How upstream cooperatives limit downstream holdups

Abstract

Abstract In this paper, we consider a downstream firm negotiating with an upstream firm, and we investigate the impact of the organizational form of the upstream firm. We show that if the upstream firm is organized like a traditional cooperative, where the members have free delivery rights and where surplus is shared in proportion to the deliveries, the downstream firm is less subject to a holdup. The cooperative form makes it possible for the upstream firm to credibly commit to deliveries. Traditional cooperatives are often considered as suffering from a volume management problem, which leads to excessive deliveries. Remedying this problem is the objective of the so-called new generation cooperatives. In a supply chain context, however, this problem may actually be beneficial. Specifically, it limits the upstream firm’s ability to hold up the downstream firm, which in turn makes possible specific downstream investments that are closer to first best. Our model lends structure to several real-world phenomena, including the apparent success of marketing cooperatives in farming, the success of open-end mutual funds, and the organization of aggregators in the new economy.