Financial and risk management in agricultural cooperatives with application to the milk industry in New Zealand

This paper studies the financial and risk management specific to agricultural cooperatives (co-ops). In order to acquire the necessary risk capital to implement competitive strategies, like value-added processing, many agricultural co-ops are adopting capital structure innovations. Fonterra, a leading and dominant company in the New Zealand dairy industry, is one such typical case. We propose a Markov decision process (MDP) model for Fonterra to make better decisions, taking into account uncertain information on milk supply, share price, milk price and farmers' investment behaviour.The objectives are to maximise equity holders' returns over time and also to minimise financial risks. Themodel is solved through an approximate dynamic programming algorithm. We also investigate the efficiency of several risk management policies through numerical experiments. The results reflect the trade-offs involved in the financial decisions, show the importance of designing effective risk management policies and yield some suggestions to mitigate financial risk.