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Investing for the Long Run	The Co-op	27	Why economists expected worker co-ops to underinvest, what the evidence actually shows, and the rules that keep members who are about to leave from starving the firm.

Investing for the Long Run

Picture a machinist who is 60 and plans to retire in three years. Her co-op is voting on a $2 million production line that will take four years to start paying off, then earn money for fifteen. Whichever way it's paid for, part of the cost comes out of the profits she shares in while she's still there, and almost all the benefit goes to people who work there after she's gone. Why would she vote yes?

That's the horizon problem: a member's stake in the firm lasts only as long as their job, but many good investments last much longer. In a conventional company the problem mostly doesn't arise. A shareholder who plans to sell next year still wants the company to invest well, because the share price reflects the future profits the investment will earn. A co-op member has no share to sell. The lock makes sure of that.

This page explains why economists worried about this, what actually happens in real co-ops, and how this model handles it.

The worry

In 1970 the economists Eirik Furubotn and Svetozar Pejovich, studying worker-run firms in Yugoslavia, argued that such firms would pay out too much and invest too little, because members can't take the value of an investment with them when they leave. The same year Jaroslav Vanek, one of the leading academic supporters of worker management, predicted underinvestment in firms that finance themselves from collective savings (both summarized in Novkovic, Journal of Socio-Economics, 2008). Taken to its extreme, the prediction is that such firms slowly starve themselves of capital.

It's a serious argument, and the design has to answer it rather than hope it away.

What actually happens

The predicted underinvestment mostly doesn't show up in the data.

• France. The largest comparison so far used two big, representative samples of French firms across many industries, including services. Worker co-ops were as productive as conventional firms or more so, used their equipment and labor efficiently, and weren't inefficiently small. Contrary to the textbook prediction, they grew as fast as conventional firms or faster (Fakhfakh, Pérotin and Gago, ILR Review, 2012).
• Italy. A study of a large panel of Italian worker and social co-ops tested the prediction directly. It found the opposite of what the theory expects: the more of a co-op's capital was held in collective reserves that no member can withdraw, the more productive it was (George, Fontanari and Tortia, 2019).

But there's a catch, and it matters. These co-ops don't get to choose freely. Italian law requires every co-op to put at least 30% of each year's profit into a reserve that members can never take out (Italian Civil Code, art. 2545-quater; Lomuscio and Tortia, 2023). Mondragon did the same thing by its own rules. So the honest reading isn't "the horizon problem is a myth." It's "a required reserve seems to be enough to keep it in check."

Mondragon's history shows the pressure is real. When its co-ops set their own reserve levels, the share of profit going into reserves swung from 35–53% in the 1960s down to 11–29% in the 1970s. One co-op, Alecoop, which employs students who leave every three years, faced losing its capital as each group took its money out, so it raised its reserve share to 60%. In 1989 Mondragon raised the minimum reserve for all its co-ops from 20% to 50% of profit (Morris, The Mondragón System, 1992). Where the horizon pressure bit, the answer was a bigger required reserve.

The fix that backfired: selling your place

There is an obvious way to solve the horizon problem completely: let members sell their membership when they leave. Then, like a shareholder, a retiring member benefits from every good investment, because it raises the price of their place.

The plywood co-ops of the Pacific Northwest did exactly this. Each member owned one share, and shares could be sold to new members. For decades they were among the most durable worker-owned firms in American manufacturing. Economists who later studied the share prices found membership had been extremely profitable (Craig and Pencavel, American Economic Review, 1992).

Then success worked against them. Workers nearing retirement found their shares had risen from $1,000–2,000 to $25,000, $50,000 or more. Young workers couldn't afford to buy in, so retiring members sold to conventional lumber companies instead (Lindenfeld and Wynn, 1995). Observers called it "the failure of success." It wasn't the only cause of their decline. The whole plywood industry moved south from the 1960s on, and many conventional mills in the Northwest closed too (Pencavel, lecture notes on worker co-ops, 2018). But the co-ops that were sold while still profitable were sold because their members could sell them.

The retiring plywood workers weren't doing anything wrong. They were making a free choice with property they legally owned. This model simply doesn't create that property. A tradable membership turns the co-op back into something owned and sold, which is exactly the claim the thesis says this kind of firm exists to prevent. And it prices the next generation of workers out, which is how the plywood mills ended up being sold.

Who pays for an investment, and when

The horizon problem bites when the members voting today pay for an investment whose benefits arrive after they leave. How much it bites depends on where the money comes from.

1. The reserve. At least 30% of every year's profit goes into the co-op's permanent reserve (see Member Capital Accounts). No current member can ever take that money home, so spending it on a long-lived investment doesn't take anything out of our machinist's pocket. The reserve is money that already belongs to the co-op's future, and it gets spent on the co-op's future.

2. Members' accounts. Money members leave in their capital accounts isn't lost when they leave. It's paid back to them with interest. So if the co-op keeps more of this year's profit in members' accounts to pay for the new line, the machinist gets her money back when she retires. Her real cost is the wait, and the risk that the co-op fails.

3. Spreading the cost over time. A business doesn't count the whole price of a machine as a cost in the year it's bought. It spreads the cost over the machine's working life. A $2 million line that lasts 20 years counts as $100,000 of cost a year. This is called depreciation, and it's how ordinary accounting already works. The profit split is based on profit after depreciation, so the machinist isn't charged for the years after she leaves. The bank does the same with repayment: loans for buildings and long-lived equipment are paid back over the asset's working life, up to 25 years for real estate, the same limit the SBA's main loan program uses (SBA, types of 7(a) loans).

This doesn't fix everything. Depreciation spreads the cost evenly, but the payoff isn't even. If the line takes four years to start earning, the machinist is charged for three years of it and sees none of the benefit. That's the residual horizon problem, and it's why the reserve matters so much. The investments with the slowest payoff are the ones the reserve should pay for.

Where the gaps are

That leaves four ways the horizon problem can still get in.

• Paying it out as salaries. The reserve rule applies to profit, and members set their own salaries. A co-op could raise everyone's pay until there's no profit left, and the reserve would get nothing. Newer members have an extra reason to like this: their profit share starts small and grows with tenure, but their salary is paid in full from day one.
• Pay that isn't salary. Pensions promised for the future, retiree health cover, generous severance. These push costs onto whoever works there later.
• Selling off the furniture. The lock stops anyone selling the firm, but not its assets. Members about to leave could sell the building, book the gain as profit, split it, and leave their successors paying rent.
• Development that pays off late. Designing a new product or building software costs money now and pays later, but it's usually counted as a cost in the year it's spent. So the members voting today pay for all of it.

The rules

1. The reserve's share applies to pay above the going rate, too. This isn't a cap on wages. Members can pay themselves whatever they decide. But the reserve takes its 30% of everything members receive above the going rate, whether it's called profit or pay.

• The going rate for each job is the higher of two numbers: the median pay for that occupation in the co-op's own metro area, from the government's wage survey (the Bureau of Labor Statistics' Occupational Employment and Wage Statistics), or the local living wage for a full-time worker supporting one child, from MIT's Living Wage Calculator. The living-wage floor matters. In home care the median wage can be close to poverty pay, and a co-op that raises its aides to a living wage shouldn't owe anything for doing it.
• Raising the bottom is free. Pay up to one and a half times the local living wage never counts as above the going rate, so a co-op that lifts its lowest-paid well past a living wage owes the reserve nothing for it.
• It's checked job by job. Paying one group below the going rate doesn't make room to pay another group above it. An outside reviewer, the co-op's auditor or the bank's, assigns each job its occupation code from what the person actually does, not from their title, and the codes are shown to members next to each job. Where the survey has no figure for the metro area, the state figure is used, then the national one.
• It counts total pay. Employer retirement contributions above 6% of pay, bonuses, severance beyond the co-op's standard formula, and perks like a car, housing or loans to members, valued at cost, all count as pay. So does pay to non-members and to people working through a related company. Co-ops can't promise pensions or retiree benefits they don't pay for in full each year.
• How it's settled. Thirty percent of the excess is moved from members' capital accounts into the reserve. No new cash has to be found, because the members already took that money as pay. If a member's account can't cover it, the rest comes out of their future account credits, or out of their payout when they leave. For pay to non-members, it comes out of that year's members' profit pool.
• There's a precedent. US tax law already treats salaries that aren't "reasonable" as disguised profit (26 U.S.C. § 162(a)(1)), so owners can't dodge tax by calling profit pay. This rule stops the same disguise being used to dodge the reserve. The tax test is judged case by case. This one is a fixed formula, so it's cruder but much harder to argue about.

2. Gains from selling assets go to the reserve. If a co-op sells a building, equipment, a brand or a patent for more than its value on the books, the whole gain goes to the reserve, not into the profit split. A sale to an insider, or a sale-and-lease-back, is checked like any insider deal.

3. Development projects can be spread out, like machines. A co-op can designate a specific development project before it starts spending on it: designing a new product or a better production process, or building software. For the profit split only, its cost is then spread over up to five years, the same way a machine's is.

• Only real development qualifies. It has to meet the test international accounting standards already use to decide when development creates a real asset: it's technically doable, the co-op intends to finish it and can, and it's likely to earn money (IAS 38). Those standards specifically exclude training, advertising and start-up costs, and so does this rule. Those stay costs of the year they're spent.
• The people who chose it carry the risk. If a project is abandoned or written down within five years, the cost that hasn't yet been charged comes out of the capital accounts of the people who were members when it was designated, including former members whose payouts haven't been made yet. Payouts take up to five years anyway, so the money is usually still there. That makes the rule useless for pushing costs onto the next group of workers.
• Limits. The total cost still waiting to be charged can't exceed half of the co-op's average profit over the last three years, measured before any spreading. Only co-ops with an independent audit can use the rule, and the auditor checks each open project every year.
• It only changes how costs are divided between this year's members and future ones. It doesn't touch the co-op's tax return or its reports to the bank. The co-op publishes both numbers side by side.

4. Accounts earn a fair rate while they're at risk. A current member's account earns the one-year Treasury rate plus two percentage points, credited in years the co-op makes a profit. In a loss year it earns the plain Treasury rate. Money in a current member's account is at risk: it shares in the co-op's losses and ranks behind its lenders. Paying only a risk-free rate on it would push every member to take cash instead. Once a member leaves, the balance earns the plain Treasury rate. It no longer shares in losses, so it's no longer at risk, and nobody should collect a premium from the work of people they no longer work alongside. For comparison, Italian law lets co-ops pay members up to 2.5 points above the rate on its postal savings bonds on the capital they've put in (Lomuscio and Tortia, 2023), and Mondragon paid 6% plus an adjustment for inflation (Morris, 1992). The details are on the capital accounts page.

What's still open

• The end game. A co-op whose members are mostly close to retirement and not being replaced could let its equipment wear out. The reserve can't be taken, and the rules above catch most of the ways to pay it out. But nothing forces a co-op to maintain what it has once its bank loan is repaid.
• Too much investment, not too little. Reserve money can't be paid out, so there's a risk it gets spent on expansion that doesn't pay. Fagor, Mondragon's appliance maker, expanded across Europe and China, mostly on borrowed money, including buying the French appliance maker Brandt in 2005. Then the Spanish housing crash took away its main market, and it went bankrupt in 2013 (Wikipedia). Outside a bank loan, nothing here tests whether a big project is worth it.
• Whether 30% is enough. Italy requires 30%. Mondragon found 20% too low and moved to 50%. This model uses 30% as a minimum that each co-op can raise. The pilot measures investment per worker, and the return it earns, against matched conventional firms. So if co-ops invest too little, or waste what they invest, it will show.
• Is the account rate right? Two points above Treasury is well below what investors expect from a small business, so members may still prefer cash. Paying the co-op's own return on its assets instead would reward good investment directly, but it would also make the account more volatile. Which is better is unsettled.