Must read for all Fonterra members

Taken from Cooperatives NEWS october – november 2009

A must read for all Fonterra members looking into the proposed Capital restructuring.

Caroline

Aligning with member interests
and democratic control
by Peter Harris
Historically, cooperatives and mutuals have played a massive part in the New Zealand economy. Despite this, the standard governance texts and best practice manuals fudges the distinction between different forms of commercial incorporation. Specifically, cooperatives form to correct imbalances that develop when traditional investor-owned companies operate in market economies.
These are to:
● Protect members from poor quality, unsafe services and overpriced goods that result from weak competition;
● Gain access to markets where infrastructure is weak or expensive (eg packaging, transport, distribution);
● Provide services that are not profitable to commercial operators (such as in remote areas);
● Capture a share of value added from commercial provision;
● Secure economies of scale with buying or selling power.
DUTY OF CARE
Cooperatives pursue mutual interests as users of services as opposed to the investor interests of providers of services. They therefore form and persist as an alternative to the delivery of service through conventional, investor-owned enterprises. Both are owned. Both are governed. Both have to have regard to commercial disciplines or else they will go broke. Both need to be aware of the interests of other stakeholders in order to retain patronage and support. Where they part company is where the directors focus their attention when they exercise a necessary “duty of care”. Commercial company directors do develop a set of tools that are of benefit in a cooperative company: audit and risk oversight, remuneration of senior managers, investment of treasury type funds, legal compliance disciplines and so on.
However, those common competencies are not sufficient. There is a need for an almost 180 degree reorientation of the duty of care in relation to promotion of the interests of the owners as users as opposed to owners as investors.
In checking whether co-ops are being governed in a way that is fully aligned with member interests and democratic control, I think we can develop some tests. Here are ten questions, but this is by no means an exhaustive list.
1. Do the directors ask whether there is more value to the owners from continuing in business and accumulating assets, or selling up and distributing them?
If they do, they don’t get it. They are operating outside the primary area of responsibility as directors of a cooperative, elevating the interest of investors to the cardinal interest. In fact most co-op members have very little skin in the game as investors, but a lot at stake as users. By way of example, owners of a fertiliser co-op do not really care what the value of their shares is:
they care passionately that the co-op delivers the right quantity and quality of fertiliser on time at a good price.
If directors ask whether there is still a market imbalance that needs to be addressed, or whether the interests of co-op members are being met by conventional enterprises, they are still focussing on the cardinal interests of the owners.

2. How often do directors review the shape and form of the benefit that their members get from participating in the co-op?
If the co-op simply matches the competition in form and price of service, it is not correcting a market imbalance: it is perpetuating it. The competition leads, the co-op follows. It competes essentially by using the margin created by its “free capital” (owners’ equity and accumulated reserves on which it does not have to pay a dividend). Nominally anyway, a “real cooperative” does pay owners market rates on capital left in the business: it just does not give voting rights pro rata with capital contributed and distributes surpluses (above those needed to sustain adequate reserves) on the basis of level of participation in co-op activities. In practice, accumulated reserves are an undifferentiated wash-up from past activities, so payment of a market rate to contributors is not a realistic option. But this should not detract from the need to keep the member interest top of mind, or else the co-op is largely benefiting directors and staff, not members.

3. Do directors regularly assess the extent to which their service configuration and price ensure that returns to members are pro rata with their participation in the trading activities of the co-op?

If they do not, they can easily see the co-op drift as members who cross-subsidise others react to another form of market imbalance (administered imbalance) and walk away.

4. What innovations has the co-op introduced in recent times?
Market outcomes change in a modern dynamic economy, so the member benefits that the co-op
can capture will alter as competition and technological change both reduce old imbalances and create opportunities for new benefits.
Innovations can be quickly imitated, so an effective co-op is innovating ahead of the competition.
If it simply imitates market innovations it loses that fundamental driver of its reason for being: to do things differently.

5. Is there an explicit succession plan for directors?
Co-ops need to be democratic and accountable. In a profit-maximising company, shareholders who are dissatisfied with the performance of directors can simply sell their shares, extract their capital and walk away. The threat of a hostile takeover bid tends to apply incentives to investor-owned company directors to maintain performance (although spectacular failures are still very frequent). However, because co-op shares can be issued with a nominal value and can be redeemed, capital market disciplines on directors are virtually nonexistent.
There is nothing wrong with that: it is just a consequence of the orientation of a co-op.
Especially in larger co-ops with diffuse memberships, it is very hard to articulate effective member voice. Hence democracy, transparency and accountability have to be worked on and led.

6. Is there a regular review of whether the organisation has been captured by a minority or special interest: be that an activist grouping within the membership, management and staff, or the incumbent directors themselves?
It is very easy, in a large organisation where owners have very little investor interest in its asset base, for complacency to set in, and for directors and managers to overlook the vested interest of minority activist groups. They are the ones that need to be pacified, so it is easy to build up a comfort blanket that says that the activists are the members.

7. Are there formal limits on the scope and level of trading with non-members?

Some form of transactions with non-members is inevitable in any co-op. The question becomes whether non-member transactions start to dominate the financial affairs of the cooperative to the extent that they subordinate the interests of members. This is particularly acute when various covenants are placed on the terms of loans and when constraints are placed on the discretion of the organisation as a contractual condition of some other transaction. The risk is that there can be a tipping point, beyond which the non-members, by virtue of financial weight, become de facto cardinal stakeholders, and the fundamental character of the coop is lost.
8. What processes are in place to ensure
capital adequacy to underpin possible
expansions of activity and to ride through periodic
difficult trading conditions?
There is a delicate balance to be struck. With relatively few exceptions (Fonterra being a major one!), members of co-ops do not have a fundamental commercial interest in the co-op: it is a part of their lives, not the centre of them. Hence they will stump up a joining fee in the form of a capital contribution but cannot be expected to regularly subscribe to new capital issues, especially since the co-op is not designed to serve their interests as investors. There are many options for capital raising:
retained surpluses, joint ventures, preference shares, subsidiary investor-oriented companies,
capital notes and the like. The point here is that it is usually too late to seek
capital to ride out a crisis, but over-capitalising “in
case” runs into demoting the member service orientation of the company. A formal recognition of where the capital adequacy boundary lies, how it is to be sustained, and how capitalisation strategies support the member interest focus of the co-op is required: capital management
should not be a default outcome of governance.
9. Are special steps taken to reinforce a sense of belonging among members: to reinforce and refresh the “common bond”?
A robust cooperative relies partly on individual members seeing personal value in the collective
benefits that flow out of their joint activities, but that attachment can be weak and fickle.
The co-op can be reinforced if there are routine reviews of what binds members as opposed to simply what benefits them.
10. Is there a director approved programme of induction of managers and staff to reflect the member benefit orientation of the organisation?
Organisational values penetrate management and staff slowly and unevenly, and can be a source
of tension within the staff (especially among managers) if they are not formally communicated and supported. Fundamentally, the question that directors need to ask is whether the co-op is a membership mutual benefit organisation, an insiders’ support facility, or a directors and staff benevolent society.

SHORTCOMINGS
The Institute of Directors has assembled a framework for the governance of companies that brings together values, principles and practices. On the face of it, they seem like the sorts of values that might sit easily with any co-op: integrity, enterprise, fairness, transparency, accountability and efficiency. What is missing is a clear specification of what the interests of the “shareholder” are. There is not a robust recognition that the very reason for owning an enterprise can reflect different and divergent dimensions of the personal interests of the shareholder. It is covered in the overall wash-up of achieving the “mission and purpose” of the organisation, and to be fair that can be something other than value maximising. My question, though, is if in practice the natural orientation of directors of co-ops leads them as a matter of first principle to question the fundamental orientation of the interests of the owner.
Even if it happens, I really doubt that it is pervasive, but for co-ops to be fully on mission, that orientation needs to be pervasive.
If it is, all is well.
If not, the question becomes how to overhaul cooperative director induction, training, assessment, and compliance routines and manuals to achieve it.●