On misplaced trust

The Globe and Mail reports on the continued growth of income trusts in Canada, noting that in the longer term the trust form of organization may continue expanding for reasons beyond its tax implications:

Until this week, in fact, when (BCE CEO Michael) Sabia announced the creation of Canada's largest income trust, the company had argued that the telecom business was changing too rapidly for management to adopt such an inflexible business structure.

But the straitjacket, for many, explains much of the appeal of the almighty trust. What started as a way for small companies to cut their tax bills has become something else — a tool for shareholders to reclaim some of the discretion that once belonged almost exclusively to CEOs and directors, and at the same time address one of their deepest concerns: a lack of faith in corporate executives to spend their excess cash wisely...

Indeed, one of the reasons shareholders have gravitated toward trusts is that they function as a kind of a leash on executives bent on sacrificing upfront, predictable profits in their core business in favour of empire-building or diversification. Because trusts pay out the bulk of their cash to unitholders, they are forced, in essence, to ask permission from investors every time they want to raise money for a large acquisition...

The trust market can be a stern taskmaster, and it expects its cash distributions to be made routinely, with no exceptions. If a regular company has a bad quarter, or makes an acquisition that doesn't pay for itself within a prescribed time, it can typically soldier on. For a trust, however, the problems are more transparent, and one bad deal can force management to cut distributions. When that happens, the punishment is usually swift.

Now, it's understandable that shareholders would seek a way to increase their say over the management of businesses generally. But that can easily be done through better corporate governance processes within corporations themselves - and without the wider downsides of a move toward the income-trust format.

After all, Canada already faces a shortage of savings, which is only exacerbated by the Cons' eagerness to encourage yet more consumption through indiscriminate GST cuts. And it's hard to see how matters can do anything but get worse when the latest business fad sets increased cash payouts as the default, punishes businesses harshly for short-term downturns which may not be reasonably avoidable, and makes longer-term investment the exception rather than something to be expected.

Unfortunately, any increased move toward income trusts only seems destined to make Canada's productivity concerns even worse. And with the Cons apparently planning to do nothing more than "monitor" the situation with no plan for action, it'll take a change in government for anything to be done before the damage is irreversible.