Investment in a Thin and Uncertain Market: A Dynamic Study of the Formation and Stability of New Generation Cooperatives

Member-owned firms have become increasingly prominent in many industries, including the ethanol industry. Despite an upsurge in the popularity of member-owned firms, especially the new generation cooperatives (NGC's) that now dominate Minnesota's ethanol industry, there has been little research directed toward understanding why NGC's might proliferate in one industry while investor-owned firms are more prevalent in others. There are three main objectives in this study. The first objective is to analyze producer investment in a new generation ethanol cooperative. This study shows that the traditional net present value rule of investing does not provide an adequate model of investment when volatile prices make returns uncertain and when an investment provides significant diversification benefits. An agent's true demand for NGC shares is often well below the investment threshold predicted by the traditional net present value rule. The second is to model the market for stock in NGC's under various assumptions about the stock trading mechanism and to explore the investment and disinvestments decisions of members and the cooperative under each assumption. It is shown that the method by which the stock is traded has an effect on the value of the stock, the liquidity of the stock, and ultimately the ability of the cooperative to form and survive. The third objective is to apply the model to two policy issues that are currently important to the ethanol industry: the threat of takeover of NGC's by investor-owned firms (IOF) and the impact of the ethanol subsidy on the formation and stability of ethanol plants. First, takeovers of NGC's are most likely to occur when the ethanol price and the corn price are both low because IOF's and NGC members respond differently to price risk. With respect to ethanol subsidies, it is shown that removing the ethanol subsidy would result in fewer ethanol plants, but those that do form would most likely be NGC's. Existing NGC's would also be less likely to be taken over by IOF's if the ethanol subsidy were eliminated, although more NGC's would be abandoned by their members.