Accepted Manuscript

Title: Are cooperative firms a less competitive form of

business? Production efficiency and financial viability of
cooperative firms with tradable membership shares

Author: Kazuhiko Mikami

PII: S0939-3625(18)30307-8
DOI: https://doi.org/10.1016/j.ecosys.2017.11.005
Reference: ECOSYS 662

To appear in: Economic Systems

Received date: 7-11-2016

Revised date: 22-11-2017
Accepted date: 30-11-2017

Please cite this article as: Mikami K, Are cooperative firms a less
competitive form of business? Production efficiency and financial viability of
cooperative firms with tradable membership shares, Economic Systems (2018),
https://doi.org/10.1016/j.ecosys.2017.11.005

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Are cooperative firms a less competitive form of business? Production efficiency and
financial viability of cooperative firms with tradable membership shares

Kazuhiko Mikami*

Department of Applied Economics, University of Hyogo, Kobe, Hyogo, 651-2197, Japan

*Tel.: +81-78-794-7052, fax: +81-78-794-6166;

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E-mail address: mikami@econ.u-hyogo.ac.jp

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Highlights

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 Cooperative firms are generally considered to be a less competitive form of business

than capitalist firms.

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 Cooperative firms issuing tradable membership shares are considered.
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 Such cooperative firms are shown to be as efficient and financially viable as capitalist
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firms.
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Abstract

Cooperative firms are generally considered a less competitive form of business than
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conventional capitalist firms in a market system. In this study, we consider cooperative firms that
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issue tradable membership shares and show that they are in principle as efficient and financially
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viable as capitalist firms. This implies that, if allowed to issue tradable membership shares,

cooperative firms could be a promising alternative to capitalist firms in a wider range of

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circumstances.

Keywords: Cooperative firm, Tradable membership share, Production efficiency, Financial

viability

JEL classification: P13; G32

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1. Introduction

1.1 Aims of the paper

Despite the important role they play in some sectors of the economy, cooperative firms are

generally considered a less competitive form of business than conventional capitalist firms in a

market system. This perception seems to be rooted in two perceived weaknesses inherent in

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cooperative firms.

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First, cooperative firms are often thought to be inferior in production efficiency. This feature is

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most apparent in studies of the so-called Illyrian labor-managed firms (Ward, 1958; Domar, 1966;

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Vanek, 1970; Meade, 1972). Illyrian labor-managed firms are a type of worker cooperative that is

supposed to maximize net income per member. A major feature of this type of firm is that, in an
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attempt to increase net income per member, the firm restricts membership size and operates at a
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sub-optimal production level, causing the value of the marginal product to exceed the marginal
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cost. This is comparable to the behavior of a profit-maximizing capitalist firm, which operates at
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the optimal production level, where the value of the marginal product equals the marginal cost.
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Regarding this problem, the relevant literature suggests that the misalignment between the

marginal product and marginal cost in an Illyrian labor-managed firm can be corrected by hiring
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non-member wage workers or increasing membership (Dow, 1986, 1996; Sertel, 1987, 1991; Fehr,

1993), although both methods have problems (Ben-Ner, 1984; Dow, 2003).
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CC

Second, cooperative firms are also considered to be inferior in financial viability. A capitalist

firm issues stock, which investors buy on the premise that they can resell it on the stock market.
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Through this mechanism, a capitalist firm can raise permanent equity capital. By contrast, a

cooperative firm issues membership and allocates it to those who wish to become members.

However, because membership is usually not marketable, members who wish to withdraw from

the firm and recoup their initial investment must have the firm redeem their membership. This is

actually what cooperative firms do in practice. Thus, their equity capital is by nature variable in

2
response to the entry and exit of members. Alternatively, cooperative firms need to rely on debt

capital. Debt requires high interest rate payments in the absence of eligible collateral, and a large

stock of debt increases the risk of financial distress and default. This financial instability

compared to capitalist firms has been widely recognized as a major weakness of cooperative

firms both empirically (Thornley, 1981; Oakshott, 1990) and theoretically (Laidlaw, 1987; Böök,

1992; Jossa, 2014). As one way to overcome this problem, recent research suggests the

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introduction of unredeemable membership shares in cooperative firms (Mikami, 2010, 2013,

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2015).

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On the basis of these observations and studies, we consider tradable membership shares in

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cooperative firms and examine their implications for the production efficiency and financial

viability of cooperative firms in comparison to capitalist firms.

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1.2 Tradable membership shares
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Conventionally, membership shares in cooperative firms are not regarded as tradable

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instruments. In fact, essentially, tradable membership shares are inconsistent with the so-called
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“open membership,” one of seven cooperative principles established by the International

Co-operative Alliance. Under this principle, those who want to become members of a
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cooperative firm can do so at any time by paying in refundable share capital, while those who

want to quit can do so at any time by having the firm refund their share capital. Where this
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principle prevails, the market for membership shares does not evolve like the market for ordinary

commodities, whether real or financial, such as automobiles, houses, or company stocks. (For
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example, if one could obtain a car at any time by paying a refundable deposit to a car dealer and

relinquish the car to the dealer at any time by having the deposit refunded, the market for used

cars would not evolve.) Open membership is thus intrinsically incompatible with the free trade of

membership shares on an open market.

We should note, however, that open membership and the non-tradability of membership

3
shares are not inevitable consequences of the organizational attributes of cooperative firms.

Rather, from a technical point of view, cooperative firms can make their membership shares

transferable and tradable without abandoning their essential nature of being owned by members

as input providers or output customers rather than capitalists. In fact, plywood worker

cooperatives in the US Pacific Northwest used to issue tradable membership shares (Berman,

1967; Craig and Pencavel, 1992, 1995), as do housing consumer cooperatives in the Nordic

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countries today (Lilleholt, 1998).

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1.3 Research method

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Tradable membership shares in a cooperative firm are no different from shares of stock in a

capitalist firm, except that the former involve transactions of real goods or services with the firm
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(Mikami, 2016). In a capitalist firm, holding shares is separate from transactions involving real
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goods and services and therefore the number of outstanding shares is unrelated to the production
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level per se. By contrast, in a cooperative firm, holding membership shares is tied to providing
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inputs to the firm (worker cooperative) or receiving output from the firm (consumer
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cooperative); therefore, the number of outstanding membership shares is directly related to the

level of production. Thus, to judge the production efficiency of a cooperative firm, we need to
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examine whether this type of firm has adequate incentives to issue and maintain an appropriate

number of membership shares.

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CC

It seems appropriate to start the discussion by referring to the decision-making process related

to issuing shares in an ordinary company. First, we should note that it is an entrepreneur, and not
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shareholders, who plans to establish a company (Spulber, 2009). Obviously, this is because at the

pre-establishment stage, shares have not yet been issued and hence there are no shareholders. The

entrepreneur thus decides the number of shares the company issues at the time of incorporation.

Second, after the subscription and payment for shares, the entrepreneur registers the company,

which formally defines its establishment. Third, after incorporation, a general meeting of the

4
shareholders is organized as the supreme governing body of the company. It appoints directors,

and the board of directors appoints a manager (who may or may not be the same person as the

entrepreneur). Thereafter, the manager runs the company under the supervision of the board of

directors and the general meeting of the shareholders. As the directors represent shareholders (at

least formally), the manager can change the number of the company’s outstanding shares only if

it is in the shareholders’ interest.

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We assume that entrepreneurs play the same role in establishing cooperative firms as they do

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in establishing ordinary companies. That is, we do not distinguish between entrepreneurs who

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establish cooperative firms and those who establish capitalist firms, either as functions or as

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persons. We thus assume that an entrepreneur decides the number of membership shares the

cooperative firm issues at the time of incorporation, and thereafter, the manager changes the
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number of outstanding membership shares only if it is in the members’ interest.
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This view of the entrepreneur of a cooperative firm (who may be referred to as a “cooperative
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entrepreneur” in short) might be debatable because it deviates from the general perception among
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scholars and practitioners that a cooperative firm is a mutual organization, and thus a cooperative
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entrepreneur has (or should have) an altruistic rather than an individually rational personality.

Although this might be more or less true in the real world, in this study we do not differentiate the
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nature of entrepreneurs establishing capitalist and cooperative firms for two reasons. First, for

analytical purposes, we need to exclude the effects of the different nature or personality of
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entrepreneurs from the effects of the different ownership structure of firms. Second, from a

practical point of view, it seems that cooperative firms should not rely too much upon the
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altruistic spirit of cooperative entrepreneurs. Rather, for a vigorous development of the

cooperative sector, it seems that cooperative firms should structure themselves so that the

cooperative form of business attracts not only altruistic entrepreneurs but also ordinary ones.

5
1.4 Main results

We first show that an entrepreneur establishing a cooperative firm will issue an optimal

number of membership shares (Proposition 1). A corollary of this result is that the entrepreneur

can raise the same amount of capital by selling shares in a cooperative firm as they can by selling

shares in a capitalist firm (Proposition 2). We further show that the manager of the cooperative

firm will maintain the initial number of shares (Proposition 3) because any deviation from the

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initial level would harm the shareholders’ interest.

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Our conclusion is therefore that cooperative firms will issue and maintain the optimal number

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of membership shares, which means that they operate at an efficient production level. Therefore,

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if their membership shares were tradable in the market, cooperative firms would in principle be

as efficient and financially viable as capitalist firms.

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This general conclusion has an important implication for tradable membership shares in
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worker cooperatives; it implies that tradable shares in worker cooperatives would promote job
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security, which is one of the most important requirements in this type of firm and a prominent
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assumption of the model of Illyrian labor-managed firms developed by Ward (1958) and his
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followers.
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1.5 Structure of the paper

The rest of the paper is structured as follows. Section 2 discusses the premises of the study.
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Section 3 presents the model of a firm that is organized as either a capitalist or a cooperative firm.

On the basis of this model, Section 4 examines the optimality of the membership size in a
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cooperative firm that is determined by an entrepreneur at the firm’s establishment stage. Section

5 then explores if the initial membership size can be maintained after the firm commences

operations under shareholders’ control. Section 6 next considers possible reasons why

membership shares in cooperative firms may not be as transferable as shares in capitalist firms.

In light of the considerations in Sections 4 to 6, Section 7 examines cases of cooperative firms

6
with transferable shares. Section 8 concludes the paper.

2. Premises

There are various types of cooperatives in our society; accordingly, several models of

cooperatives have been developed by academics and practitioners. In this section, before

proceeding with the formal analysis, we characterize and summarize the features of the

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cooperative firm examined in this study relative to some representative types of cooperatives

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both in theory and practice.

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2.1 Economic system

First, the cooperative firm we study is one that operates in a capitalist economy.
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To make this seemingly obvious point clear, we first mention a few examples of cooperatives
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in a socialist economy. Self-managed worker cooperatives in the former Yugoslavia are a
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well-known model of worker cooperatives in a socialist system. In this type of worker

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cooperative, assets for production are owned not by the firm but by “society,” which is actually
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the state, whereas the management and operation of the firm are controlled by the workers. As

another example, in the Soviet Union and socialist Eastern European countries, consumer
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cooperatives were the de facto agencies of the communist regime in charge of rationing food and

household goods (Piechowski, 1994, 1999).

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By contrast, cooperative firms modeled in this study are private organizations that are

independent of the state and owned exclusively by their individual members.

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2.2 Legal personality

Second, this study assumes a cooperative firm that is incorporated by law, and thus has the

status of a legal personality. This assumption implies a distinction between the ownership of a

firm and the ownership of the firm’s assets.

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 In an unincorporated firm, there is no clear distinction between the ownership of a firm and

the ownership of its assets: the firm owner practically owns the firm’s assets. For example, in an

unincorporated family-run grocery store, the store’s assets—from the store building and the lot

on which the store is built to the shelves, refrigerators and foodstuffs—all belong to the family

who owns the sole proprietorship.

This is not the case for an incorporated firm. An incorporated firm is a legal person and hence

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the formal owner of all the assets for production that belong to the firm—from current and fixed

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assets to intangible and other assets. By contrast, the shareholders of an incorporated firm are not

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the owners of the firm’s assets, but of the firm itself. This distinction between the ownership of a

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firm and its assets is not a mere legal fiction but has significant economic implications

(Hansmann, 1996, 2014; Iwai, 2002). In particular, legal personality is a method to protect a
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firm’s assets from individual shareholders and is considered the counterpart of the rule of limited
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liability (Kraakman et al., 2009). Because of this legal technique, the shareholders of an
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incorporated firm cannot claim or liquidate any part of the firm’s assets at their individual
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discretion.
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Thus, capitalist and cooperative firms do not differ with respect to asset ownership: the legal

entity owns the assets for production in both cases. The difference between the two types of firms
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is the structure of the ownership of the legal entity itself: a capitalist firm is owned and controlled

by those who provide the firm with only financial capital, whereas a cooperative firm is owned
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and controlled by those who transact with the firm as input suppliers or output customers. These

features hold true regardless of whether the firm’s shares are tradable or not.
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2.3 Method of finance

Third, cooperative firms, like any other types of enterprises that operate in a capitalist

economy and have a legal personality, require funding. This study assumes that cooperative

firms have a method of equity financing similar to that of a conventional corporation.

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 With this respect, an important scholarly classification of worker cooperatives—the type of

cooperative firm that has attracted most attention and was studied most intensively—is the

division into labor-managed and worker-managed firms (Vanek, 1970; Jossa, 2012, 2014).1 The

two types of worker cooperatives can be distinguished according to their method of raising

capital. A labor-managed firm finances investment with borrowed funds (debt capital), whereas a

worker-managed firm finances investment with its own funds (equity capital), provided by

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members. A consequence of this difference is that labor-managed firms segregate labor income

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from capital income, while worker-managed firms do not. Furthermore, there is a clear symmetry

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between capitalist and labor-managed firms, where the former have fixed capital and variable

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labor, while the latter have fixed labor and variable capital (Jossa, 2014).

The worker cooperative discussed in this study is similar to the worker-managed firm in the
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last classification in that they both finance investment with equity capital. At the same time,
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however, they are dissimilar in that, to raise equity, the former uses tradable membership shares
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and the latter typically resorts to the founding members’ assets.

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ED

2.4 Asset locks

The fourth point also involves the financing of cooperatives. Some cooperatives, particularly
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those in continental Europe, apply the rule of asset locks. Under this rule, the firm retains and

accumulates a substantial portion of the surplus as assets. The firm’s assets are considered
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collective assets, which are non-divisible and non-appropriable by individual members. Thereby,

asset locks in a cooperative may be described as cooperative or collective ownership of assets,

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which contrasts with (so to speak) the private ownership of assets in a cooperative that has no

such rule. The cooperative firms modeled in this study do not apply the rule of asset locks and

hence could be categorized as cooperatives adopting private ownership of assets.

However, if we consider an incorporated cooperative, which has a legal personality as

1
The concept of labor-managed firms discussed in this subsection is not the same as that of the Illyrian
labor-managed firms mentioned in Section 1.

9
discussed in Subsection 2.2, and if the question is whether the rule of asset locks is stipulated in

its articles of association (i.e., not stipulated by law), the difference between the private and

collective ownership of assets is somewhat ambiguous, and hence it may not be appropriate to

categorize the cooperative firm modeled in this study as one with private rather than collective

ownership of assets. This is because, even without the rule of asset locks, assets in an

incorporated cooperative firm belong to the firm as a legal person and therefore individual

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members cannot claim the firm’s assets in ordinary situations.2 Indeed, this feature applies not

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only to incorporated cooperative firms but also to all incorporated private enterprises including

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ordinary business corporations, in which stockholders cannot individually claim their shares of

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the firms’ assets.

Nevertheless, the model of a cooperative firm developed in this study is not inconsistent with
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locked assets. Under the rule of asset locks, the cooperative firm in our model would reserve
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some portion of surpluses, accumulate it in the firm, and distribute the remainder to members.
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Asset locks can also be consistent with the tradability of membership shares. If a member of a
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cooperative firm quits the firm by selling their shares to a new member, the firm’s capital
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structure does not change, where locked assets neither affect nor are affected by trading in

membership shares. Furthermore, the share price reflects any benefits from locked assets. For
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example, if asset locks are used to stabilize wages and employment in a worker cooperative

(Navarra, 2013) and the members favor this course of action, then the price of the membership
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shares will be higher with asset locks than with the outright distribution of all surpluses.
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2.5 A remark

In a market economy, economic decisions and activities are guided by the price mechanism

embedded in the market. Nevertheless, even within a market economy, non-market coordination

mechanisms operate in firms (Coase, 1937). Two such mechanisms are hierarchy and

2
Asset locks do matter in special circumstances, such as bankruptcy or dissolution of the firm.

10
cooperation. Hierarchy is a vertical and authoritative coordination method commonly used in

capitalist firms (Williamson, 1979, 1985; Milgrom and Roberts, 1992). By contrast, cooperation

is a horizontal and reciprocal coordination method that can be observed in cooperative firms

(Hansmann, 1996).

If membership shares are marketable, members change according to the trade of shares in the

market rather than the entry and exit of members that occurs outside the market. In this sense,

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issuing tradable membership shares may imply a partial shift in the coordination method within a

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cooperative firm from the cooperation mechanism to the market mechanism.

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This shift in the coordination method may at first glance seem to work against the

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establishment and operation of cooperative firms because it is generally understood that

cooperative firms demonstrate their strengths in circumstances where markets fail to function
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efficiently. This is not necessarily the case, however. To clarify this point, let us first distinguish
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between market failure in the goods and services market and market failure in the capital market.
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In a cooperative firm, an input or output, which is a real good or service, is transacted between
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the firm and its members outside the market, and this is why market failure in the market for an
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input or output can be avoided by establishing a cooperative firm (Hansmann, 1996; Mikami,

2011). For example, if there is market failure in the labor/product market due to
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monopsony/monopoly, inefficiencies caused by the market failure can be avoided by organizing

the firm as a worker/consumer cooperative (Mikami, 2003). It should be noted here that a
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cooperative firm has the advantage of avoiding market failure in the goods and services market

regardless of the tradability of its membership shares.

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The logic in the last paragraph works conversely when there is market failure in the debt

capital market, which is most plausibly induced by asymmetric information between lenders and

borrowers (Mikami and Tanaka, 2010). In this case, a cooperative firm is disadvantaged in

raising capital compared to a capitalist firm because the former has only limited access to share

capital, whereas the latter has a strong and stable method of raising equity on the stock market.

11
Indeed, this difference is considered to be the principal reason for the predominance of capitalist

firms and the rarity of cooperative firms in market economies, particularly in capital-intensive

industrial sectors.

Our reasoning is therefore that, by issuing tradable membership shares, a cooperative firm can

increase its ability to raise equity, thus reducing its dependence on the debt capital market, while

maintaining its advantage of avoiding market failure in the goods and services market.

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3. The model

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We consider an entrepreneur who establishes a firm as either a capitalist firm (which is owned

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by capitalists who only provide financial capital to the firm), a worker cooperative (which is

owned by workers who provide labor input to the firm), or a consumer cooperative (which is
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owned by consumers who receive the firm’s output).3 After determining the type of firm to
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establish, the entrepreneur issues the firm’s shares and sells them in the share market to raise
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equity. This equity is used to acquire assets for production that are necessary for the firm’s
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operation.
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For analytical simplicity, we make the following assumptions: (1) the required amount of

assets for production is exogenously determined; (2) fixed tangible assets, if any, do not
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depreciate over time and thus do not change in value in the firm’s balance sheet; and (3) the firm

finances the assets entirely with equity and thus does not rely on debt.
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The firm uses the assets for production and labor to produce output. This production

technology is expressed by a function 𝑓 that relates the quantity of labor input 𝑙 ≥ 0 used for
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production to the quantity of output 𝑓(𝑙) ≥ 0 produced in each period. We assume that 𝑓 is

strictly concave and differentiable.

In each period and for each unit of labor supplied, workers incur disutility 𝑤 > 0, which turns

out to be the wage at which the firm hires labor. Similarly, in each period and for each unit of

3
For a detailed discussion of the definition of each type of firm, see Mikami (2016).

12
output consumed, consumers obtain utility 𝑣 > 0, which turns out to be the price at which the

firm sells the output.

Let 𝛿 > 0 be the parameter of time preference. Then,

𝑤 𝑤 1+𝛿
𝑊: = 𝑤 + + 2
+⋯= 𝑤
1 + 𝛿 (1 + 𝛿) 𝛿

is the discounted sum of the stream of disutility/wage 𝑤 incurred/received by a worker who

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supplies one unit of labor each period. Similarly,

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𝑣 𝑣 1+𝛿
𝑉: = 𝑣 + + 2
+⋯= 𝑣
1 + 𝛿 (1 + 𝛿) 𝛿

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is the discounted sum of the stream of utility/price 𝑣 obtained/paid by a consumer who

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consumes one unit of output each period.

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The firm rewards the entrepreneur with entrepreneurial profit, whose present value is denoted
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by 𝑅 ≥ 0 . For expositional convenience, we assume that this payment is made in equal
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installments 𝑟 over time, where
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𝑟 𝑟 1+𝛿
𝑅: = 𝑟 + + 2
+⋯= 𝑟.
1 + 𝛿 (1 + 𝛿) 𝛿
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Firms of all types issue shares, but the shares differ between the three types of firms. (1)
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Shares in a capitalist firm are tied neither to the provision of labor to the firm nor to the delivery

of the product from the firm. Shareholders receive dividends in cash that are proportional to the
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number of shares they hold. (2) Shares in a worker cooperative are tied to the provision of labor

to the firm. Shareholders provide labor to the firm and receive dividends in cash in proportion to
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the number of shares they hold. (3) Shares in a consumer cooperative are tied to receiving the

product from the firm. Shareholders receive the product from the firm as dividends in kind in

proportion to the number of shares they hold.4

4
Although we do not deal explicitly with the issue of voting rights of shareholders in this study, we suggest two
possibilities for the allocation of votes among shareholders. One is that the number of votes is proportional to the
number of shares held by shareholders (one share-one vote) in a capitalist firm, while it is equal for all (one

13
 The time structure of the model is as follows. Let 𝐴 be the total value of the assets for

production that are required to start and run the business.

<insert Tables 1-3 around here>

If it is established as a capitalist firm, the firm (i) issues shares and sells them to capitalists to

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raise equity 𝐸, which is spent on the assets for production so that 𝐸 = 𝐴; (ii) hires 𝑙 units of

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labor at wage 𝑤, produces 𝑓(𝑙) units of output, and sells the output at price 𝑣, thus earning cash

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flow 𝑣𝑓(𝑙) − 𝑤𝑙, from which the installment 𝑟 of entrepreneurial reward is deducted; and (iii)

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distributes the remaining cash flow 𝑣𝑓(𝑙) − 𝑤𝑙 − 𝑟 to the shareholders as dividends in cash.

The firm repeats stages (ii) and (iii) in each subsequent period. Table 1 shows the firm’s balance
U
N
sheet in each stage.
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If it is established as a worker cooperative, the firm (i) issues shares and sells them to workers

to raise equity 𝐸, which is spent on the assets for production so that 𝐸 = 𝐴; (ii) uses 𝑙 units of
M

labor provided by the shareholders for production, produces 𝑓(𝑙) units of output, and sells the
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output at price 𝑣, thus earning cash flow 𝑣𝑓(𝑙), from which the installment 𝑟 of entrepreneurial

reward is deducted; and (iii) distributes the remaining cash flow 𝑣𝑓(𝑙) − 𝑟 to the shareholders
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as dividends in cash. The firm repeats stages (ii) and (iii) in each subsequent period. Table 2
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shows the firm’s balance sheet in each stage.

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If it is established as a consumer cooperative, the firm (i) issues shares and sells them to

consumers to raise equity 𝐸, which is spent on the assets for production so that 𝐸 = 𝐴; (ii) hires
A

𝑙 units of labor at wage 𝑤, thus incurring labor costs 𝑤𝑙, produces 𝑓(𝑙) units of output, and

books the installment 𝑟 of entrepreneurial reward; and (iii) collects the labor and installment

member-one vote) independently of the number of held shares in a cooperative firm. These are common practices in
the real world. Another possibility is that the number of votes is proportional to the number of shares held by
shareholders in both types of firms. This may not be a common practice for cooperative firms but is not peculiar
from a theoretical standpoint (Mikami, 2016).

14
costs 𝑤𝑙 + 𝑟 from the shareholders, thus settling liabilities, and distributes the 𝑓(𝑙) units of

output to the shareholders as dividends in kind. The firm repeats stages (ii) and (iii) in each

subsequent period. Table 3 shows the firm’s balance sheet in each stage.

4. Membership size chosen by an entrepreneur

This section explores whether an entrepreneur establishing a cooperative firm is motivated to

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choose an efficient membership size at the time of incorporation. We first consider the case of a

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capitalist firm as a benchmark and then examine the case of a cooperative firm.

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4.1 Capitalist firm

Suppose that the entrepreneur chooses to issue 𝑚 units of shares at the time of establishing a
U
N
capitalist firm.

The firm hires labor at wage 𝑤 and sells the output at price 𝑣. If the firm hires 𝑙 units of
A

labor and produces 𝑓(𝑙) units of output, it earns cash flow 𝑣𝑓(𝑙) − 𝑤𝑙 in each period. From this
M

cash flow, the firm deducts the installment 𝑟 of the entrepreneurial reward, thus leaving the firm
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with a cash flow of 𝑣𝑓(𝑙) − 𝑤𝑙 − 𝑟 in each period. The discounted sum of the stream of this

cash flow is given by 𝑉𝑓(𝑙) − 𝑊𝑙 − 𝑅.

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This cash flow is distributed to the shareholders as dividends in proportion to the number of
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shares they hold. The discounted sum of the stream of dividends per share, which serves as the
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share price 𝑝, is given by

𝑉𝑓(𝑙) − 𝑊𝑙 − 𝑅
𝑝= . (1)
𝑚
A

By (1), the equity 𝐸 that the firm can raise in the share market is given by

𝐸 = 𝑝𝑚 = 𝑉𝑓(𝑙) − 𝑊𝑙 − 𝑅. (2)

Note that (2) reflects the dividend discount model, which states that the total market value of a

15
firm is equal to the discounted sum of the stream of dividends paid by the firm.5

The entrepreneur spends the amount 𝐸 in (2) on the assets for production that are required to

run the business, whose value is 𝐴, so that

𝑉𝑓(𝑙) − 𝑊𝑙 − 𝑅 = 𝐴 (3)

from which we have

𝑅 = 𝑉𝑓(𝑙) − 𝑊𝑙 − 𝐴. (4)

T
IP
The entrepreneur maximizes entrepreneurial reward 𝑅 . Let 𝑙 ∗ be the level of 𝑙 that

R
maximizes 𝑅 given by (4). Note that 𝑉𝑓(𝑙) − 𝑊𝑙 on the RHS of (4) represents the value of the

SC
firm. Because 𝐴 is a constant, the employment level 𝑙 that maximizes the entrepreneurial

reward coincides with that which maximizes the value of the firm. Therefore, 𝑙 ∗ is also the
U
N
efficient employment level for the firm.

With this employment level 𝑙 ∗ , the entrepreneurial reward 𝑅 ∗ is given by

A
M

𝑅 ∗ = 𝑉𝑓(𝑙 ∗ ) − 𝑊𝑙 ∗ − 𝐴. (5)

For simplicity, we assume that the entrepreneur’s opportunity cost of establishing a firm is zero
ED

and they choose to establish a firm on the boundary case (i.e., when the entrepreneurial reward is

zero). Then, the entrepreneur establishes a firm if and only if 𝑅 ∗ ≥ 0. Consequently, the
PT

maximum amount 𝐴∗ of assets for production that a capitalist firm can afford in the share market
E

is obtained by substituting 𝑅 ∗ = 0 in (5), so that

CC

𝐴∗ = 𝑉𝑓(𝑙 ∗ ) − 𝑊𝑙 ∗ . (6)
A

4.2 Cooperative firm

We first consider a worker cooperative. We measure the unit of shares in a worker cooperative

such that one unit of shares requires the shareholders to provide the firm with one unit of labor

each period. Therefore, if the entrepreneur chooses to issue 𝑙 units of shares, this implies that the

5
See, for instance, Brealey et al. (2001), Chapter 5.

16
firm procures 𝑙 units of labor from its members and produces 𝑓(𝑙) units of output to sell in the

product market each period.

The firm sells the output at price 𝑣. Because the firm sells 𝑓(𝑙) units of output, it earns cash

flow 𝑣𝑓(𝑙) in each period. From this cash flow, the firm deducts the installment 𝑟 of

entrepreneurial reward, thus leaving the firm with cash flow 𝑣𝑓(𝑙) − 𝑟 in each period. The

discounted sum of the stream of this cash flow is given by 𝑉𝑓(𝑙) − 𝑅.

T
This cash flow is distributed to the shareholders as dividends in proportion to the number of

IP
shares they hold. The dividends per share are then given by

R
𝑉𝑓(𝑙) − 𝑅
.

SC
𝑙

On the other hand, if a shareholder holds one unit of the firm’s shares, they have to provide the

U
firm with one unit of labor and hence incur disutility 𝑤 each period, whose discounted sum is
N
𝑊. Therefore, the net benefit of holding one unit of shares, which serves as the share price 𝑝, is
A
given by
M

𝑉𝑓(𝑙) − 𝑅
𝑝= − 𝑊. (7)
𝑙
ED

We confirm here that for the share price (7) to prevail in the primary share market, it is essential

that the shares be tradable in the secondary share market. By (7), the equity 𝐸 that the firm can
PT

raise in the share market is given by 𝐸 = 𝑝𝑙, which is equal to (2).

E

The entrepreneur spends this amount 𝐸 of money given by (2) on the assets for production,
CC

valued at 𝐴, that are required to run the business, so that we have (3) and (4). The entrepreneur

maximizes entrepreneurial reward 𝑅 given by (4) and chooses 𝑙 ∗ . Similarly to the case of a
A

capitalist firm, because 𝑉𝑓(𝑙) − 𝑊𝑙 in (4) represents the value of the firm and 𝐴 is a constant,

𝑙 ∗ is the efficient employment level for the firm.

The entrepreneurial reward 𝑅 ∗ is then given by (5). The maximum amount 𝐴∗ of assets for

production that a worker cooperative can afford in the share market is obtained by substituting

𝑅 ∗ = 0 in (5), so that we have (6). This implies that a worker cooperative can afford as many
17
assets for production by issuing shares of membership as a capitalist firm can by issuing shares of

stock.

We next consider a consumer cooperative. We measure the unit of shares in a consumer

cooperative such that one unit of shares entitles the shareholders to receive one unit of the firm’s

output as dividends in kind each period. Therefore, if the entrepreneur chooses to issue 𝑓(𝑙)

units of shares, it implies that the firm needs to employ 𝑙 units of labor to produce 𝑓(𝑙) units of

T
output to distribute to its members each period.

IP
The firm hires labor at wage 𝑤. Because the firm needs to hire 𝑙 units of labor, it incurs labor

R
costs of 𝑤𝑙 each period. In addition, the firm books the installment 𝑟 of entrepreneurial reward.

SC
Therefore, the shareholders incur costs of 𝑤𝑙 + 𝑟 each period. The discounted sum of these

costs is given by 𝑊𝑙 + 𝑅.
U
N
These costs are incurred by the shareholders according to the number of shares they hold.
A
These costs per share are then given by

𝑊𝑙 + 𝑅
M

.
𝑓(𝑙)
ED

On the other hand, if a shareholder holds one unit of the firm’s shares, they receive one unit of the

firm’s product and hence enjoy utility 𝑣 each period, whose discounted sum is 𝑉. Therefore, the
PT

net benefit of holding one unit of shares, which serves as the share price 𝑝, is given by

𝑊𝑙 + 𝑅
𝑝=𝑉− . (8)
E

𝑓(𝑙)
CC

We note again that for the shares to sell at the price given by (8) in the primary share market, the

shares must be tradable in the secondary share market. By (8), the equity 𝐸 that the firm can
A

raise in the share market is given by 𝐸 = 𝑝𝑓(𝑙), which is equal to (2).

The entrepreneur spends the amount 𝐸 of money given by (2) on the assets for production,

valued at 𝐴, that are required to run the business. Thus, we have (3) and (4). The entrepreneur

maximizes entrepreneurial reward 𝑅 given by (4) and chooses 𝑙 ∗ , which is the efficient

18
employment level for the firm.

The entrepreneurial reward 𝑅 ∗ is then given by (5). The maximum amount 𝐴∗ of assets for

production that a consumer cooperative can afford in the share market is obtained by substituting

𝑅 ∗ = 0 in (5), so that we have (6), implying that a consumer cooperative can afford as many

assets for production by issuing shares of membership as a capitalist firm can by issuing shares of

stock.

T
Several remarks must be made here concerning the model of a cooperative firm as discussed

IP
in this subsection.

R
First, our model of a cooperative firm is not necessarily a plain description of the cooperative

SC
commonly observed in the real world, but rather a theoretical abstraction that is comparable to a

capitalist firm on an equal footing in the analysis.

U
N
Second, concerning the first point, it might be useful to provide additional explanations of a

consumer cooperative. More precisely, the members of a consumer cooperative do not “buy” the
A

firm’s product in the ordinary sense, but practically bear the costs of producing the product. This
M

is evident in balance sheets (ii) and (iii) in Table 3. In the transition from sheet (ii) to sheet (iii),
ED

the liabilities 𝑤𝑙 + 𝑟 are offset by the corresponding payment from the members in exchange for

the delivery of the product. Indeed, this is what consumer cooperatives are supposed to do in
PT

practice, where they price their merchandise so that they can recoup the costs and at least break
E

even. For this reason, some consumer cooperatives refer to the price they charge for their
CC

merchandise as the “supply price” to distinguish it from the “market price.”

Third, the observation in the second remark may clarify the relationship between
A

shareholdings and the reception of products as dividends in kind in a consumer cooperative. The

basic structure of a consumer cooperative is that the members incur the costs of production and

receive the product in proportion to the number of shares they hold. Therefore, for instance, a

member who holds two units of shares incurs twice as much cost and receives twice as much

product as a member who holds one unit of shares.

19
4.3 Summary

The analysis in the last two subsections leads to the following two results.

Proposition 1:

An entrepreneur establishing a cooperative firm chooses the optimal membership size, so that

the firm starts to operate at an efficient production level.

T
IP
Proposition 2:

R
A cooperative firm can raise as much equity for investment in production assets by issuing

SC
shares of membership as a capitalist firm can by issuing shares of stock.

5. Membership size chosen by shareholders U

N
This section explores whether the shareholders of a cooperative firm maintain the
A

membership size that has been chosen by the entrepreneur at the time of the firm’s establishment.
M

Similarly to the analysis conducted in Section 4, we first consider the case of a capitalist firm as a
ED

benchmark and then examine the case of a cooperative firm.

PT

5.1 Capitalist firm

We first consider the case where the manager of a capitalist firm attempts to reduce the
E

number of shares from 𝑚 to 𝑚0 (< 𝑚).

CC

The firm, if it wishes, can buy back shares at the price of (𝑉𝑓(𝑙 ∗ ) − 𝑊𝑙 ∗ − 𝑅 ∗ )/𝑚 per share.
A

Therefore, the change in the firm’s cash flow that results from buying back (𝑚 − 𝑚0 ) units of

shares is given by

𝑉𝑓(𝑙 ∗ ) − 𝑊𝑙 ∗ − 𝑅 ∗
Δ1− = − ( ) (𝑚 − 𝑚0 ). (9)
𝑚

20
 On the other hand, if the number of shares is reduced from 𝑚 to 𝑚0 , earnings per share

increase from (𝑉𝑓(𝑙 ∗ ) − 𝑊𝑙 ∗ − 𝑅 ∗ )/𝑚 to (𝑉𝑓(𝑙 ∗ ) − 𝑊𝑙 ∗ − 𝑅 ∗ )/𝑚0. The firm can collect the

difference without making the remaining shares less profitable. Thus, the change in cash flow

that results from collecting the difference is given by

𝑉𝑓(𝑙 ∗ ) − 𝑊𝑙 ∗ − 𝑅 ∗ 𝑉𝑓(𝑙 ∗ ) − 𝑊𝑙 ∗ − 𝑅 ∗
Δ−
2 =( − ) 𝑚0 . (10)
𝑚0 𝑚

T
IP
Adding up (9) and (10), the change in cash flow that results from buying back (𝑚 − 𝑚0 )

R
units of shares is given by

SC
Δ− = Δ1− + Δ−
2 = 0.

Therefore, any proposal to reduce the number of shares is not (positively) supported by the

shareholders. U
N
We next consider the case where the manager attempts to increase the number of shares from
A
𝑚 to 𝑚0 (> 𝑚).
M

The firm can sell additional shares at (𝑉𝑓(𝑙 ∗ ) − 𝑊𝑙 ∗ − 𝑅 ∗ )/𝑚0 per share.6 Therefore, the
ED

change in cash flow that results from selling additional (𝑚0 − 𝑚) units of shares is given by

𝑉𝑓(𝑙 ∗ ) − 𝑊𝑙 ∗ − 𝑅 ∗
Δ1+ =( ) (𝑚0 − 𝑚). (11)
𝑚0
PT

On the other hand, if the number of shares is increased from 𝑚 to 𝑚0 , earnings per share fall
E

from (𝑉𝑓(𝑙 ∗ ) − 𝑊𝑙 ∗ − 𝑅 ∗ )/𝑚 to (𝑉𝑓(𝑙 ∗ ) − 𝑊𝑙 ∗ − 𝑅 ∗ )/𝑚0 . The firm needs to compensate for
CC

the difference in order to ensure that the original shares are not less profitable and have their

holders admit the increase in the number of shares. The change in cash flow that results from this
A

compensation is given by

𝑉𝑓(𝑙 ∗ ) − 𝑊𝑙 ∗ − 𝑅 ∗ 𝑉𝑓(𝑙 ∗ ) − 𝑊𝑙 ∗ − 𝑅 ∗
Δ+
2 = − ( − ) 𝑚. (12)
𝑚 𝑚0

Adding up (11) and (12), the change in cash flow that results from selling additional (𝑚0 −

6
The firm cannot sell new shares at (𝑉𝑓(𝑙 ∗ ) − 𝑊𝑙 ∗ − 𝑅∗ )/𝑚 because, after increasing the number of shares,
earnings per share fall from (𝑉𝑓(𝑙 ∗ ) − 𝑊𝑙 ∗ − 𝑅∗ )/𝑚 to (𝑉𝑓(𝑙 ∗ ) − 𝑊𝑙 ∗ − 𝑅 ∗ )/𝑚0 .

21
𝑚) units of shares is given by

Δ+ = Δ1+ + Δ+
2 = 0.

Therefore, any proposal to increase the number of shares is not (positively) supported by the

shareholders.

5.2 Cooperative firm

T
We first consider a worker cooperative. Because shares in a worker cooperative relate to labor

IP
input, a change in the number of shares directly affects the firm’s production level.

R
We first consider the case where the manager attempts to reduce the number of shares from 𝑙 ∗

SC
to 𝑙0 (< 𝑙 ∗ ).

U
N
<insert Figure 1 around here>
A

The firm can buy back shares at (𝑉𝑓(𝑙 ∗ ) − 𝑅 ∗ )/𝑙 ∗ − 𝑊 per share. Therefore, the change in
M

cash flow that results from buying back (𝑙 ∗ − 𝑙0 ) units of shares is given by
ED

𝑉𝑓(𝑙 ∗ ) − 𝑅 ∗
Δ1− = −( ∗
− 𝑊) (𝑙 ∗ − 𝑙0 ). (13)
𝑙
PT

On the other hand, if the number of shares is reduced from 𝑙 ∗ to 𝑙0 , labor input decreases

from 𝑙 ∗ to 𝑙0 . A decrease in labor input from 𝑙 ∗ to 𝑙0 changes earnings per share from
E

(𝑉𝑓(𝑙 ∗ ) − 𝑅 ∗ )/𝑙 ∗ to (𝑉𝑓(𝑙0 ) − 𝑅 ∗ )/𝑙0. Note that, as a result of the decrease in labor input, gross
CC

earnings per share rise from 𝑉𝑓(𝑙 ∗ )/𝑙 ∗ to 𝑉𝑓(𝑙0 )/𝑙0 due to the concavity of function 𝑓 ,

whereas payment per share for entrepreneurial reward rises from 𝑅 ∗ /𝑙 ∗ to 𝑅 ∗ /𝑙0 . If the former
A

effect is dominant, the firm can collect the increment in earnings per share without making the

remaining shares less profitable. If the latter effect is dominant, the firm has to compensate for

the decline in earnings per share so as to ensure that the remaining shares are not less profitable.

In any case, the change in cash flow that results from the change in earnings per share is given by

22
 𝑉𝑓(𝑙0 ) − 𝑅 ∗ 𝑉𝑓(𝑙 ∗ ) − 𝑅 ∗
Δ2− = ( − ) 𝑙0 . (14)
𝑙0 𝑙∗

Adding up (13) and (14), the change in cash flow that results from buying back (𝑙 ∗ − 𝑙0 )

units of shares is given by

Δ− = Δ1− + Δ− ∗ ∗
2 = 𝑊(𝑙 − 𝑙0 ) − (𝑉𝑓(𝑙 ) − 𝑉𝑓(𝑙0 )) < 0 (15)

where the inequality follows from the strict concavity of function 𝑓 (cf. Figure 1).7 Therefore,

T
any proposal to reduce the number of shares is not supported by the shareholders.

IP
We next consider the case where the manager attempts to increase the number of shares from

R
𝑙 ∗ to 𝑙0 (> 𝑙 ∗ ).

SC
<insert Figure 2 around here>

U
N
The firm can sell additional shares at (𝑉𝑓(𝑙0 ) − 𝑅 ∗ )/𝑙0 − 𝑊 per share. Therefore, the
A
change in cash flow that results from selling additional (𝑙0 − 𝑙 ∗ ) units of shares is given by
M

𝑉𝑓(𝑙0 ) − 𝑅 ∗
Δ+
1 = ( − 𝑊) (𝑙0 − 𝑙 ∗ ). (16)
𝑙0
ED

On the other hand, if the number of shares is increased from 𝑙 ∗ to 𝑙0 , labor input increases from

𝑙 ∗ to 𝑙0 . An increase in labor input from 𝑙 ∗ to 𝑙0 changes earnings per share from (𝑉𝑓(𝑙 ∗ ) −
PT

𝑅 ∗ )/𝑙 ∗ to (𝑉𝑓(𝑙0 ) − 𝑅 ∗ )/𝑙0. Note that, as a result of the increase in labor input, gross earnings per
E

share fall from 𝑉𝑓(𝑙 ∗ )/𝑙 ∗ to 𝑉𝑓(𝑙0 )/𝑙0 due to the concavity of function 𝑓, whereas the payment
CC

per share for entrepreneurial reward falls from 𝑅 ∗ /𝑙 ∗ to 𝑅 ∗ /𝑙0 . If the former effect is dominant,

the firm has to compensate for the decline in earnings per share so as to ensure that the original
A

shares are not less profitable. If the latter effect is dominant, the firm can collect the increment in

earnings per share without making the original shares less profitable. In any case, the change in

7
Because 𝑓 is strictly concave, it holds for any 𝑙 ≠ 𝑙 ∗ that 𝑓(𝑙) < 𝑓(𝑙 ∗ ) + 𝑓 ′ (𝑙 ∗ )(𝑙 − 𝑙 ∗ ) (for this property of a
strictly concave function, see Bazaraa and Shetty (1979), Theorem 3.3.3). Because it holds that 𝑉𝑓 ′ (𝑙 ∗ ) = 𝑊 as a
result of the maximization of (4), substituting 𝑙 = 𝑙0 yields the inequality in (15).

23
cash flow that results from the change in earnings per share is given by

𝑉𝑓(𝑙 ∗ ) − 𝑅 ∗ 𝑉𝑓(𝑙0 ) − 𝑅 ∗ ∗
Δ+2 = − ( − )𝑙 . (17)
𝑙∗ 𝑙0

Adding up (16) and (17), the change in cash flow that results from selling additional (𝑙0 − 𝑙 ∗ )

units of shares is given by

Δ+ = Δ+ + ∗ ∗
1 + Δ2 = (𝑉𝑓(𝑙0 ) − 𝑉𝑓(𝑙 )) − 𝑊(𝑙0 − 𝑙 ) < 0 (18)

T
where the inequality follows from the strict concavity of function 𝑓 (cf. Figure 2).8 Therefore,

IP
any proposal to increase the number of shares is not supported by the shareholders.

R
Thus, the size of membership shares in a worker cooperative is stable at the initial level under

SC
the discretion of the shareholders.9

We next consider a consumer cooperative. Because shares in a consumer cooperative relate to

U
the output, a change in the number of shares directly affects the firm’s production level.
N
We first consider the case where the manager attempts to reduce the number of shares from
A

𝑓(𝑙 ∗ ) to 𝑓(𝑙0 )(< 𝑓(𝑙 ∗ )), in which 𝑙0 is the quantity of labor input that produces exactly 𝑓(𝑙0 )
M

units of output.
ED

<insert Figure 3 around here>

PT

The firm can buy back shares at 𝑉 − (𝑊𝑙 ∗ + 𝑅 ∗ )/𝑓(𝑙 ∗ ) per share. Therefore, the change in
E

cash flow that results from buying back (𝑓(𝑙 ∗ ) − 𝑓(𝑙0 )) units of shares is given by
CC

𝑊𝑙 ∗ + 𝑅 ∗
Δ−
1 = − (𝑉 − ) (𝑓(𝑙 ∗ ) − 𝑓(𝑙0 )). (19)
𝑓(𝑙 ∗ )
A

On the other hand, if the number of shares is reduced from 𝑓(𝑙 ∗ ) to 𝑓(𝑙0 ), the output

8
Because 𝑓 is strictly concave, it holds for any 𝑙 ≠ 𝑙 ∗ that 𝑓(𝑙) < 𝑓(𝑙 ∗ ) + 𝑓 ′ (𝑙 ∗ )(𝑙 − 𝑙 ∗ ). Using the first-order
condition 𝑉𝑓 ′ (𝑙 ∗ ) = 𝑊 for the maximization of (4) and letting 𝑙 = 𝑙0 , we obtain the inequality in (18).
9
We can apply the arguments for a worker cooperative developed in this subsection in reverse to the case where the
number of shares issued at the beginning happens to be less than or greater than 𝑙 ∗ . If the initial quantity 𝑙 is less than
𝑙 ∗ , a proposal to increase the number of shares from 𝑙 to 𝑙 ∗ is supported by the shareholders. Similarly, if the initial
quantity 𝑙 is greater than 𝑙 ∗ , a proposal to reduce the number of shares from 𝑙 to 𝑙 ∗ is supported by the shareholders.
Hence, we see that the efficient size 𝑙 ∗ of membership is not only stable but also resilient in a worker cooperative.

24
decreases from 𝑓(𝑙 ∗ ) to 𝑓(𝑙0 ). A decrease in output from 𝑓(𝑙 ∗ ) to 𝑓(𝑙0 ) changes total costs

per share from (𝑊𝑙 ∗ + 𝑅 ∗ )/𝑓(𝑙 ∗ ) to (𝑊𝑙0 + 𝑅 ∗ )/𝑓(𝑙0 ). As a result of the decrease in output,

which backwardly causes a decrease in labor input, labor costs per share fall from 𝑊𝑙 ∗ /𝑓(𝑙 ∗ ) to

𝑊𝑙0 /𝑓(𝑙0 ) due to the concavity of function 𝑓 (note in Figure 3 that labor costs per share are the

inverse of output per labor 𝑓(𝑙)/𝑙 multiplied by 𝑊). At the same time, payment per share for

entrepreneurial reward increases from 𝑅 ∗ /𝑓(𝑙 ∗ ) to 𝑅 ∗ /𝑓(𝑙0 ). If the former effect is dominant,

T
the firm can collect the decline in total costs per share without making the remaining shares more

IP
costly to own. If the latter effect is dominant, the firm has to compensate for the increment in total

R
costs per share so as to ensure that the remaining shares are not more costly to own. In any case,

SC
the change in cash flow that results from the change in total costs per share is given by

𝑊𝑙0 + 𝑅 ∗ 𝑊𝑙 ∗ + 𝑅 ∗
Δ−2 = −(
𝑓(𝑙0 )
−
𝑓(𝑙 ∗ ) U
) 𝑓(𝑙0 ). (20)
N
Adding up (19) and (20), the change in cash flow that results from buying back (𝑓(𝑙 ∗ ) −
A
𝑓(𝑙0 )) units of shares is given by (15), where the inequality follows from the strict concavity of
M

function 𝑓 (cf. Figure 3). 10 Therefore, any proposal to reduce the number of shares is not
ED

supported by the shareholders.

We next consider the case where the manager attempts to increase the number of shares from
PT

𝑓(𝑙 ∗ ) to 𝑓(𝑙0 )(> 𝑓(𝑙 ∗ )).

E

<insert Figure 4 around here>

CC

The firm can sell additional shares at 𝑉 − (𝑊𝑙0 + 𝑅 ∗ )/𝑓(𝑙0 ) per share. Therefore, the change
A

in cash flow that results from selling additional (𝑓(𝑙0 ) − 𝑓(𝑙 ∗ )) units of shares is given by

𝑊𝑙0 + 𝑅 ∗
Δ+
1 = (𝑉 − ) (𝑓(𝑙0 ) − 𝑓(𝑙 ∗ )). (21)
𝑓(𝑙0 )

10
We can show the inequality in (15) in the present case by applying the same procedure as shown in footnote 7.

25
 On the other hand, if the number of shares is increased from 𝑓(𝑙 ∗ ) to 𝑓(𝑙0 ), the output

increases from 𝑓(𝑙 ∗ ) to 𝑓(𝑙0 ). An increase in output from 𝑓(𝑙 ∗ ) to 𝑓(𝑙0 ) changes total costs per

share from (𝑊𝑙 ∗ + 𝑅 ∗ )/𝑓(𝑙 ∗ ) to (𝑊𝑙0 + 𝑅 ∗ )/𝑓(𝑙0 ) . Due to the increase in output, which

backwardly causes an increase in labor input, labor costs per share rise from 𝑊𝑙 ∗ /𝑓(𝑙 ∗ ) to

𝑊𝑙0 /𝑓(𝑙0 ) due to the concavity of function 𝑓 (note again that, in Figure 4, labor costs per share

are the inverse of output per labor 𝑓(𝑙)/𝑙 multiplied by 𝑊). At the same time, payment per share

T
for entrepreneurial reward falls from 𝑅 ∗ /𝑓(𝑙 ∗ ) to 𝑅 ∗ /𝑓(𝑙0 ). If the former effect is dominant, the

IP
firm has to compensate for the increment in total costs per share so as to ensure that the original

R
shares are not more costly to own. If the latter effect is dominant, the firm can collect the decline in

SC
total costs per share without making the original shares more costly to own. In any case, the change

U
in cash flow that results from the change in total costs per share is given by

𝑊𝑙 ∗ + 𝑅 ∗ 𝑊𝑙0 + 𝑅 ∗
N
Δ+2 =( − ) 𝑓(𝑙 ∗ ). (22)
𝑓(𝑙 ∗ ) 𝑓(𝑙0 )
A
Adding up (21) and (22), the change in cash flow that results from selling additional (𝑓(𝑙0 ) −
M

𝑓(𝑙 ∗ )) units of shares is given by (18), where the inequality follows from the strict concavity of
ED

function 𝑓 (cf. Figure 4).11 Therefore, any proposal to increase the number of shares is not

supported by the shareholders.

PT

Thus, the size of membership shares in a consumer cooperative is stable at the initial level

under the discretion of the shareholders.12

E

It may be helpful here to discuss the analysis of the worker cooperative in the present
CC

subsection. Conventionally, worker cooperatives have a strong preference for job stability and
A

against layoffs. The analytical procedure used in the analysis to reduce the number of shares in a

worker cooperative may be interpreted to ignore this feature of a worker cooperative. However,

11
We can show the inequality in (18) in the present case by applying the same procedure as shown in footnote 8.
12
We can apply the arguments for a consumer cooperative developed in this subsection in reverse to the case where
the number of shares issued at the beginning happens to be less than or greater than 𝑓(𝑙 ∗ ). If the initial quantity 𝑓(𝑙)
is less than 𝑓(𝑙 ∗ ), a proposal to increase the number of shares from 𝑓(𝑙) to 𝑓(𝑙 ∗ ) is supported by the shareholders.
Similarly, if the initial quantity 𝑓(𝑙) is greater than 𝑓(𝑙 ∗ ), a proposal to reduce the number of shares from 𝑓(𝑙) to
𝑓(𝑙 ∗ ) is supported by the shareholders. Hence, we see that the efficient size 𝑓(𝑙 ∗ ) of membership is not only stable
but also resilient in a consumer cooperative.

26
the assumption here is not that members of a worker cooperative are laid off against their will but

that they are willing to sell their shares back to the firm at fair value and then voluntarily reduce

their working time or leave the firm. Essentially, the analysis in this subsection aims to clarify the

basic feature and function of tradable membership shares in this type of firm.

5.3 Summary

T
The analysis in the last subsection leads to the following result.

IP
Proposition 3:

R
The shareholders of a cooperative firm do not change the membership size chosen optimally

SC
by the entrepreneur at the time of the firm’s establishment, so that the cooperative firm keeps

operating at an efficient production level.

U
N
6. Obstacles in membership share trading
A

In the last two sections, we confirmed that if membership shares in cooperative firms were
M

tradable with no restriction, a membership market would play the role that a stock market plays
ED

for capitalist firms, and consequently cooperative firms would be as efficient and financially

viable as capitalist firms.

PT

In practice, however, even if legal restrictions on the transfer of membership shares were

lifted, impediments would remain that could hinder the trade of membership shares on an open
E
CC

market. In this section, we examine the non-legal economic factors that can restrict the full

functioning of a membership market.

A

6.1 Homogeneity of members

In a worker cooperative, the ownership of shares implies the provision of labor to the firm.

Labor is intrinsically heterogeneous as a factor of production. Therefore, the outgoing members

of a worker cooperative can sell their shares only to those who are competent to perform the

27
duties of their current positions, which makes it difficult for the shares to be traded as freely as

those in a capitalist firm. This tendency seems more conspicuous for worker cooperatives that

require specific and skilled labor than for those that require only general and unskilled labor.

Nevertheless, the existence of a market for highly specific and skilled workers—such as lawyers,

accountants and architects—seems to imply that a market for shares in worker cooperatives

requiring this type of labor can exist as well.

T
By contrast, in most cases, shares in a consumer cooperative are considered to be traded

IP
almost as freely as those in a capitalist firm. In a consumer cooperative, the ownership of shares

R
implies the reception of the firm’s output. Because ordinarily no special qualification is

SC
necessary to consume a product, the outgoing member can sell their shares to anyone who wants

to become a member of the consumer cooperative and receive its product.

U
N
6.2 Risk diversification
A

Tradable membership shares in a cooperative firm are financial securities, just like shares of
M

stock in a capitalist firm, and expose their owners to financial risk.

ED

With this respect, shareholders of a worker cooperative seem to be quite vulnerable to

financial risk. An employee, particularly a regular employee, usually works for one firm at a
PT

time. Therefore, a worker who wants to be a member of a successful worker cooperative, where

share prices tend to be high, would need to spend a large amount of money to buy the firm’s
E
CC

shares at the outset. In addition, if the worker, after joining the firm, needs to invest in and

accumulate firm-specific human capital, they would end up putting both their financial and
A

human capital in one firm, which is not preferable in terms of risk diversification. Because of

these reasons, workers may hesitate to purchase shares in worker cooperatives, thus shrinking the

market for membership shares in this type of cooperative firm.

By contrast, the shareholders of a consumer cooperative seem to be in a much better position

than those of a worker cooperative. Consumers are usually customers of many firms, and

28
therefore those who become shareholders of a consumer cooperative would not need to invest a

substantial part of their financial wealth in a single consumer cooperative. In addition, unlike

workers, consumers do not need to make firm-specific investments in human capital in order to

be the customers of a consumer cooperative. For these reasons, risk diversification does not seem

to be a major problem for the shareholders of a consumer cooperative.

T
6.3 Wealth constraint

IP
Along with the problem of risk diversification as discussed in the previous subsection,

R
workers may face budget constraints when buying the shares of a worker cooperative at the

SC
outset. Such constraints will evidently reduce the tradability of shares in worker cooperatives.

Indeed, this problem may be one reason why US plywood worker cooperatives, which were once
U
quite successful, could not survive for long. We discuss this issue in detail in Subsection 7.1.
N
Furthermore, when the budget constraints of workers are tight, a worker cooperative may be
A

inclined to accept new members based on their wealth rather than their competencies, which
M

hurts not only the firm’s productivity but also social justice and equity.
ED

There are several methods to mitigate these problems. First, the incoming members of a

worker cooperative may buy shares on loan at the outset and later have installments deducted
PT

from their payroll. This is what US plywood worker cooperatives used to do (Berman, 1967;

Craig and Pencavel, 1992, 1995). Second, workers may buy shares in a worker cooperative by
E
CC

mortgaging the shares themselves. This is the method used in Finnish housing cooperatives,

though they are consumer rather than worker cooperatives.

A

By contrast, for the same reason as discussed in the previous subsection, consumer

cooperatives generally seem to be less vulnerable to the budget constraints of new members than

worker cooperatives when selling membership shares.

29
6.4 Asymmetric information

There is usually information asymmetry between a cooperative firm and its incoming

members about firm characteristics, such as the conditions of the workplace offered by a worker

cooperative or the quality of the products delivered by a consumer cooperative. This information

asymmetry tends to discourage potential new members from purchasing shares and reduce the

tradability of shares in a cooperative firm on the open market.

T
Actually, this kind of problem arising from asymmetric information is prevalent not only in

IP
cooperative firms but in all types of firms, including capitalist ones. In a capitalist firm, there is

R
usually information asymmetry regarding the firm’s profitability, where outside investors are

SC
less informed than managers. In this situation, share trading is more or less depressed. Thus, the

economic environment is considered to determine the degree to which asymmetric information

U
affects the tradability of shares in capitalist and cooperative firms.
N
A

7. Tradable membership shares in practice

M

In light of the theory developed in Sections 3 to 5, as well as the arguments discussed in the
ED

previous section, this section examines how the market for membership shares can work in

practice.
PT

7.1 US plywood worker cooperatives

E
CC

The rise and fall of plywood worker cooperatives in the US Pacific Northwest, which we

briefly mentioned in Subsections 1.2 and 6.3, show both the difficulty and feasibility of
A

managing cooperative firms that issue tradable membership shares.

Since the establishment of Olympia Veneer in the early 20th century, the first of this kind of

worker cooperative, about 30 plywood worker cooperatives operated in the region. Most of these

firms existed for over 20 years. During their most successful period, their output accounted for

about 12 percent of all US plywood production.

30
 Towards the end of the 20th century, these worker cooperatives gradually decreased in

number and eventually disappeared. Interestingly, there were two contrasting reasons for their

disappearance. First, some worker cooperatives were simply not competitive enough to survive

unfavorable market conditions at that time, particularly the unstable supply of raw materials and

the dwindling demand for plywood. Second, despite the unfavorable market conditions, other

worker cooperatives were profitable, so much so that they transformed themselves into capitalist

T
firms. A principal reason for this transformation was that the share price of these successful

IP
worker cooperatives was so high that retiring members could not find young workers who could

R
afford to buy the shares. Consequently, outgoing members sold their shares to lumber

SC
companies.13

The second reason for the disappearance of plywood worker cooperatives shows the
U
vulnerability of the market for membership shares in worker cooperatives. The direct cause of the
N
unintended transformation of the enterprise form was the relatively small size of the membership
A

market and the limited budgets of individual buyers on the market. More essentially, however, if
M

membership creates sufficient economic value in the future, there should be methods to capture
ED

part of the future value in advance and use it to purchase the membership offered for sale on the

market today. Specifically, such methods take the form of installments and mortgages, as
PT

mentioned in Subsection 6.3. With these financial techniques, the adverse effects of wealth

constraints could be alleviated. Indeed, these financial methods allow the market for membership
E
CC

shares in housing cooperatives to work normally, as discussed in the next subsection.

A

7.2 Nordic housing consumer cooperatives

Housing consumer cooperatives in the Nordic countries are another example of cooperative

firms that issue tradable membership shares. Among others, the Finnish system of

asunto-osakeyhtiö (literally “housing company”) is the example that best fits our model of a

13
Berman, 1967; Lindenfeld and Wynn, 1995.

31
cooperative firm issuing tradable shares.

In this housing system, a residential building is owned by a housing company, which has a

legal personality, and the shares of the housing company are owned by the residents (therefore,

the residents are the shareholders of the housing company). The shares of a housing company are

transferable without restriction, and they are usually as expensive as privately-owned apartments

in a condominium. Those who buy the shares typically afford the costs by mortgaging the shares

T
themselves.

IP
This system has been successful in the Finnish housing market. It is estimated that housing

R
companies own nearly all multi-story residential buildings and non-detached small houses in

SC
Finland, which comprise 55.6 percent of all houses in the country (Lilleholt, 1998). One reason

why the market for shares in housing companies functions normally is that the number of these
U
shares is necessarily constant and hence membership is closed. That is, because the number of the
N
blocks of shares is determined by the number of flats in the building, those who want to live in the
A

building need to buy shares from those who move out, and vice versa.14
M
ED

7.3 Israeli community cooperatives15

The final example is neither a worker nor consumer cooperative. A moshav is an agricultural
PT

community cooperative in Israel. A moshav conducts a wide range of activities for member

residents of the community, from the collective purchasing of farm inputs and the collective
E
CC

marketing of agricultural products to savings, credit and insurance, the retail of food and

household goods, and even public administration.

A

One distinguishing feature of a moshav is that its farmland is divided into farm lots of equal

size, 3 hectares on average, and its membership is tied to the right to use a single lot. Because the

14
A similar mechanism exists in some golf clubs and resort country clubs. These clubs issue and sell membership in
advance, and spend the proceeds on developing golf courses or resort complexes. When the construction work is
done, the clubs grant their members the right to use the facilities. The club members can liquidate their membership
by selling it on the market. The market for membership in these clubs is generally small and immature, however,
reflecting the relatively small size of this economic sector.
15
This subsection is based on Galor (2014, 2015a, 2015b) and additional information is obtained from the author.

32
total area of farmland in the village is fixed and the farm lots are not allowed to be combined or

subdivided, the number of memberships is constant over time. Membership is usually inherited by

one of the member’s children. However, childless members can sell their membership to farmers

outside the village at the market price or for the real value of the share capital.

Along with the kibbutz, another type of community cooperative in Israel, the moshav has been

prevalent in rural areas throughout the country over the past century. The system of the moshav

T
seems to provide another indication that closed membership is the key feature required for a

IP
market for membership shares to function well.

R
SC
8. Conclusion

8.1 Summary
U
Are cooperative firms intrinsically a less competitive form of business than conventional
N
capitalist firms? This study examined this question assuming that cooperative firms issue
A

tradable membership shares.

M

We showed that a cooperative firm has an adequate incentive to issue and maintain the
ED

optimal number of membership shares, which implies that it operates at an efficient production

level (Propositions 1 and 3). We also revealed that a cooperative firm can raise as much capital as
PT

a capitalist firm by issuing tradable membership shares in the market (Proposition 2).

These results are contrary to the common belief that cooperative firms are by nature not a
E
CC

competitive form of business in a market system compared to capitalist firms. This study rather

suggests that if membership shares were tradable in the market, cooperative firms would in
A

principle be as efficient and financially viable as capitalist firms. Considering the fact that

currently most cooperative firms are prohibited or restricted from issuing tradable membership

shares by rule, this type of firm, if allowed to issue tradable membership shares, could evolve

into a promising alternative to capitalist firms in a wider range of circumstances, depending on

the nature of its inputs and outputs, production technology, and the type and size of market

33
failure.

8.2 Concluding remarks

Finally, there are some remarks on this study.

First, let us recall the argument on asset locks discussed in Subsection 2.4. The economic

environment surrounding cooperative firms is more complex in practice than in theory.

T
Therefore, it is possible for a cooperative firm to be more efficient and financially viable when it

IP
issues non-transferable shares combined with asset locks, as many existing cooperatives do, than

R
when it issues transferable shares, as assumed in this study. However, it seems unreasonable to

SC
prohibit all cooperative firms from issuing transferable shares uniformly and comprehensively

by legislation. Rather, it seems more reasonable to let cooperative firms determine the attributes
U
of the shares they issue, stipulating them in their individual articles of associations, and choose
N
their methods of finance. Then, cooperative firms with a cost to make their shares transferable in
A

excess of the benefit will choose to keep the traditional style and issue non-transferable shares,
M

whereas those whose benefit of making their shares transferable exceeds the cost will choose to
ED

adopt the unconventional style and issue transferable shares.

Second, a cooperative firm issuing transferable shares as modeled and analyzed in this study
PT

could be identified as a specific type of for-profit firm rather than a typical form of cooperative.

Indeed, if a cooperative is by definition required to be a firm whose membership is

E
CC

non-transferable, as is often stipulated in cooperative law, then the cooperative firm portrayed in

this study may not fall into the category of cooperative. It should be stressed, however, that a
A

cooperative firm issuing tradable shares is still owned and controlled by its members, who serve

as the firm’s employees or customers, and not by capitalists, who would only provide financial

capital to the firm. Thus, a cooperative firm issuing tradable shares as modeled in this study is

considered to have the essential feature of an ordinary cooperative.

Third, tradable membership shares in a cooperative firm can be regarded as financial

34
securities, as discussed in Subsection 6.2. It may thus be feared that they could be subject to

speculative investment, just like stocks in capitalist firms. Although this possibility cannot be

ruled out, the motivation for speculative investment in shares in cooperative firms is generally

considered to be weaker than that for speculative investment in shares in capitalist firms because

shares in cooperative firms are tied to transactions of real goods and services with the firm. For

example, an investment in shares in a worker cooperative implies that the investor becomes the

T
firm’s employee. Alternatively, an investment in shares in a consumer cooperative implies that

IP
the investor becomes the firm’s customer. Of course, it is not impossible for an investor to

R
become an employee or a customer of the firm in which they invest. In that case, however, the

SC
transaction costs of the investment will be much higher than when investing in a capitalist firm,

where the investor is not required to become either the employee or the customer of the firm. For
U
this reason, cooperative firms issuing tradable shares are generally considered to be less
N
vulnerable to speculative investment than capitalist firms.
A

Fourth, the present study focused on the effects of a market for membership shares on the
M

production efficiency of cooperative firms and their ability to raise capital, and did not inquire
ED

into its effects on the governance of cooperative firms. The latter aspect is an important question

that requires further theoretical study, which we leave to future research.

E PT

Acknowledgements: The author would like to thank two anonymous reviewers of the journal for
CC

their detailed and constructive critique. Thanks are also due to Zvi Galor and Naoki Tsujikawa
A

for providing information and suggestions. This study was financially supported by a

Grant-in-Aid for Scientific Research from the Japan Society for the Promotion of Science (No.

26380306), which is gratefully acknowledged.

35
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Figure 1. Buying back membership shares in a worker cooperative

T
R IP
SC
U
N
A
M
ED
E PT
CC
A

39
Figure 2. Issuing additional membership shares in a worker cooperative

T
R IP
SC
U
N
A
M
ED
E PT
CC
A

40
Figure 3. Buying back membership shares in a consumer cooperative

T
R IP
SC
U
N
A
M
ED
E PT
CC
A

41
Figure 4. Issuing additional membership shares in a consumer cooperative

T
R IP
SC
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N
A
M
ED
E PT
CC
A

42
Table 1. Capitalist firm

(i)
Assets Equity
Current/fixed
A Paid-in capital E
assets

Total assets A Total equity E

T
(ii)
Assets Equity

IP
Current/fixed
A Paid-in capital E
assets

R
Cash vf(l)-wl-r Surplus vf(l)-wl-r

SC
Total assets A+vf(l)-wl-r Total equity E+vf(l)-wl-r

(iii)
Assets
Current/fixed
Equity
U
N
A Paid-in capital E
assets
A
Total assets A Total equity E
M

Note: A=E
ED
E PT
CC
A

43
Table 2. Worker cooperative

(i)
Assets Equity
Current/fixed assets A Paid-in capital E

Total assets A Total equity E

(ii)

T
Assets Equity
Current/fixed assets A Paid-in capital E

IP
Cash vf(l)-r Surplus vf(l)-r

R
Total assets A+vf(l)-r Total equity E+vf(l)-r

SC
(iii)
Assets Equity
Current/fixed assets A Paid-in capital E

U
N
Total assets A Total equity E
A
Note: A=E
M
ED
E PT
CC
A

44
Table 3. Consumer cooperative

(i)
Assets Equity
Current/fixed assets A Paid-in capital E

Total assets A Total equity E

(ii)

T
Assets Liabilities
Current/fixed assets A Accrued wage wl

IP
Accrued
Inventories of product wl+r r
installment

R
Equity

SC
Paid-in capital E

Total liabilities and

Total assets A+wl+r
equity
U E+wl+r
N
(iii)
Assets Equity
A
Current/fixed assets A Paid-in capital E
M

Total assets A Total equity E

ED

Note: A=E
E PT
CC
A

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