Optimal capital structure in agricultural cooperatives and implications for equity retirement
ISSN: 0002-1466
Article publication date: 27 October 2020
Issue publication date: 15 March 2021
Abstract
Purpose
This paper presents a model for determining the optimal capital structure for cooperatives and explores the relationship between financial leverage and the ability of cooperatives to retire member equity.
Design/methodology/approach
A model is developed to determine the optimal capital structure and explore the relationship between capital structure and the rate at which a cooperative can retire member equity. Using data from cooperative financial statements, ordinary least-squares regressions are conducted to test two hypotheses on capital structure and equity retirement.
Findings
The model shows that the optimal capital structure is determined by the ratio of the rate of return on capital employed to the interest rate on borrowed capital and the required level of interest coverage. The regressions suggest that cooperatives choose their capital structure largely according to the rate of return on capital employed and the interest rate in a manner consistent with maximizing the rate of return on equity and that the rate at which cooperatives can retire member equity is directly related to leverage.
Research limitations/implications
The model does not consider unallocated earnings. Analysis of the relationship between leverage and equity retirement yields results contrary to the assumptions of earlier studies.
Practical implications
Cooperatives can use the model because the necessary parameters are easily understood and readily available from financial statements, lenders and industry sources.
Originality/value
The model is developed specifically for determining the capital structure of cooperatives and differs substantially from the corporate model. A theoretical basis is provided for the relationship between leverage and equity retirement.
Keywords
Acknowledgements
The authors would like to express their appreciation to Robert Pace, CoBank portfolio management analyst, and to an anonymous reviewer whose comments helped improve the analysis. This paper is based on research that was partially supported by the Nebraska Agricultural Experiment Station with funding from the Hatch Act (Accession Number 1009207) through the National Institute of Food and Agriculture.
Citation
Royer, J. and McKee, G. (2021), "Optimal capital structure in agricultural cooperatives and implications for equity retirement", Agricultural Finance Review, Vol. 81 No. 2, pp. 277-291. https://doi.org/10.1108/AFR-03-2020-0044
Publisher
:Emerald Publishing Limited
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