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«Volume 23 2009 Page 1-19 The Restructuring of the Saskatchewan Wheat Pool: Overconfidence and Agency Murray E. Fulton∗ Kathy A. Larson† ∗ ...»

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I think after that, in the 80s and 90s, that is when the quintessential struggle between the board and management started. This is an issue for every organization that has boards, whether appointed, elected,... you have the board and then have your senior management. Senior management is always in a better position information wise, the management staff were usually higher-trained educated people with all sorts of skills, everything from being able to do social research to accounting to all those things.... You could see the gradual change where the board became almost dependent as opposed to being the final decisionmaking body. They basically became dependent on management to tell them, ’Here’s what you should do and here’s why you should do it.’ At the board level there probably wasn’t the capability... but in terms of being able to make some of these major decisions around [Project Horizon], they pretty much had no choice but to go with what management put before them and as best as they could make decisions on it.

The relatively complex agency relationships that existed in the Pool after the conversion greatly influenced the decisions that were made. For the most part, senior management was able to bring the board on side with respect to its view of the Vol. 23[2009] 13 SWP’s future path. All interviewees agreed that, given the deregulation occurring in the 1980s and early 1990s, the grain industry was evolving into a new system with new players. They also agreed that the Pool had a strategy to remain a dominant player, although to achieve this goal they would have to move quickly. A senior manager recalled that “as all the regulations fell away from the grain side [the Pool] simply had no choice but to become much more market-driven and market influenced.” A diversification strategy was so important that both the board and management believed that the Pool would not survive if it did not diversify.

The acceptance of management’s vision likely reduced the board’s incentive to monitor management’s actions. The investments and activities proposed by the Pool were clearly associated with a diversification strategy, and the agreed upon need to move quickly meant that the board’s ability to hold up investment decisions for sober second thought and analysis was greatly reduced.

There was also no strong incentive for either of the two main principals— farmers and investors—to monitor the actions of their agent, namely the board.

Patronage payments ended with the share conversion, so farmers lost their incentive to ensure that investments were properly undertaken. And because investors (the B share owners) could not vote, and therefore could not influence the board, they too lacked an incentive to monitor the decisions being made. This lack of incentive from both principals was likely a contributing factor in why the board failed in its oversight role.

Other factors, however, were also at work. The “need for confidentiality increased when [the Pool] went to a share offering.” The Pool had to become less specific about where it had business interests because of the risk of insider trading. This lack of information sharing was part of a larger pattern observed by board members. As one board member saw it, “There were a lot of things shared with the president that never got adequately shared with the rest of the board. Getting things done became more important than sharing information.” Senior management, however, saw the situation differently. As senior managers remarked, “the amount of information we supplied was information overload at times,” and “it was more that the board did not know the questions to ask.” In a similar vein, the comment was made that, “[t]he board of directors did not have the makeup or the people on it that would normally have served that check and balance to senior management.” At the same time, “as the business got more sophisticated, and more complicated, and moved further away from the farm gate it got tougher” for board members to assess proposals. The volume of proposals and expected promptness for decisions to be made “would have been difficult even for a competent board to stay abreast and do a fair job of assessing what was coming in.” 14 Journal of Cooperatives As the Pool expanded, it became increasingly difficult for board members to provide expertise. Some senior managers said “there wasn’t the person [on the board] who would do the homework” because, for board members it was “stepping way beyond your comfort zone,” and “when it came to managing an entity that was worth close to a billion dollars in assets they were a little out of their league.” A board member admitted that “as we got more external, we had to rely more and more on our CEO and CFO and others to provide us with the types of insights and analysis we needed to make decisions.” Overconfidence and Lack of Oversight – Impact on Investment Decisions To further understand how overconfidence and lack of oversight affected investment decisions, this section examines three investments that were mentioned during nearly every interview: (1) Project Horizon; (2) Humboldt Flour Mills; and (3) the foreign direct investments.

Project Horizon began with an announcement of the location of all twentytwo elevators. Construction also began more or less simultaneously on all the high throughput elevators. The Pool “firmly believed they were going to stop the competition literally by tying up all the construction capacity for these high throughput elevators in the short-run.” This “move quickly” approach did not work. Board members were astonished that companies would build facilities just a few miles down the road from a SWP high throughput location. The competition’s response negatively affected the Pool’s revenue projections from grain handling, as the Pool had “explicitly included in their assumptions that their producers would go to their high throughput elevators.” The revenue shortfall was also likely a result of falling member commitment.

As Lang and Fulton (2004) argue, member commitment fell, in part, because the members no longer saw the Pool as operating in their best interest. This belief was partially a consequence of the investment activities pursued by the Pool and the manner in which they were carried out, as the example of Humboldt Flour Mills shows.

Even though Humboldt Flour Mills was not the Pool’s largest investment, it “was the bellwether that told everybody else in rural Saskatchewan [that the Pool] was out of control.” One senior manager described the 1998 acquisition of Humboldt Flour Mills as “a bidding war with Agricore.” When Alberta Wheat Pool expressed interest in the company, the Pool “didn’t want Alberta Wheat Pool in farm supplies in innermost Saskatchewan,” so the Pool “ended [up] paying C$16 million for Humboldt Flour Mills.” A range of managers and board members saw the acquisition as “keep[ing] Agricore out” even if that meant paying “far more than what made economic sense.” Vol. 23[2009] 15 On the foreign investment side, the Pool made investments in grain handling terminals in Poland and Mexico in 1997, and in a grain-marketing firm in England in 1998. All of these investments were unsuccessful. Interviewees lay part of the blame for these failed investments on “unscrupulous partners” and data from a consulting company that “did not come to fruition.” There were interviewees who partly

blame the Pool because these were areas where the Pool had no traditional operating knowledge. One board member was highly critical of the terminal investments:

“I think whether it was bad analysis or it was a lack of insight into the changing environment, I guess not fully appreciating the strategic influences in those respective countries and unstable environments.” These examples further illustrate the underlying errors that were made in the analysis of investment projects, the over-optimism that was present in the organization, and of the lack of effective oversight. Anchoring, the confirmation bias, and competitor neglect were present. Hubris was also a factor—management had a belief they could make investments in virtually any area, regardless of whether they had any experience.

Discussion and Conclusions Looking back at what transpired at SWP in the 1990s, it is not surprising that the investments made during this period were largely unsuccessful. Both agency problems and overconfident leaders were present in the Pool. The agency problem was exacerbated by three factors: (1) ownership and control were separated via the A-B share structure, leading to a situation where neither the farmer members nor the investors had an incentive to carefully monitor the activities of the CEO and senior management; (2) the sheer volume of the investment and acquisition activity that was undertaken made it virtually impossible for a board to stay on top of what was happening; and (3) as a result of the change in financial structure, the senior management had available to it a large amount of debt capital. This easy access to funds also exacerbated the overconfidence and hubris that the CEO and senior management exhibited—new investments could be undertaken without being be subjected to the scrutiny of the capital market.

In short, SWP succumbed to the two classic problems associated with financial investment activity, agency problems and management overconfidence. The result was as expected—the Pool overinvested and made poor investments, the consequence of which was that its financial viability was severely challenged. What started as an attempt to keep the SWP competitive in a rapidly changing market ended with SWP making bad business decisions, which in turn resulted in the loss of the Pool’s cooperative structure.

16 Journal of Cooperatives What lessons does the SWP case provide to other cooperatives? Given their relatively complex agency problems, cooperatives must ensure that someone has an incentive to oversee the board. In traditional co-ops, the members often play this role. If members become less connected to the cooperative—perhaps because of increased size or increased variety of activities—it is important that the board remains independent and accountable. This point is particularly important if the sources of financing for the co-op become increasingly diverse, which in turn means that the incentive for any group to monitor the actions of senior management is reduced.

Oversight by the board is also important. Agriculture co-ops must ensure that board members have the necessary support and skills to undertake their fiduciary responsibilities. Many co-ops have changed their board makeup to include appointed members with specialized knowledge and expertise in the fields of finance, marketing, and accounting. It makes sense to provide finance and management training courses for the board to ensure that they can analyze projections and assumptions behind the decisions being made. A board with strong knowledge and business skills will help alleviate the risk of information asymmetry.

These suggestions are means of dealing with the long understood problem of information asymmetry. The case presented in this article suggests that cognitive asymmetry is also important. It is critical that a board find ways of getting at the cognitive errors that they and their senior management are likely to make. There are ways, for instance, of dealing with overconfidence and the cognitive errors that underpin it, and cooperative boards need to embrace these techniques. One technique that has been suggested is the use of reference classes, a set of analogous situations to which the current decision can be compared. This technique can be combined with a process that explicitly accounts for bias (Lovallo & Kahneman 2003). While boards should not be expected to actually carry out an analysis of proposals using this technique, they can ensure that it or something similar is used as a part of all decision-making. A board, for instance, could establish a policy whereby it would not approve a proposal without a report on the results of such exercises.

In summary, cooperatives are likely to face an increasing number of governance problems as they adapt to rapidly changing economic environments and adopt increasingly complex forms of financing. As the SWP example illustrates, problems of agency and cognition can be particularly troublesome for cooperatives. Special attention to these problems will be necessary if cooperatives are to retain their cooperative nature.

Notes Vol. 23[2009] 17

1. See Fowke (1957) for a history of the Prairie grain industry from 1900–1950. For a history of the Saskatchewan Wheat Pool prior to the 1980s, see Fairbairn (1984).

2. While the Pool was under no legal obligation to repay member equity, there was a strong expectation by the membership that repayment would occur.

3. A trading period prior to the share opening allowed farmers to trade shares amongst each other. At the start of trading on April 2, 1996 Saskatchewan farmer-members owned just over half (53 percent) of the Pool’s capital. There were 29.6 million Class B shares issued; 15.7 million to farmers; 6.4 million to non-Saskatchewan investors; 6.1 million to Saskatchewan investors; and 1.1 million to SWP employees (Briere 1996).

4. As a publicly traded cooperative from 1996 to 2005, the SWP’s ticker symbol was SWP.B.

5. For an examination of Agricore United’s decision to accept the Pool’s takeover bid, see Earl (2009).

6. To satisfy the federal Competition Bureau, the Pool and Agricore United were required to turn over ownership of 24 elevators and nine farm service centres to JRI and Cargill (Ewins 2007a). Without this turnover, Viterra would have controlled 68% of the licensed storage capacity in Western Canada (Ewins 2007b).

7. In explaining the role of overconfidence and hubris on business strategy, Lovallo & Kahneman (2003) are followed closely.

8. Using evidence from 1973–1998, Andrade, Mitchell, and Stafford (2001) present evidence that the stock value of the acquiring firm falls with an acquisition, although this result is not statistically significant at the five percent level. A review of numerous earlier studies is also provided in this paper.

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