:LPE:

The Globe reports that CIBC World Markets’ analysts contend that income trusts are not just for mature businesses, but also good business associations for high-growth companies. Some things to bear in mind:

+ CIBC World Markets has been one of the early and largest dealmakers in the income trust craze, and as such, has a conflict of interest in any critical commentary on income trusts.

+ income trusts are currently being examined by the Federal government, because they “avoid” normal corporate law taxes — this makes the timing of such boosterism very suspect.

+ in fact, for the past 50 years, about 75% of corporate finance has been provided by internal sources (i.e., retained earnings), not equity markets — there is no reason, other than the tax avoidance, to suppose that income trusts provide better or more efficient corporate finance structures.

+ if the unlikely comes ot pass and the Minister of Finance taxes trusts at the same rate as corporations currently pay (because there is no functional or economic reason to differentiate the two), then a significant chunk of CIBC World Market’s business, and several Bay St. law firms, will evaporate.

On a historical note, the reason the “conventional wisdom” characterized income trusts as appropriate for mature industries, was because they were first used in resource extraction and real estate development, where high fixed costs were sunk and the main profit centre was the continuing revenue from extraction or rents, which would steadily pay and deplete over time. Trusts were an administratively (and tax) efficient way to distribute these income streams. After equities became hard to sell in 2000, bankers started using the trust structure for deals to squeeze out a few points of EBITA per unit, helping to compensate for the discount the market was providing. If the tax advantage was eliminated, there could be several reasons from an economic, securityholder and governance perspective why income trusts are not appropriate vehicles for start-ups, high growth or other businesses.

Train

Originally uploaded by Simon Archer.

These are my three nieces last summer on Vancouver Island. I believe that my brother is playing some kind of trick on them.

Barrie McKenna has written in this weekend’s Globe that Hugo Chavez, the President of Venezuela, has started a “Bolivarian revolution”. Let’s hope so, before something bad happens. The Globe is of course, a dismayed counter-revolutionary, and McKenna quotes several Canadian mining companies’ disapproval. These resource companies should be ignored.

Chavez has borrowed the name of the most famous Latin American independence leader, Simon Bolivar, the Liberator, who led independence movements from the Spanish Crown in Venezeula, Colombia, Chile, Boliva, Ecuador and the territory of Colombia that would later be annexed by U.S. forces and called Panama. His influence was wider than that group of countries: most towns in Latin America have an Avenida Bolivar, there are universities, streets, monuments, social programs, and any number of other places named after him. He died in 1830.

September is independence month for most of those countries and several others in Latin America, all taking place in the first half of the 19th century. Chile was September 18, El Salvador, Honduras, Guatemala and Costa Rica September 15, Mexico September 16 (Ecuador and Bolivia in August, Venezuela in July).

Walter LaFaber has written a decent book on how the promise of these revolutionary independence movements were inspired by Rousseau, the French Revolution and in particular the Revolution of Independence in the U.S. The book tells the sad history of U.S. ambitions in Central America stifling these nascent nationalist movements and creating a system of (unstable) client states, the conditions of which being so wretched that they lead to “inevitable revolutions.” Eduardo Galeano has written one of the most innovative popular histories of the southern Americas, the Open Veins of Latin America, and Pablo Neruda has written one of the defining long poems of Western literature that encapsulates this history, Canto General.

Several books have recently turned (once again) to the analysis of the corporation, asking what the “nature” of a corporation is or can be. Perhaps most famous is Joel Bakan’s The Corporation, which formed the basis for a feature-length documentary.

The problem of the “nature” of a corporation has several aspects, the typical question being, why is a corporation a “legal person” apart from its owners and operators? This is known in the professional literature as the problem of separate legal personality, and it occupied legal minds for much of the early and mid-20th century. The technical answer is, because we have statutes deeming that to be the case. More complicated answers form the debates in the academic literature.

Bakan’s contribution is to ask the question, If it is a separate legal person, what sort of person is it? To which he answers, a psychopath by standard medical definitions. It is a good device. The bad part is, it doesn’t really help anyone understand corporations. Part of the effort to problematize corporations as persons has been to show that they are *not* persons, but a standard form of business method, a type of vehicle for conducting affairs, or if you like, a technology. Bakan’s contribution is useful for attracting attention and lisence fees, but it actually reinforces the notion that a corporation is an actual separate legal person. It fetishizes the form, I suppose, and misses the proper focus on analysis. In B akan’s defence, he is not writing for a legal academic audience, but a popular one, and he’s not a corporate law scholar — he’s best known for his administrative law and constitutional law work.

The movie of the same name www.thecorporation.com takes a broader canvass, and becomes an indictment (long overdue) of Western capitalism, rooting’s its current vagaries in the corporate form. It is a decent bit of leftist agitprop, and you would be forgiven for coming away with relatively little understanding of the corporation as a social institution.

The NY Times reports that corporate fraud and scandals may be a significant cause of the slow job growth that has plagued the current business cycle. (Compared to other business cycles, this one has had the weakest job growth since measurements began). The culprit is convenient and tempting to blame: corporate fraud has scared investors and made management more cautious in investing corporate profits. (Corporate profits are being made at record rates in this business cycle). There may be something to this argument, but I am suspicious, because coporate reinvestment of profits in productive resources (physical plant, new production) has been declining steadily through the 1990s and 2000s, most especially in high-cost and low-profit mature industries, like manufacturing and transport. Where theese profits are going is not clearly understood, but two main destinations appear to be securityholders and corporate debt repayment (which can be securityholders or other lenders). In other words, there appears to be a transfer of corporate profits away from the business and its employee stakeholders, and toward its owners and debt-holders, leaving little money for reinvestment. The impact of corporate scandals may exacerbate this trend, but it pre-dated the current spate, and appears to be less significant an impact in comparison with the larger transfer of wealth happening via the securities markets.

An interesting tidbit from the annals of financial psychology, reported by Reuters. Little more than anecdotal, it somehow confirms the stereotype.

A real gem for those interested in social statistics: the Economist has reported on an article by Dr. John Iaonnidis, which is the culmination of work he has been doing for at least 10 years on evidence-based research. The latest is that about half research-based medical papers have false conclusions. Although he reviews medical research only, the lessons are valid for any social science. The main reasons for such high failure rates are:

1. Misunderstanding statistical significance. A 5% chance, or 1 in 20, is often considered statistically significant. What is less understood is this is a significant occurence where there very few alternative hypotheses that could explain the causal relationship being studied. Where there are dozens or hundreds of possible explanations, a 1-in-20 chance of occuring holds less significance. Or, in other words, offers marginally more than chance.

2. Sample sizes. Small sample sizes do not produce robustly generalizable results. It is striking how often this pitfall is overlooked.

3. Weak correlations, or searching for correlations, not testing them. This is the result of, in some ways, poor understanding of statistical significance and poor modelling or construction of hypotheses. Where outcomes do not match expectations, these are still useful negative outcomes in that they may help us understand why we didn’t get the results expected. But weak connections don’t make a positive outcome, and “finding” alternative hypotheses half-way through a study is a red flag. In medicine, for example, the rule of thumb is that placebos work to the same effect in about 20% of cases. That is, people told they are on a drug show the same effects as those actually on the drug, 20% of the time (my suspicion is that this rate is higher in the UK, for cultural reasons). If a drug test comes in at lower than 20% positive outcomes and the placebo effect is normal, it suggests that the drug is not having the intended effect, and could even be retarding normal placebo effects. But mostly it suggests that we just don’t know if the drug worked at all.

4. Researcher bias. Financial influence (say, funding by a phrama company) or researchers’ “pet theories” are both typical ways in which to bias a result, even in a “hard” science like medicine or biology.

These are all things people have noticed about research in both hard and soft sciences for a century or so. Iaonnidis has provided a useful quantification of these mistakes.

J.K. Galbraith, one of the grand old men of institutional economics and perennial commentator on brief histories of financial euphoria, said that one of the sure signs of a speculative bubble in financial markets is the “invention” of new forms of credit to sell to people who otherwise could not afford to borrow.

Enter the interest-only-adjustable-rate mortage. These innovative mortgages permit people to borrow money, not pay any principle, and only pay a below-market rate of interest in the first few years. The unpaid interest is added to the principle, and payments in later years increase substantially. In effect, this puts off paying the mortgage, and I suppose the innovation is that this mortgage grows bigger, not smaller, as you pay it, until you begin paying the market rate of interest (or higher).

People with “lower credit scores” may use these if they don’t have enough downpayment or can’t affort the carrying costs initially — but fully expect to find the resources to pay normal interest rates, or more, at some future date.

Basically, this mortgage is a very, very large bet that (a) you will win the lottery or get a substantial raise from your boss, or (b) the price of your house will rise enough by the time the bank forcloses on your ever-inflating mortgage that it can cover the deferred interest payments, plus the amount you borrowed.

These are going to be trouble for banks when they ballon enough to warrant foreclosure, to the extent the risk with them is not re-packaged as a securitization or a credit derivative and sold to an insurance company or pension fund, in which case, not only didn’t you get a raise, but your insurance premiums just went up and your pension fund shrank. Bad deal.