Ownership Structure And Endogenous Quality Choice

This paper examines how ownership structure affects quality choice and the subsequent equilibrium outcomes within a duopoly framework. Specifically, investor owned firms and cooperatives are analyzed in a closed market setting where these firms may coexist in the economy. The conditions under which ownership structure matters are identified. We conclude that ownership structure matters if the cost of quality at farm level is fixed or if there is a variable cost exhibiting non-constant returns to scale. Two farm level cost functions, a fixed cost function that is increasing and convex in quality, and a variable cost function that is increasing and convex in quantity are analyzed. The two processing firms play a two-stage game where each of the firms produces either high or low quality goods. In the first stage they decide the level of quality to produce, and in the second stage they compete in prices. In the case of a fixed cost function only cooperatives consider the costs incurred at farm level in the first stage of the game. Hence, investor owned firms produce higher levels of qualities at lower prices and generates a larger consumer surplus than cooperatives. The high quality market share is constant in all scenarios. In the case of a variable cost function at farm level, the cooperative has a cost advantage, as the investor owned processor has to pay farm level marginal cost for all farm inputs. It is found that cooperatives generate higher levels and larger quantities of the high quality good at lower prices. This results in higher profits and a larger market share of the high quality good. The cooperative structure also generates a larger consumer surplus and a higher total welfare than the investor owned structure.