoma State University

 

The revolving stock in a traditional cooperative is an interesting instrument. Unlike stock in a publicly traded corporation, it has no market value. This absence of a market value necessitates that it be eventually redeemed by the cooperative firm. This creates the unique structure of the cooperative where equity is continually being destroyed and replenished. Even the national accounting standards board has at times been concerned, or perhaps confused, about cooperative equity. This generated proposals that cooperative equity be treated as instruments with properties of debt. Cooperative accountants were quick to point out that this structure would leave cooperatives without owners.

I have heard both members and cooperative leaders proclaim that a cooperative’s revolving equity is debt. The member’s statement is usually made as part of an argument that the cooperative must redeem their equity at a given age. Cooperative managers sometimes describe revolving equity as debt as part of a rationale for retaining funds as unallocated reserves (retained earnings) rather than as allocated equity. Managers and board members in a cooperative struggling to reduce revolving periods are often particularly hesitant to issue new equity.

Despite the unique characteristics of cooperative equity, it is not debt. Unlike a debt instrument, the cooperative board has discretion as to when it is redeemed. When required by financial circumstances, cooperative equity can be written down in value. A cooperative that has experienced losses obviously doesn’t have the unilateral ability to write down its debt. Cooperative stock has value to members only when it is redeemed. The principle of distributing patronage in proportion to business volume is only ultimately fulfilled when the distributed stock has been redeemed. While it is essential that cooperatives redeem stock, the member is the owner of the firm. Unlike lenders, owners receive the residual claim. The board’s first priority should be to manage the cooperative’s balance sheet. The equity redemption budget should be determined by the cooperative’s financial resources, not as an implication of the redemption system.

Profitable cooperatives absolutely can issue equity and redeem it on an acceptable cycle. There is clear evidence of this from some of Oklahoma’s cotton ginning cooperatives that have very short revolving cycles. Providing your cooperative has adequate levels of unallocated equity, you should have no hesitation in retaining funds as allocated equity. In fact, it is the only vehicle of retaining funds that provides an ultimate benefit to the member. Retained patronage is the primary vehicle for members to build ownership in their cooperative. Issuing stock is not creating debt but rather creating owners.

Myth:  Cooperative Stock is Debt

Status: Busted!

 

12-21-2011