What makes a business a co-operative?

With questions being raised over the future structure of the Co-operative Bank, academic Johnston Birchall has authored a report, which has been released by Co-operatives UK, looking at...

With questions being raised over the future structure of the Co-operative Bank, academic Johnston Birchall has authored a report, which has been released by Co-operatives UK, looking at how 'minority investor-owned co-operatives' are already in existance and how they work . . .

In defining co-operatives, several attributes may be seen as important, but the question of ownership comes first. In the simplest definition, a co-operative is a business owned, controlled and run for the benefit of, its members.
    
Ownership is the most fundamental defining characteristic, from which the others follow, and if these others are compromised – because the business is only partly controlled by the members or they do not get much benefit – then it is still a co-operative, even if it is a failing one. The International Co-operative Alliance’s identity statement starts further back from the ‘association of persons’ who come together to meet their needs through a co-operative, but it also emphasises the importance of the enterprise being ‘jointly-owned’.
    
This simple defining characteristic is complicated when investor- owners are allowed into the business, and the purpose of this report is to explore implications for governance of a co-operative. There are two processes by which member ownership and investor-ownership can come together. The first is uncontentious. People may buy shares in an existing business and organise together as a co-operative group to exert influence over it. When they become majority owners, the business has reached a point where it can be recognised as being a kind of co-operative. Employee share ownership schemes and football supporters’ trusts are good examples.
    
In the field of banking, Credit Agricole is another, more complicated, example where different types of bank have merged and converted into new forms. While it used to be state owned and still has some private shareholders, it has become majority owned by co-operative banks over time.
    
The second process is more controversial. A co-operative business may need an injection of capital that it cannot raise from among the members (at least not as quickly as it needs). There are some good reasons for this – it may: be failing and so need to raise capital to meet business losses; be meeting stiff competition and so need to expand quickly in order to defend or capture market advantages; be looking to invest in innovation and new technology or to expand into new markets; or it may simply be required by regulator to raise levels of capital reserves. There are many advantages in being a member-owned co-operative.
    
One of the disadvantages is that when capital is needed quickly the co-operative cannot raise it by going to the market and offering ownership shares. Sometimes this means it is tempted to take investor-owners into the business through a stock market flotation.
If the co-operative consists of individual members, it takes the members’ ownership stake and puts it in a holding company that then acts as an institutional investor in the business. The holding company is a kind of unseen presence behind a business that has a share price, practices ‘investor-relations’ and looks to all the world like a conventional investor-owned company. If the co-operative is a higher level organisation owned by other co-operatives (like some insurance co-operatives), or if it is a wholly-owned subsidiary of a co-operative (like the UK Co-operative Bank), then the owner-co-operatives already have a separate corporate structure in which to enter the new business as institutional shareholders.
    
The way we value these minority investor-owner co-operatives (for convenience we will now refer to them as MIOCs) depends partly on their history and current trajectory. Co-operatives that started off as investor-owned businesses but are becoming more co-operative over time have a moral advantage; nobody would argue that they are not ‘real’ co-operatives, even if they are not yet purely member-owned.    
Co-operatives that allow investor-owners into their ownership structure are generally seen as having weakened their co-operative nature, because they are allowing a different type of ownership where voting power is weighed according to the size of shareholding and owners are remunerated as investors rather than as users of the business. It can be seen as a partial demutualisation; a part, at least, of their co-operative is now run along different lines, with different priorities and underlying principles. The governance of the business will have to be shared, with consequences that are difficult to predict.
    
In writing this report, it began with the assertion that in defining co-operatives the question of ownership comes first. All the other characteristics of a co-operative follow on from this. However, when one looks at businesses from the outside, this is less obvious.
    
Institutional theorists talk of ‘isomorphism’; businesses that are in the same sector look very much like each other whatever their type of ownership. Banks look like other banks, whether they are co-operatives, savings banks or investor-owned.

Food retailers look just like other food retailers, whether they are family businesses, supermarket chains or consumer co-operatives. Dairies look like dairies whether or not the farmers own them. Isomorphism comes from market competition, from the need to conform to government regulation, from the need to hire professional managers who are all trained in the same way, and from the basic human desire to emulate others who are more successful. So we should not over-emphasise the differences between organisations on the basis of their ownership.
    
On the other hand, ownership sets limits on what a business can do, and owners have a great deal of power to stop their boards and managers from acting in ways that go against their interests. If the interests of owners and their boards and executives are not aligned, then the business will suffer. If a mixed ownership structure is chosen, with different interests pulling in different directions, then the costs of such ownership will eventually lead to either bankruptcy or conversion to a simpler, more stable ownership type.     
    
The conversion of co-operatives into hybrids that have a minority of investor owners has uncertain outcomes, and there are few precedents to follow. The case studies presented in the report suggest that it is perfectly possible for co-operative banks, insurance societies and agricultural co-operatives to become MIOBs, but that some of those that do find it too difficult and move back to the pure co-operative model.

Others find that the co-operative share is diluted over time so that the co-operative becomes just one institutional investor among others. When the model works, it does seem to lead to a dilution of the meaning of ownership among co-operative members.
     
Despite these different business trajectories, a close comparison of the governance codes of co-operative boards and investor- owned business Boards shows that there is considerable overlap. In many ways, the governance of an MIOB will be ‘governance as usual’.  
    
However, pulling in one direction is the idea of membership, with boards being responsible for encouraging member participation in lower level democratic structures, and encouraging active members to stand for election. Pulling in the other direction is the idea of governance on behalf of shareholders, with boards being responsible merely for having a dialogue with major investors and, providing they are successful, being more distanced from their owners.
    
Yet it is possible that, if handled well, the combination of pressures from consumer members and from investors could lead to better business performance and greater accountability. The adoption of a governance code based on the different strengths of the co-operative and corporate codes could also benefit the business. One lesson that comes from the experience of existing MIOBs is that these issues cannot be left to chance and have to recognised and planned for.
  
• Johnston Birchall is Professor of Social Policy at Stirling University. His focus is on member-owned businesses and public service agencies that involve users in their governance.

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