Goddard, Ellen W.

Hailu, Getu

Jeffrey, Scott R.

Ng, Desmond W.

English

Research Papers in Economics

Incentive Incompatibility in Co-operative Agribusiness Firms 
in Canada: Does Supply Management Matter?
Getu Hailu, Scott R. Jeffrey, Ellen W. Goddard, and Desmond Ng
Relatively few studies have estimated and tested 
the impact of agency costs of debt on costs of pro-
duction or productivity of firms (e.g., Kim and 
Maksimovic 1990; Featherstone and Al-Kheraiji 
1995; Bernstein and Nadiri 1993; Hossain and Jain 
2001). The empirical evidence from these studies 
indicates that the estimated magnitude of agency 
costs would undoubtedly influence the firm’s capi-
tal-structure decision. All of these studies have been 
conducted for firms in the U.S.; agency costs of 
debt have not yet been addressed in the context of 
Canadian co-operative agribusiness firms, specifi-
cally in supply-managed industries. 
Does Supply Management Matter?
Supply management is a long-standing policy in 
some sectors of Canadian agriculture—dairy prod-
ucts, chicken, turkey, and eggs. It may be argued that 
supply-management policy may partially mitigate 
agency costs of debt for co-operative processors 
facing regulated raw-material supply, such as firms 
purchasing farm commodities in supply-managed 
sectors. 
Given production control, and invoking the Le 
Chatelier-Samuelson principle, more restrictions 
make choice variables less responsive to changes 
in exogenous variables (Chambers 1988). This sug-
gests that the degree of economic importance of 
agency costs may be different for firms operating 
in regulated versus unregulated industries. Thus the 
agency costs of debt may be less pronounced under 
supply management. Whether supply management 
could circumvent the agency problem merits serious 
consideration.
Data 
Based on the objectives of the study, two case co-
operative firms are selected: Lilydale Poultry Co-
operative Limited, a case representing a centralized 
marketing co-operative operating in a supply-man-
aged industry; and Alberta Honey Producers Co-op-
erative, a case representing a centralized marketing 
Hailu, Jeffrey, Goddard, and Ng are Ph.D. candidate, associate 
professor, professor and Chair, and assistant professor, 
respectively, Department of Rural Economy, University of 
Alberta, Edmonton, Canada.
Funding for this for this study was provided by Cooperative 
Program in Agricultural Marketing and Business, University 
of Alberta. 
An incentive incompatibility exists when the 
maximization objectives of the parties to a co-
operative diverge, and suboptimal allocation of 
resources within an organization may result. This 
is consistent with the prediction that agency costs 
of debt may cause a potential deterioration in cost 
efficiency (Barnea, Haugen, and Senbet 1985; Jen-
sen and Meckling 1976). An extensive literature 
has investigated the benefits and costs of the use 
of debt financing, both theoretically (e.g., Jensen 
and Meckling 1976) and empirically (e.g., Kim 
and Maksimovic 1990). However, the issue of 
how Canadian supply-management policy impacts 
the agency costs of debt resulting from incentive 
incompatibility has received little attention. The 
objective of this study is to investigate the impact 
of supply-management policy on the agency costs 
of debt for selected cases of Canadian co-operative 
agribusiness firms. 
Literature Review
Agency problems arise if the owner of the firm del-
egates a task to a manager who has an incentive-
incompatibility constraint and the information about 
the manager is imperfect. Agency problems may 
even be more pronounced in the case of a co-opera-
tive firm where managers of the firm may not have 
share-ownership rights. Unless the agency problems 
are resolved they lead to suboptimal allocation of 
resources within the organization, resulting in in-
creased costs of production (Barnea, Haugen, and 
Senbet 1985). Agency problems related to debt 
arise from asymmetric information, risk incentive, 
investment incentive, and bankruptcy problems 
(Barnea, Haugen, and Senbet 1985; Jensen and 
Meckling 1976). Hailu, Jeffrey, Goddard, and Ng Incentive Incompatibility in Co-operative Agribusiness Firms in Canada   111
co-operative operating in an unregulated industry. 
The two cases were selected to explore whether 
supply management influences agency costs of 
debt. Lilydale Poultry Co-operative Limited oper-
ates six poultry farms, seven poultry-processing 
plants, two further-processing operations, five 
hatcheries, a rendering plant, and egg-grading and 
-processing plants. The Alberta Honey Producers 
Co-operative processes and packages pure natural 
honey and honey-related products.
Data on sales of co-operative output, costs of 
labor, costs of raw material inputs, costs of other 
variable inputs, depreciation, capital investment, 
property, buildings, equipment, and long-term debt 
are obtained from annual reports for the two co-
operatives. Additional data are obtained from vari-
ous Statistics Canada publications and web sites. 
To empirically investigate the impacts of agency 
costs of debt on resource allocation, a translog cost 
function is used that incorporates pre-existing debt 
as a “shift-variable”.
Results1
Agency costs of debt are measured and tested us-
ing the statistical significance of the cost elasticity 
of debt. The cost elasticity of debt is calculated at 
mean values of the variables in the model for both 
co-operatives. For the Alberta Honey Producers Co-
operative model the estimated cost elasticity of debt 
averages 0.067 and it is statistically significant at 
the 5% level. This is consistent with the prediction 
that agency costs of debt may cause a potential de-
terioration in cost efficiency (Barnea, Haugen, and 
Senbet 1985; Jensen and Meckling 1976). This find-
ing suggests that, with other things held constant, a 
10% increase in the level of debt results in 0.67% 
increase in the total variable costs of production 
for Alberta Honey Producers Co-operative that is 
attributable to agency problems. 
For Lilydale Poultry Co-operative, the estimated 
cost elasticity of debt is 0.06, but is statistically 
insignificant. Based on the theoretical claim and 
empirical results, it is likely that supply manage-
ment has lessened agency costs of debt. This might 
be due to the fact that supply management through 
predetermined levels of raw materials is equivalent 
to monitoring the level of processor output, avoid-
ing managerial shirking effects that negatively affect 
the level of output. 
Conclusion
Though previous empirical evidence has invariably 
reported the existence of agency costs for aggregate 
sample or industries, the agency cost of debt in these 
case studies was found to be firm-specific. Evidence 
of statistically significant agency costs of debt was 
found in one of the two case co-operatives. Agency 
costs of debt may have a consequential influence 
on the cost efficiency of co-operative agribusiness 
firms. The agency costs of debt may have different 
impacts under different regulatory environments. 
Thus if there are any agency costs, capital-invest-
ment decisions or capital-budgeting analysis should 
account for the agency costs of debt, and cash flows 
should be discounted at the agency cost-adjusted 
cost of capital. Finally, since this is a comparative 
case study, the findings cannot be generalized to 
other co-operatives. 
References
Barnea, A., R. A. Haugen, and L. W. Senbet. 1985. 
Agency Problems and Financial Contracting. 
Prentice-Hall, Inc., New Jersey. 
Bernstein, J. I. and M. I. Nadiri. 1993. “Production, 
Financial Structure and Productivity Growth in 
U.S. Manufacturing.” NBER Working Paper 
Series, Working Paper No. 4309. Cambridge.
Chambers, R. G. 1988. Applied Production Analy-
sis: A Dual Approach. Cambridge University 
Press, Cambridge.
Featherstone, A. M, and A. Al-Kheraiji. 1995. “Debt 
and input misallocation of agricultural supply 
and marketing cooperatives.” Applied Econom-
ics 27(9):871–878.
Hossain, F. and R. Jain. 2001. “Financial Struc-
ture, Production and Productivity Growth in 
U.S. Food Manufacturing Industry.” Paper 
presented at the annual meetings of the AAEA, 
August 5–8. Chicago.
Jensen, M. C. and W. H. Meckling. 1976. “Theory 
of the Firm: Managerial Behavior, Agency Costs, 
and Ownership Structure.” Journal of Financial 
Economics 3(4):305–60.
Kim, M. and V. Maksimovic. 1990. “Debt and Input 
Misallocation.” The Journal of Finance 45(3):
795–816.
1 The translog cost-functions parameter and elasticity estimates 
are available upon request.

Applied Production Analysis: A Dual Approach.

Debt and input misallocation of agricultural supply and marketing cooperatives.”

The translog cost-functions parameter and elasticity estimates are available upon request.

INCENTIVE INCOMPATIBILITY IN CO-OPERATIVE AGRIBUSINESS FIRMS IN CANADA: DOES SUPPLY MANAGEMENT MATTER?

INCENTIVE INCOMPATIBILITY IN CO-OPERATIVE AGRIBUSINESS FIRMS IN CANADA: DOES SUPPLY MANAGEMENT MATTER?

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