10. Co-operative Principles and Capital Formation

Critics say that the easiest solution to deficient capital formation in co-operatives is to turn all co-operatives into private limited companies. Is it possible to improve capital formation in co-operatives without sacrificing the main principles of cooperation?

The Principle of User-ownership

This principle restricts ownership of the co-operative to the users. Persons, who do not use the services, are not allowed to be members and, therefore, the shares of cooperatives cannot be traded in a stock exchange for sale to any capital investor. The shares of the co-operative do not have a market and the member’s shares cannot be sold at a higher value, but the co-operative redeems the shares at their nominal or purchase value when the member withdraws from active use of the co-operative services. The non-marketability of member shares denies the member the right to use his/her share as a means to accumulate capital gain (value) and thus serves as a disincentive in attracting capital. The co-operative investor-owner does not obtain similar benefits from his capital investment in the co-operative as he would in an investor-owned firm.

Accepting the above inherent deficiencies, there are several aspects in the implementation of the principle of user-ownership in Kenyan co-operatives, which warrant discussion:

1. The position of member-owners of co-operatives has been historically vague, because a co-operative has had according to law a monopoly in its area and no competing services have been allowed. Government has built, developed and controlled the co-operatives to the extent that co-operatives have been considered to be public property. Management has had almost a free hand in making deductions from member produce payments and in using the money in the way they have considered best. Members have remained a mass of largely passive suppliers, whose ownership and autonomy has not been respected adequately.

2. Members have not invested in the share capital of the co-operatives, also partly because the investment does not accumulate exchange value and partly because with only a minimum number of shares the member can gain access to the bulk of member services offered by the co-operative.

3. A person can become a member with full powers to use all the facilities by buying one share of nominal value irrespective of the net worth of the cooperative per member. Because the cost of new member entry does not change over time in spite of increases in co-operative net worth, new members can join the co-operative at a highly subsidised price, and in a sense become “free riders”.

4. The co-operatives collect money from the user-owners by deducting the repayments of investment loans from the producer payments. Because the net worth per member is much higher than the share capital per member without significant financing from internally generated surplus, it is seems that the additional capital contributed by the members is entered in the books of the cooperatives into the indivisible capital. An average member may have contributed 2,000-3,000 shillings or more from the producer payments. This capital contributed by the member is then often recorded in the collective and indivisible capital of the co-operative rather than converting these payments into additional member shares. Members seldom receive recognition for their increased financial stake. In the end, a retiring member may have only one share of 20 shillings and the value of the redeemed share will not buy him/her much after withdrawing from the co-operative after 20-30 years. A member loses the investment to the co-operative, which does not encourage the member to appreciate the financial participation as an owner.

5. User-ownership principle assumes that only the active farmers are the decision-makers in the co-operative. In reality, members do not bother to redeem their shares and withdraw from membership because of the negligible value of their shares. The membership registers of co-operatives include frequently a high number of passive members (20-50%) which is contrary to the user-ownership principle and does not promote mutuality between active members. For the purpose of redeeming the capital invested by the owners, co-operatives should rather view share capital as a long-term loan. Capital redemption plans are not yet prepared by the Kenyan co-operatives and require internal profitability. Kenyan co-operatives have not educated their members on the benefits, which may accrue to them after the active membership period and the need to generate funds consistently from operations in order to pay these benefits.

1. Charging new members a fair value for investments already made in the cooperative.
2. Issuing of share certificates to full value of members’ contributions.
3. Capital redemption to passive members.

According to user-control, members participate democratically in decision making in their co-operative according to a one-member, one-vote principle. User-control is important from the democratic control point-of-view. The main causes of loss of capital in Kenyan co-operatives and hence the need for improved user-control are in controlling misuse of the society’s funds and members’ right to obtain transparent financial information. In the surveyed co-operatives, two deficiencies in the implementation of the principle of user-control were noted:

1. Members’ funds of the co-operatives have been abused and mismanaged leading to large financial losses and lost confidence. There was hardly a single cooperative in the survey that had not, at one time or another in its history had a case of fraud or mismanagement. Yet no evidence was found of a single court case of fraud of co-operative funds. The principle of user-control does not extend to the control of the co-operative’s funds because of the lack of transparency. Management has been able to hide transactions behind accountancy jargon, which has not been understood by any member, delay disclosure and inhibit information flow by providing only verbal reporting.

2. A vital group of users does not have ownership or control in the matters related to the governance of the co-operative society. Women have been recognised by most of the interviewed (members and staff) to be the main suppliers of produce to the co-operatives. It is also recognised in this survey that women have priorities, interests and aspirations that are often different from the male-users of co-operatives. Yet women are left out of the decision-making process in the organisations, which rely for their growth and success on the active participation of its suppliers. Women cannot influence the development of the co-operatives. The main argument for excluding women is that only men can own land and should be members. This takes away the legitimate right of active female suppliers to participate in co-operative decision-making. Another significant consensus among all members, including the male members, was that women are more trusted than men are in financial affairs. Management interviews were fairly unanimous in saying that representation by women would be welcomed, but it was also clear that management had so far done little in actively seeking such a motion. At the same time, the failure of many co-operatives in this survey in respect of transparency and trust by members in management has been recognised as a major obstacle to capital formation. Promoting women’s participation in decision-making might help solve the problem. We believe that it would be in the interests of the management to work proactively towards having female members in the management committees. Promotion of women’s rights would give a more democratic, future-oriented and perhaps also a more trustworthy image to the management.

1. Improved transparency in financial information and decision-making. Good transparency will allow members’ control, which will improve trust and image of the co-operative and hence lead to a better environment for capital formation. At the moment, management is considered to be too powerful to allow them to ignore members’ needs to control the co-operative. Members will have to form delegations to go to meet the management and demand additional information. There are, however, many opportunities for a proactive management to upgrade member information of the co-operatives financial status such as to:

· introduce computer accounting to provide up-to-date financial information,

· provide written information to members of the financial status of the cooperative,

· use of charts and other illustrations in financial reporting with the help of computer programmes or manually,

· organise quarterly discussions of the society’s financial results at factory level,

· allow for supervisory committees as internal auditors representing the members as watchdogs of the management committee. The work of these committees would be important in all types of co-operatives to dispel hearsay and rumours about possible mismanagement.

2. Prosecution of criminal fraud cases. Earlier, the Government “guaranteed” the safeguarding of members’ funds by its control mechanisms and in case of a major failure, by taking over the management of the co-operative. The policy in criminal fraud cases was not to prosecute guilty parties, but to let time heel the wounds. This policy allowed mismanagement and fraud of “the public cooperative funds” without punishment, which lead not only to loss of significant amounts of capital, but to the loss of credibility of the co-operatives in safeguarding members’ funds. A pronounced attitude should be taken to consider the members’ property in the co-operative as private, not public or governmental. Societies should be advised to take all criminal fraud and mismanagement cases into court. This would communicate a change of norms to the members, which will improve trust and create a better environment for capital formation.

3. Allow women and youth farmers to become members although they are not landowners. To preserve the one-member, one-vote principle, the issues of share holding and voting rights of a member are already separated. Similarly, the question of land ownership and voting rights can be separated by promoting married couples to buy a voting right to both husband and wife. Should voting by secret ballot be made a norm, women could have an unrestricted right to participate in general meetings and vote according to their wish. In this way, the marked absence of women from the management of co-operatives could change. Equally to women, youth, suppliers on their own right, but living on the father’s land before an official sub-division, do not have voting rights either. Cooperatives should adopt a new attitude, which would honour the rights of active suppliers, the young farmers, to become members of the society. This would improve the image of the co-operatives into more dynamic institutions, which the youth could identify better with.

The user-benefit principle of co-operation requires that benefits of membership be distributed to user-members equally on the basis of the volume of use. This is often interpreted also as business-at-cost. Business-at-cost is misunderstood to legitimise the common practise of draining a society of its operational funds as has been witnessed in most of the surveyed co-operatives.

Members as suppliers to their dairy or coffee marketing co-operative consider that their society has made a surplus only because it has paid too little for their produce. Members of consumer co-operatives consider that the co-operative’s surplus has been generated only due to overcharging the consumers. The concept of business-at-cost is understood to require that any surplus be paid back to the members in the name of fairness. Members then take the whole surplus out and leave nothing in the organisation for future expenses or investments.

This survey of agricultural marketing and supply societies confirmed that members preferred to minimise the net income of the society and to maximise the price they receive for their produce. Members did not allow the co-operative to accumulate capital from a positive net result that could be paid back at the end of the year in the form of possible patronage refunds or retained in the organisation for future use. Their rigid adherence to the concept of business-at-cost did not allow the co-operative to raise capital from its internal efficiency.

Ironically, the above practise does not extend to a loss made by the cooperative. Members do not consider themselves liable to pay an additional fee or reduce their produce payments to cover a loss. “Let the organisation suffer, while we take out what we deserve.” It would be important for simplicity of operations and capital formation to refrain from losses. Should profits be shared, losses should be shared as well. A loss will convey a message, a very simple control signal that something is wrong. The problem should then be dealt with immediately and it is better to suffer a loss in one year by deducting from the members so that no accumulated losses are carried forward. Such a procedure will also lead to increased member interest to keep management accountable for their actions.