A. Managing Entry and Exit

Assume that vineyard owners are of either high or low ability. Given the organizational characteristics of cooperatives, the latter are more likely to join than the former. This situation, in turn, exacerbates the already existing inefficiency, as the new members anticipate that they do not have to bear the full costs of their behavior. Precontractual opportunism—i.e., adverse selection—can be avoided by a combination of measures that enable incumbents to screen applicants. The use of these measures helps reduce information asymmetries between incumbents and applicants, as they require the latter to invest in the production of a costly and, therefore, credible signal that eventually leads to a “separating equilibrium” (Spence, Reference Spence1973, Reference Spence2002). First is the introduction of a waiting period of, say, three to five years, during which the applicant has to demonstrate his or her ability while being paid lower prices for the grapes delivered than incumbents; second is the introduction of an application fee, which is nonrefundable in case the applicant is not admitted after the probation period. The combination of these measures induces self-selection processes among potential applicants, as only high-ability grape growers are willing to invest in the production of this costly signal; low-ability grape growers correctly anticipate that they are unlikely to get their bonds back.

To induce high-ability growers not to start minimizing their efforts once they have joined but to continue working at a high level (i.e., to avoid postcontractual opportunism in the form of moral hazard), memberships of growers whose performances deteriorate should be terminated following a notification period of, say, two years in case their performances do not improve (i.e., if the quality they deliver continues to remain below 90 percent of the average, for instance). The use of these measures again induces self-selection prior to application, as low-ability producers correctly anticipate that they are less likely than high-ability producers to constantly deliver grape quality above the threshold required for continued membership.

The combination of the measures discussed so far increases homogeneity among members and, therefore, organizational efficiency. The German Association of Quality Wine Producers, the members of which can charge a considerable price premium of around 15 percent per bottle (Frick and Simmons, Reference Frick and Simmons2013), is known for a similar procedure to select new members, combining a mix of screening and signaling elements that provide monitoring possibilities as well as incentives to incumbent firms. The regional VDP (Verband der Prädikatsweingüter or German Association of Quality Wine Estates) branches (one in each of the thirteen wine-growing regions in Germany) invite wineries with distinguished individual reputations to join them after having monitored the potential members’ performances for an extended period of time. Thus, growers cannot apply for membership but are selected by incumbent firms based on their past performances and merits. In addition, members who fail to produce grapes that satisfy the organization's quality goals for a number of years are induced to leave “voluntarily” (an exit is never labeled a “dismissal”). This selection procedure has a number of side effects. First, even growers with established individual reputations consider their memberships valuable assets, as they enable them to sell their wines at significantly higher prices. Second, due to this price premium, members have an incentive to closely monitor each other, as a decline in quality by some firms is detrimental to the individuals as well as to the collective reputation of all wineries belonging to the association. Thus, under specific circumstances (i.e., regional proximity and familiarity with neighboring growers in the typically small villages where most wineries are located), profit-maximizing firms are likely to invest in the production of a public good, creating a positive externality that benefits those living farther away. These benefactors, in turn, are then likely to reciprocate by investing in the same kinds of activities, creating a virtuous circle of mutual control (for a theoretical discussion, see Tirole (Reference Tirole1988)).

B. Managing Membership by Rank-Order Tournaments

Tournaments or contests are ubiquitous and have been shown to elicit the desired behaviors of participants (i.e., higher productivity) in a wide range of occupations (e.g., Backes-Gellner and Pull (Reference Backes-Gellner and Pull2014), with evidence on salespeople; Bodreau, Lakhani, and Menietti (Reference Bodreau, Lakhani and Menietti2016), on software programmers; Kale, Reis, and Venkateswaran (Reference Kale, Reis and Venkateswaran2009), on managers; and—perhaps most relevant in the present context—Knoeber (Reference Knoeber1989), on farmers).

Tournaments represent a test of abilities and motivations among the individual participants (here, the individual members of a cooperative); the common “rules of the game” have the character of a fixed effect that allows relative evaluations. Participants are assumed to choose actions to optimize against the efforts of their fellow members—who are at the same time contestants—given the rules of the game and the costs and rewards of winning. Finally, the reward structure (consisting of additional pay for superior grape quality) is a predetermined list of prizes that increase in rank. This structure is stated in advance and adhered to after the tournament. Superior performance is always rewarded, because otherwise contestants would have no incentive to expend the effort needed to increase the perceived quality of their grapes (Lazear and Rosen, Reference Lazear and Rosen1981).

When all contestants are equally talented and equally endowed, a symmetric pure-strategy equilibrium exists in which all growers choose the same level of effort as a best response to the efforts of other growers, and each has a perceived equal chance of winning. In this situation, the equilibrium level of effort is an increasing function of the difference in rewards between winning and losing. A grower's output (the quality of the grapes delivered) depends on deterministic as well as on random causes. Measured performance is a random variable in which the individual grape grower's choice of effort shifts the mean of the distribution of total harvest quality. Random components refer to common effects, such as weather and soil conditions, and to an independent and identically distributed error distribution representing pure luck and other chance factors beyond one's control.

On the other hand, when contestants are heterogeneous, more able growers have a greater chance of winning in equilibrium. In contests in which growers have no more information about their abilities than others do, the equilibrium remains symmetric. Yet if growers’ abilities are known to each other, heterogeneity reduces incentives to expend effort: weaker growers know that their success probabilities are below average, inducing them to put forth less effort. This knowledge in turn induces stronger growers to put forth less effort, because their winning probabilities are larger. These performance-dilution effects can be overcome by adjusting the prize distribution—that is, by increasing the prize spread between winning and losing prizes or by skewing the prize structure more heavily toward the top ranks. This adjustment deters weaker growers from entering the contest, because their increased losing prospects reduce their expected income compared to the income from alternatives. However, although doing so is efficient on self-selection grounds, skewing rewards creates social costs in escalating the remaining growers’ incentives to win beyond their socially efficient levels. The assumption that an optimum prize distribution exists for contests with homogenous growers as well as in cases where growers are heterogeneous implies that a unique spread between winning and losing prizes maximizes the value of the contest.

Thus, although consensus stipulates that “incentives matter” (e.g., Prendergast (Reference Prendergast1999) with lots of evidence), it is often not clear how these incentives should look, because “strong incentives are very often a bad idea, especially within organizations. … The problem is that people respond just as strongly to badly designed incentives as they do to well-structured ones. And when those badly designed incentives are strong, they can lead to really egregious forms of behavior, and the results can then be horrendous” (Roberts, Reference Roberts2010, 125). It may therefore, be optimal for the cooperative not only to award prizes to the winner(s) but also to offer a low prize to relatively few bottom performers. The reason is that low-ability producers are discouraged less under these conditions compared to winner-prize tournaments awarding high prizes to few top performers. This incentive in turn increases the losers’ probability to enter future tournaments (Balafoutas et al., Reference Balafoutas, Dutcher, Lindner and Ryvkin2017).

C. Managing Membership by Investing in Corporate Culture

Corporate culture represents the unspoken code of communication among the individual members of an organization, a convention that helps coordinate their activities. In the managerial literature, the focus is on culture as a set of norms and values that are widely shared and strongly held throughout the organization and that can influence not only members’ focus of attention and shape their interpretations of events but also guide their attitudes and behavior (O'Reilly and Chatman, Reference O'Reilly and Chatman1996). In this sense, the function played by culture is that of “social control”: if people share a common set of expectations with the people they work with, they are under their control whenever they are in their presence. In this respect, culture complements more traditional control systems, such as monitoring and financial incentives. Thus, corporate culture does not change the preferences of individuals—it only alters their incentives in a repeated game (see Kreps, Reference Kreps, Alt and Shepsle1990).

Investing in the creation and maintenance of a corporate culture is, therefore, likely to improve the motivation of an organization's members and, eventually, their productivity. However, the time and effort required to build a corporate culture may in many cases deter management to take the initiative and start the process of convincing members to commit to a “quality strategy.” This kind of reluctance is likely to occur if managers have private information about their future careers and expect to not be with the cooperative once the returns to the change in culture become apparent. Yet given the long periods of time for which individuals typically remain in a cooperative (the annual turnover rate in membership is less than 5 percent), these investments most likely pay off, particularly if they are combined with a careful selection of new members and adequate sanctions against poorly performing incumbents.Footnote ¹ Members of a cooperative should, therefore, consider rewarding their managers for short-term efforts to improve the organization's long-term performance (Holmstrom and Milgrom, Reference Holmstrom and Milgrom1987). Thus, the combination of indirect (shared norms and values) and direct control (mutual monitoring activities) involves two different yet equally important ingredients of a cooperative's continuous improvement process.