Bill Fitzwater Cooperative Chair
Oklahoma State University
Cooperatives typically distribute earnings to members in patronage refunds which can be some combination of cash, qualified stock and non-qualified stock. Earnings distributed as patronage refunds achieve single taxation although, in the case of non-qualified stock, the timing is delayed until the stock is redeemed. That raises the question as to why a cooperative would want to issue dividends (payments based on ownership) on all or some portion of the stock held by members.
One rationale is to create an additional layer of equity, which will be semi-permanent equity, on the balance sheet. This equity might be supplied by outside investors, as is the case with some regional cooperatives, or from members who have their equity redeemed in the form of a dividend bearing stock rather than cash. The dividend provides the incentive for the outside investor or member to leave the funds in the cooperative. There must be a system for redeeming this equity, often on demand, but the board has the discretion to suspend redemption. A board would want to be very cautious with that option if they didn’t want the supply of funds to dry up. Adding semi-permanent equity increases total equity and somewhat simplifies balance sheet management since a smaller percentage of total equity is subject to the swings of equity redemption.
A second, somewhat fuzzy rationale is to improve the perception of cooperative equity and better highlight the “user-owner” role of cooperative membership. Paying dividends, at some point in the stock’s lifecycle counters the claim that there is no return on cooperative stock. A category of members are now holding cooperative stock voluntarily. The concept that the cooperative needs investment from members to invest in infrastructure and other profit generating assets is perhaps reinforced.
A third rationale for creating dividend bearing stock is the one that has more recently generated attention. This is the desire to use the after-tax portion of profits from non-member business to pay dividends on stock held by members rather than retain those funds as unallocated reserves. This is a two part rationale. The cooperative wants to manage its ratio of unallocated equity to allocated equity and the cooperative wants to distribute non-member generated profits to members. Those profits are already taxable to the cooperative so there is no tax effect created by the dividend, just the decision to distribute rather than retain the funds. The dividend rate which is paid with after tax funds is more expensive than interest but the funds go to members. The cooperative is not increasing unallocated equity which they may feel is at an unacceptably high ratio to total equity. The previously discussed rationales of semi-permanent equity and enhancing the “user-owner” role are of course also in play.
Dividend bearing stock is just one of the many potential moving pieces in the cooperative financial model. In my next newsletter I’ll discuss more of the issues relating to dividends.