Generalization of findings

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Consequently, if the claim is accepted, other research omitting to control for the financial environ-ment also suffers from omitted factor bias. The scope for further research is substantial.

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Figure 3.11: The effect of the financial institutional environment on organizational form

At first glance it may seem odd that monitoring costs differ with the direction of integration, and in the case of full-scale integration most likely there would be no difference. But considering agricul-ture where the cooperative is a common organizational form, the case of processing and marketing cooperatives enables farmers in the production stage to forward integrate into the processing of ag-ricultural commodities to avoid potential hold-up problems and ensuring sufficient coordination.

The cost of monitoring cooperative management for cooperative members is likely to be much low-er than if the management of the processing firm had to monitor the management of backward inte-grated production units.

The cooperative organizational form is, however, based on relatively easy access to credit for the producers. This factor is determined by the financial institutions, which is why financial institutions matter in the understanding of why specific organizational forms emerge, evolve and/or persist.

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The other integration extreme seen in agriculture is the backward vertical integration of processors, which enables the coordination and increasing willingness to make specific investments as the risk of hold-ups is reduced. Backward integration in livestock value chains is seen in the U.S., among other places, where intermediate levels of vertical integration or quasi-integration are seen in the form of contract production. Backward vertical integration is a likely consequence of relatively re-stricted access to credit, and lower relative costs of monitoring the processor than the producer, from the equity investor’s point of view.

The central tenet in this theory is that financial institutions matter, paraphrasing Vernon Smith’

statement that “institutions matter because incentives and information matter” (Smith, 1994, p.

116), the proposition of this theory could be formulated as follows:

Financial institutions matter with respect to organization and risk management because financial institutions determine the access to credit, which crowd outs outside equity in the organizational structure of the firm and hedging in the risk management of the firm.

This proposition does not imply that other institutional factors are unimportant, the intention is ra-ther to stress that financial institutions may not get the attention they deserve in research related to New Institutional Economics and to explain, in more detailed, why and how financial institutions matter with respect to organizational form.

With the term financial institutions, the whole financial system is addressed, at all levels, ranging from the informal institutional level based on traditions, customs, norms and religion, to formal institutions such as policy, legislature, bureaucracy and to governance structures of financial organ-izations and marginal price/quantity considerations (Williamson, 2000). All these levels of the fi-nancial system may affect the cost of using debt. The cost of debt being different than the price, e.g.

the interest, charged by the lender. As discussed in section 3.2.1, debt has multiple characteristics all of which affect the cost of using debt, but which are not necessarily built into the price mecha-nism.

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Figure 3.12a): Governance structure: Leveraged sole proprietorship

Figure 3.12b): Governance structure: Leveraged joint stock company

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Synthesizing all these factors in the concept of the marginal cost of debt, and comparing these with the marginal cost of outside equity and the marginal return on investment can illustrate the effect of financial institutions on organizational form. Figure 3.12a) illustrates an organization, the size of which is determined by the marginal return on investment (MRI) and the marginal cost of capital (MCC) represented by the substitutes marginal cost of debt (MCD) and marginal cost of outside equity (MCE)¹⁷. The optimal scale of the organization is where the MRI = MCC which is Min(MCD, MCE). The case represented in Figure 3.12 a) is a case where the MRI = MCD < MCE, meaning that the optimal scale is reached where the marginal cost of debt is below the marginal cost of outside equity. Notice that the MCD dominates MCE within the scale of the organization. This determines that the organizational form be a leveraged sole proprietorship. Figure 3.12b) illustrates a case, otherwise similar to a), but where the financial institutions make access to credit harder and therefore the marginal cost of debt higher. In this case the MRI = MCC where MCE < MCD and the organizational form is a leveraged joint stock company.

The inner loop of figure 3.13 illustrates the narrow TCE explanation of organizational change criti-cized by James et al. (2011) for omitting the financial environment. In contrast, the proposition of this paper is illustrated in the outer loop of Figure 3.13. The brief TCE story is that new technologi-cal developments lead to investments in specific assets, and that this affects the organizational form.

The longer story proposed here begins the same way, but realizes that investments need to be fi-nanced. The choice of financial structure depends on the financial institutions determining the ac-cess to credit and will affect the balancing of business risk and financial risk. This may affect the use of other risk management alternatives such as hedging, and will affect the organizational form.

The organizational form may affect the diffusion of new technologies and the circle is complete.

This illustration suggests important interaction between organization, finance and risk management, as well as production technology. Exogenous changes in one factor are likely to increase the proba-bility of adaptive change in the other factors.

17 MCD and MCE being functions of the optimal use of the other substitute.

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Figure 3.13: The financial environment moderates organizational adaptation to technological change

In this paper we stress the effect of the financial system on hog marketing arrangements in the U.S.

and Denmark and link the cooperative marketing in Denmark to the Danish financial system. It must, however, be recognized that cooperatives play an important role in some agricultural sectors in the U.S., which are presumably faced with the same financial environment as the U.S. hog sector.

The estimated share of farm marketing through cooperatives in the U.S. in 2001 was 28%, ranging from 12% for the category “all other” to 13% for livestock/wool/mohair and 83% for dairy (Kreanzle and Eversull, 2003).

The hog sector is part of the livestock category where cooperative marketing plays a minor role. In the U.S. dairy sector, however, cooperatives play a major role. This illustrates that the financial en-vironment is not the whole story. One major difference between the hog sector and the dairy sector in the U.S. is the agricultural policy, which may affect the risk exposure of farmers and the ability of cooperatives to affect the farmer’s ability to cope with risk exposure. Comparisons of the reasons

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behind the cooperative organization of dairy marketing in the U.S. and the IOF organization of pro-cessing in the hog sector is beyond the scope of this paper, but it would be an interesting avenue for further research.

Legal systems affect organization in agriculture in a number of ways. They affect the way property rights are allocated and transferred, the degree to which specialization can be developed and the contracts that connect the links in the food supply chain, which means that a study of the agri-food industry has to be a combined law, economics and organizations undertaking (Ménard and Valceschini, 2005; Williamson, 1991). A “fundamental lesson of the new institutional approach to the organization of agriculture activities is that costs of alternative arrangements of transactions at the micro level as well as costs imposed on transactions by alternative policies at the macro level must be assessed in order to understand how specific solutions are selected and why some work better than others” (Ménard and Valceschini, 2005, p. 426).

Total costs cannot be seen as the sum of production costs and transaction costs. Instead they must be considered together and “efficient organization is not simply a matter of minimizing transaction costs” (Milgrom and Roberts, 1990, p. 57). Market conditions on factor markets, including financial markets, and transaction and agency costs should be analyzed simultaneously. The interaction effect between the financial environment and the contacting costs, determined by best available produc-tion technology, is a key determining factor of organizaproduc-tional form.

Changes in institutions exogenous to Danish agriculture are unfolding, notably changes in the fi-nancial institutions following the GFC, the Basel III being a prominent example. A central question posed by this paper is how to adapt to these changes. This should not be seen as an attempt to im-prove economic performance by changing one institution, but a recognition of the possible need to adapt institutions and governance structures in a response to exogenous changes in other parts of the institutional matrix. North (2005, p. 157) puts it like this: “The artifactual structure that defines the performance of an economy comprises interdependent institutions; changing just one institution in an attempt to get the desired performance is always an incomplete and sometimes a counter-productive activity.” Learning by observing practices in other institutional environments can be valuable, although exact replication of practices will be suboptimal if institutional linkages are im-portant (Williamson, 1991). This is the light in which the comparative analysis should be seen.

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Organizational conventions can be hard to change as structural inertia build up against competitive pressure from a changing institutional environment. Organizational entrepreneurship, either through experimentation or imitation of successful organizational practices elsewhere, “are likely to result in

"modification”, or a "ramification" of conventional organizational architecture that may significant-ly alter some characteristics of the existing conventions, yet retain other basic features” (Aoki, 2001, p. 129). This seems to suggest that the cooperative marketing of hogs in Denmark could and should be retained with some modifications to adapt to new institutional settings unfolding after the GFC, the cooperatives’ role in relation to the individual farmer’s ability to manage risk exposure being one such possible area for modification.

Technology, organization, finance and risk management are intertwined and all areas may be af-fected by exogenous shocks to the other. This is likely to be a general result, deviations from which are exceptions to the rule.