THE UNIVERSITY OF MICHIGAN LAW SCHOOL
The Law and Economics Workshop
Presents
AN EMPIRICAL EXAMINATION OF THE GOVERNANCE CHOICES OF
INCOME TRUSTS
by
Anita Anand, Toronto Edward Iacobucci, Toronto
THURSDAY, April 5, 2007 3:40-5:30
Room 236 Hutchins Hall
Additional hard copies of the paper are available in Room 972LR or available electronically at http://www.law.umich.edu/centersandprograms/olin/workshops.htm
An Empirical Examination of the Governance Choices of Income Trusts∗
Anita I. Anand and Edward M. Iacobucci
Faculty of Law, University of Toronto
March 22, 2007
DRAFT: NOT FOR CITATION
∗ We would like to thank Karen Andreychuk, Dubravka Colic, Tim Ho, Rutaba Khatun and Kien La for their valuable research assistance.
I. Introduction It is well understood that organizational law plays an important role in establishing terms
of a (metaphorical) contract between stakeholders in the corporation. In particular, it supplies
terms that govern significant elements of the relationships between directors, officers, creditors
and shareholders. But the precise function of law in facilitating contracting is not
uncontroversial. There are a variety of different theories as to the contribution that
organizational law, as distinct from contract law, makes to the corporate contract. For example,
Hansmann and Kraakman (2000) conclude that the essential role of organizational law is to
partition corporate assets from personal assets. They conclude that some contractual terms that
establish asset partitioning, particularly those that shield corporate assets from shareholders'
personal creditors, would simply be unavailable in the absence of organizational law because of
transaction costs.
In this article we focus on the role of organizational law, and corporate law in particular,
in providing specific governance terms in the corporate contract. Easterbrook and Fischel (1991)
(and others) suggest that corporate law is valuable in reducing transaction costs for the relevant
contracting parties. This argument is not that organizational law is essential to the adoption of
certain contractual terms, but rather that corporate law saves transaction costs by allowing
adoption of corporate law default terms simply by incorporation. Incorporation alone generates a
reasonably complete set of contractual terms. On this theory, the role of corporate law is to
provide default rules that most parties would adopt and thus limit transaction costs.
State-provided corporate law may also be a valuable alternative to strict reliance on
contract law in that it may facilitate realization of valuable network economies (Klausner 1995;
Kahan and Klausner 1997). There are positive network externalities from the adoption of a
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particular contractual term by a corporation. For example, the more entities that adopt the term,
the greater the certainty over time of the term's meaning because of the higher probability of
litigation that clarifies its legal significance. This in turn reduces costs from uncertainty. State-
provided corporate law facilitates standardization and coordination of contractual choices.
Under this theory, private contracting alone would lead to insufficient standardization.
Another theory of how corporate law creates gains unachievable under contract law alone
is that it imposes some mandatory terms that cannot be subject to renegotiation. Contract law is
generally permissive of renegotiation, which leads to concern that on occasion one party may be
in a position opportunistically to insist on renegotiation (Aivazian, Penny and Trebilcock, 1984).
Sailors, for example, may demand extra pay when out at sea and the captain has little choice.1
Courts struggle with reconciling expansive freedom to recontract with concerns about
opportunism. Corporate law can avoid these problems in some instances by creating mandatory
terms. Directors' duties, for example, cannot be opportunistically set aside by directors who
manipulate votes in their favour, perhaps by strategically bundling propositions to shareholders
(Gordon, 1989). Conversely, shareholders cannot opportunistically impose more stringent
standards on directors and officers to take advantage of firm-specific investments of human
capital by the directors or officers in the corporation. The mandatory nature of some rules may
therefore be welcome from a contractual perspective.
Recently, Hansmann (2006) proposes that organizational law is useful in that the
contracting parties can avoid internal decision-making dysfunctions when seeking to amend the
corporate contract by relying on the state to make the relevant amendments. Thus, when a
corporation adopts a default rule, it adopts not only the default rule, but also adopts any
1 See Stilk v Myrick (1809), 170 E.R. 1168 where sailors negotiated to work in allegedly more difficult conditions (two crew desertions) for extra pay.
3
amendments to the default that the relevant jurisdiction subsequently adopts. Modifications of
long-term relational contracts is inevitably appropriate on occasion, and corporate law can
provide such modifications at little cost to the contracting parties. Given the pathologies of
voting to amend corporate contracts, the state-amendment process may be preferable to private
contract and amendments.
In contrast to the above approaches, Black (1990) suggests that state corporate law is
trivial. Even mandatory law can be trivial, he argues, in four respects: first, the law simply
mimics what market actors would choose if given the choice; second, private actors can often opt
out of legal rules through planning; third, some rules are unimportant in the sense that they
address issues that arise rarely; and finally, if the law does not mimic private choices, there will
be pressure to change the law.
Each of these theories is of course subject to analysis and criticism as a matter of theory.
In this article, we avoid conceptual critiques of the theories and instead focus on evidence. We
examine a database of private choices that we believe provides insight into the empirical
relevance of these theories of corporate law. Hansmann (2006) has pointed out the paucity of
idiosyncratic corporate contracting in public companies, as well as the relative empirical
insignificance of alternatives to the corporate form, particularly the business trust. The lack of
variation in corporate contracting in general makes it difficult to falsify hypotheses generated by
the various theories of the value added by corporate law. It turns out, however, that recent
developments in Canada offer the chance to examine private choices in structuring the contract
between a business and its public investors.
Business trusts of a specific form known as income trusts have blossomed in Canada in
recent years. Income trust structures have surged in popularity in the 11 years since the first
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business income trust was brought to market in 1995 (see Alarie and Iacobucci, 2007). In 1996,
the market capitalization of energy, real estate and business income trusts combined was just
$8.8 billion. By the end of 2000, the market capitalization had more than doubled to $18 billion.
By the end of 2004, it had reached $118.7 billion. As of June 30, 2006 there were 247 income
trusts listed on the Toronto Stock Exchange (TSX), with a quoted market value of $195.4 billion.
The quoted market value peaked in late 2006 at over $200 billion.
We discuss the particulars of income trust structures below, but what is essential for our
study is that governance of the trust is not the result of corporate law and private charters.
Rather, the "organizational contract," as opposed to the corporate contract, is found in the
Declaration of Trust (DOT), an agreement that establishes the trust, sets forth the relationship
between the trustees and the unitholders, and governs the structure and activities of the trust.
Trust law confers upon the organization considerable freedom to choose terms in the DOT,
rather than imposing mandatory rules. Given that business income trusts are not confined to
special roles, like special purpose vehicles in securitization contracts, but rather are substantively
similar in function to public companies, examining income trusts is probative in evaluating the
empirical plausibility of the above hypotheses about corporate law, and indeed contributes to the
formation of novel hypotheses, particularly with respect to the procedural role of law, that we
discuss below.
We hand-collected data from the DOTs of all 186 income trusts that listed on the Toronto
Stock Exchange between 1996-2005 whose DOTs were electronically available on SEDAR, the
Canadian equivalent to the US EDGAR database. This is 80.1% of the 232 trusts that listed on
the TSX in this period. We sought to determine the extent to which provisions contained in the
DOT mirror existing corporate law contained in the Canada Business Corporations Act
5
(CBCA).2 In order to investigate deviations from corporate law, we examined 26 provisions that
are mandatory in the CBCA (and are typically mandatory in the very similar provincial corporate
statutes). We grouped the provisions examined into one of four categories dealing with directors
and officers; shareholder rights; shareholder remedies and transactions. We demonstrate that
there are important differences, and some interesting similarities, between DOTs and the CBCA.
Looking behind the actual results on a provision-by-provision basis, we also show that there is
consistent and inconsistent evidence for each of the theories of corporate law outlined above.
The article proceeds as follows. Part II offers a primer on income trusts, setting the
institutional stage for our empirical study in Part III. Part III describes our methodology and
contains our (preliminary) results on the differences between DOTs and the CBCA. Part IV
analyzes the basic evidence, focussing on what the findings tell us about corporate law. Part V
[in progress] asks whether differences in governance choices across income trusts depend on
variety of factors, including the presence of a controlling unitholder, the nature of the law firm,
and whether the adoption of the trust form was by conversion of an existing public business or
by an IPO. Part VI [to be written] concludes and offers avenues for further research.
II. A Primer on Income Trusts
While there are a number of variations on the particular structure of an income trust, the
following conveys the basic idea. An income trust involves at least two organizations. There is
an operating corporation that carries on the business of the income trust. The corporation issues
all of its equity and subordinated debt to a trust. The corporation is typically highly leveraged,
but may owe little outside its debt to the trust. The trust obtains the funds to acquire the equity
2 Canada Business Corporations Act, R.S.C. 1985, c. C-44, §§ 5–12 [hereinafter CBCA].
6
and debt in the operating company by selling units to the public. The structure of the income
trust is depicted in Figure 1.
FIGURE 1
TRUST
UNITHOLDERS
OPERATINGCORPORATION
DEBT EQUITY
Tax minimization is understood to be a significant motivation for adoption of the income
trust (see, e.g., Alarie and Iacobucci 2007). If the trust pays out all the interest payments and
dividends that it receives from the operating corporation in distributions to its unitholders, the
trust pays no income tax. That is, the trust is a flow-through entity for tax purposes. The
operating corporation also largely avoids tax by adopting very high degrees of leverage. Since
interest payments from the operating corporation to the trust are deductible for tax purposes,
there is little or no corporate income tax. As a consequence, the income trust minimizes entity-
level tax. Given that corporate and personal taxes are incompletely integrated in Canada, as
elsewhere, there is a net tax savings from eliminating entity-level taxes. However, what is
particular about Canada is that unlike many other jurisdictions, there have historically been no
7
thin capitalization or similar rules that limit the tax deductibility of interest. By financing the
operating corporation with virtually 100% debt issued to the trust, the interest on such debt acts
as a tax shield sheltering the income generated by the operating corporation from tax.
The tax explanation of income trusts is incomplete (Alarie and Iacobucci, 2007). Any
corporation can adopt high degrees of leverage. The income trust is an attractive form because
the operating corporation can issue very high levels of debt while limiting agency costs of debt.
The fact that the trust owns both the debt and the equity implies that if management were to
increase the risk of the business in order to transfer wealth from debt to equity, there would be no
net gain to equity. And the fact that equity also owns debt limits bankruptcy costs in the event
that the corporation cannot make payments; renegotiation of the debt is close to costless. Put
another way, the non-arm's length debt is debt for tax purposes, but not for corporate finance
purposes. Indeed, Edgar (2004) reports that third-party lenders typically ignore intra-
organizational debt in establishing loan covenants.
It is sometimes suggested that income trusts are valuable from a corporate governance
perspective because of their significant leverage (see, e.g., Hayward, 2002). Press reports
consistently include observations from income trust champions that the organizational form is
valuable because they create an obligation to distribute profits to investors, thus minimizing
agency costs of free cash flow (Jensen 1986). It is not clear that the form itself creates such an
obligation. As Alarie and Iacobucci (2007) point out, there is no reason as a matter of trust,
corporate or contract law why the trust and the operating corporation could not renegotiate debt
to lower levels, thus giving corporate managers greater access to cash. Debt to arm's length
parties provides a commitment to distribute cash because of the threat that creditors will take
over the company in the event of non-payment. No similar commitment exists for the non-arm's-
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length debt owed by the corporation to the trust; from a legal perspective, the commitment is not
significantly stronger than the commitment of a corporation to stick to announced policy of high
dividends.
There is, however, some reason to believe that the income trust form results in a stronger
commitment to pay out cash than a corporation's high dividend policy. There is a circular,
though not necessarily incorrect, argument that the market would punish reductions in debt levels
within trusts because the market expects trusts to pay out their cash. In addition, there is a tax
penalty from reducing an income trust's distributions that does not arise for corporations
reducing dividends. Reducing interest payments from the operating corporation to the trust, all
things equal, reduces the corporation's expenses and increases its income tax. In contrast,
dividends are paid with after-tax dollars. Tax may itself contribute to the governance
motivations for adopting the trust.
As a final point of this review of the tax and finance motivations for adopting the trust, it
is noteworthy that the Conservative federal government recently proposed amending the Income
Tax Act to tax income trusts at the entity level as though they were corporations. The details of
the changes have yet to be offered, but if/when the changes occur, the tax incentives to adopt the
income trust will obviously change, and the tax-driven commitment to pay out cash will also
diminish. Because we focus on governance choices arising in past adoptions of the income trust
form (i.e. between 1996-2005), any changes to the future taxation of income trusts are for the
most part beside the point.3
It is apparent from the income trust structure that corporate law is not significant in
understanding the governance of the trust. While the operating entity is a corporation, its equity,
3 It will be interesting to observe whether the income trust falls out of favour following tax reform. The early signs are that it is. This suggests that adoption of the form is driven in significant part by tax considerations, not governance freedom.
9
and its risky debt, is owned by the trust. Governance of the trust is therefore essential in
appreciating governance of the operating corporation. The rules relating to governance of the
trust are essentially found in its DOT. We can learn a great deal about private preferences for
corporate law from examining the governance choices in the DOT.
Before we set out our methodology and data, a caveat. For a variety of reasons, our
sample of income trusts is not randomly drawn. First, tax minimization is evidently a significant
consideration in adopting the income trust form, but this feature of the trust will have a non-
uniform appeal across businesses. Businesses that do not anticipate earning significant profits
for tax purposes in the near future, for example, would not find the income trust as appealing as a
business earning significant profits now. Second, the tax-driven commitment to distribute cash
is more valuable for businesses with significant cash flow but little in the way of positive net
present value investments. If these first two features are correlated with preferences for certain
governance terms, then our dataset will not be representative. It may be, for example, that firms
that commit to pay out cash to investors have fewer concerns about managerial agency costs, and
therefore lower demand for legal governance, than the average firm.
A third reason why the sample is not random is that it is possible that firms that
particularly chafe under the rules that corporate law imposes are systematically more likely to
adopt alternative forms. Thus, there will be greater deviation from corporate law’s mandatory
terms in the governance choices of firms that have actually adopted the income trust form than
would result for corporations if given the choice. Anecdotally, however, there is reason to doubt
that this bias is particularly important. We have yet to hear of a business adopting the income
trust form because of an intention to take advantage of greater contractual freedom. Moreover,
the recent proposals to change the tax treatment of income trusts is widely predicted to dry up the
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income trust market; several high-profile corporations (e.g., Bell Canada Enterprises Inc., Telus
Inc.) have withdrawn their proposals to adopt the form following the federal government's
announcement. We suspect that contractual freedom is a side effect of the recent adoptions of
the income trust.
III. Dataset and Summary Statistics
Our dataset consists of all 186 trusts listed on the TSX between 1996-2005 whose DOTs
are publicly available on SEDAR, the Canadian equivalent of the US EDGAR database. These
trusts became listed on the TSX by different means, primarily by IPO or by conversion to a trust
under a plan of arrangement.
We isolated 26 provisions contained in the CBCA, focusing on mandatory provisions to
ensure that corporations routinely are bound by such terms and that any differences in the DOTs
represent deviations from corporate law norms. We also attempted to focus on DOT choices that
are not skewed by the presence of other mandatory laws. For example, tax law requires the trust
to have trustees who are Canadian trustees to realize pass-through status; DOTs' even greater
insistence on Canadian residency for trustees than the CBCA s. 105(3) 25% requirement for
directors is thus not reflective of purely free will. Moreover, most DOTs are silent on the
corporation's disclosure obligations when soliciting proxies, unlike corporate statutes, but this
simply reflects the redundancy of corporate law on this dimension for public companies given
requirements under securities law.
We grouped the provisions into four categories: the directors and officers group; the
shareholder rights group; the shareholder remedy group; and, the transactions group. We
reviewed the DOTs of each of the 186 income trusts in our sample to study the extent to which
11
the DOT mirrors the corporate statute with respect to our sample of provisions. We attributed a
specific code to each provision on the basis of the following. If a provision in the DOT was
identical to the corporate provision, functionally equivalent to the corporate provision, or
incorporated the provision by reference, then the DOT provision was coded as similar to the
corporate provision. If the DOT did not contain the CBCA provision, or was different in
substance (that is, not just different in wording) from the CBCA, then the DOT provision was
coded as different from the corporate provision.
Table 1 contains a frequency distribution that shows the prevalence of each particular
code with respect to the DOT provisions examined. We note significant variation among the
provisions. Therefore, it is not possible to conclude that trusts generally adopt the CBCA or
conversely that they generally do not adopt the CBCA; provision-specific analysis is required.
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Table 1: Frequency table for Mandatory Provisions
More Like CBCA (1)
Less Like CBCA (0)
Director/Officer N (%) N (%) 102(2) Indep 31(16.9) 152(83.1) 105(1) Qualifications 69(37.1) 117(62.9) 108(1) Cease to Hold Office 109(58.6) 77(41.4) 108(2) Resignation 55(19.7) 130(70.3) 109(1) Removal 126(67.7) 60(32.3) 119 Liability for Wages - 186(100) 120 Self-dealing 125(67.6) 60(32.4) 122 Duty of Care 154(82.8) 32(17.2) 123(3)(4) Defences 18(9.7) 167(90.3) Shareholder Rights 106(3) Elect Dirs (ord. res) 138(74.6) 47(25.4) 133 Meetings - annual/special 183(98.4) 3(1.6) 135 Notice - 21-60 days 185(99.5) 1(0.5) 137 S/h proposal/exemptions 4(2.2) 181(97.8) 142 Resolution Lieu of Meeting 15(8.1) 170(91.9) 143 Requisition of Meeting 35(18.8) 151(81.2) 148 Proxy Voting - Appoint 185(99.5) 1(0.5) 149 Mand. Solicitation 155(83.3) 31(16.7) 62 Appoint Auditor (ord. res.) 163(87.6) 23(12.4) 165 Removal Auditor (ord res) 163(87.6) 23(12.4) 173 Fund. Changes (spec. res) 186(100) - Shareholder Remedies 190(1) Dissent 12(6.5) 174(93.5) 190(16) Appraisal 17(9.1) 169(90.9) 239 Derivative Action - 186(100) 241 Oppression Remedy - 186(100) Transactions 189(3) sale of assets (spec.) 176(95.1) 9(4.9) 206(2) Compulsory Acq. 186(100) -
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Table 2 shows the total number of provisions in each category and the ratio of provisions
that were more like the CBCA to those that were less like the CBCA.
Table 2: Total Provisions by Category
More Like Less Like Overall
Director/Officer 687 (41.19%)
981 (58.81%) 1668
Shareholder Rights 1377 (68.6%)
631 (31.4%) 2008
Shareholder Remedies
29 (3.9%)
715 (96.1%) 744
Transactions 362 (97.6%)
9 (2.4%) 371
Overall 2455 (51.24%)
2336 (48.76%) 4791
We see that of 4791 provisions examined in the DOTs, the split between those that are
more like and those that are less like the CBCA is fairly even at 51% and 49% respectively.
However, when we look behind this number at the ratios within the individual categories, we see
that in the directors/officers category and the shareholder remedies category, trusts tend to adopt
provisions that differ from the CBCA, and that this difference is stark with regards to shareholder
remedies. In the shareholder rights and transactions categories, on the other hand, the provisions
examined tend to be more like the CBCA.
These summary statistics provide a broad overview of our dataset and the extent of
similarity and difference of DOT provisions to the CBCA. In the next section, we explain these
characteristics in more detail on a provision by provision basis. We then move on to report the
results of Chi Square testing on a set of independent variables that allows us to evaluate
differences among trusts.
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IV. Do Specific DOT Provisions Mimic the CBCA?
As discussed, we divided our analysis of DOTs into four categories: directors and
officers; shareholder rights; shareholder remedies; and transactions. In this section, we focus on
the implications of choices in these categories for theories of corporate law.
For ease of exposition, in what follows we characterize the theory that corporate law
reduces transaction costs as the "transaction cost theory;" the theory that corporate law facilitates
standardization as the "network theory"; and the idea that corporate law is trivial as the "triviality
hypothesis." We leave discussion of the theory that corporate law efficiently restricts midstream
charter amendments (the "commitment theory") and the theory that corporate law facilitates
efficient modifications to the corporate contract (the "modification theory") to the conclusion of
this section.
a) Directors and Officers
There are number of similarities and differences between DOTs and standard corporate
law rules. We begin with discussion of the composition of the board of trustees. Trust rules
deviate from corporate rules in important respects. Most fundamentally, trusts often (117/186)
deviate from the CBCA, s. 105(1)(c) requirement that directors must be natural persons; many
DOTS provide for sole trustees that are business entities like corporations. Income trust choices
suggest that the CBCA requirements are inconsistent with the transaction cost theory and the
triviality hypothesis, since corporate law is evidently neither providing what the parties want nor
giving them the choice to contract around the rules. It also sits uncomfortably with the network
theory, given that a number of trusts have willingly adopted a non-standard governance structure.
Whatever uncertainty this created for investors was apparently overcome by the gains from
delegation to a non-natural trustee.
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Another difference in the nature of trustees from that of directors concerns the CBCA's
mandatory approach to independence. The CBCA s. 102(2) requires a public company to have
at least two directors who are not employees or officers of the company or its affiliates. Some
(31/1834) trusts adopt the same rule. But the majority do not: 130/183 trusts do not establish
any independence requirements in their DOTs, and another 22/183 establish less stringent
requirements relative to those in the CBCA. How important this deviation is from the CBCA,
and thus how much doubt it casts on the transaction cost and triviality theories, would depend on
the composition of the trust boards in practice. Our suspicion is that while the trusts may not
have wanted to enshrine independence in their DOTs, many of them would have at least two
independent trustees, especially given Canada’s comply and explain regime that recommends
independence of board members as a best practice.5
Rules governing the termination of trustees in DOTs are more reflective of corporate
law's approach, though significant deviations exist. Under s. 109(1) of the CBCA, a director is
removable by a majority of votes cast; this rule is mandatory (s. 6(4)). A two-thirds majority
(126/186) of trusts adopt the same approach, while the remaining generally adopt more onerous
standards to remove trustees, such as a 2/3 majority vote to oust trustees in the absence of cause.
A significant minority opt out of the CBCA, suggesting that there is demand for tougher removal
standards than those imposed on a mandatory basis by the CBCA. These data challenge the
transaction costs, network effects (a significant minority are willing to deviate from standard
rules on trustee removal) and triviality theories (though this would depend in part on how often
there is a contested removal vote in practice).
4 The denominator is sometimes less than 186 where we are missing data on particular provisions. 5 NI 58-201 “Corporate Governance Practices” online http://www.osc.gov.on.ca/Regulation/Rulemaking/Current/Part5/rule_20041029_58-201_corp-gov-guidelines.jsp.
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Interestingly, resignation of trustees tends to be more difficult in many DOTs than under
CBCA rules. CBCA s. 108(2) provides that a director's resignation is effective on the date of the
sending of written resignation to the corporation, or on a date specified in the resignation,
whichever is later. A two-thirds majority of income trusts (130/185) specify more onerous
requirements, ranging from a 30 day notice requirement to a provision that no resignation is
effective until a replacement trustee has been appointed. This is one of the few provisions in
DOTs that is more stringent for directors/trustees than corporate rules. It is not easy to explain
this deviation. One possibility is that it is systematically more difficult to appoint trustees than it
is to appoint directors because of Canadian residency requirements. For tax reasons, there are
strict Canadian residency requirements for trustees, while Canadian corporations need only have
25% of directors who are Canadian residents. With a smaller talent pool, it is not unreasonable
to imagine that replacing a trustee is more difficult than replacing a director, all things equal.
Another difference is that 77/186 trusts deviate from the CBCA's provision setting out the
conditions under which a director ceases to hold office: death, removal or resignation. These
non-conforming trusts typically have non-natural trustees, further evidence of the potential
significance of this choice. Their DOT provisions may disqualify an entity from being a trustee
in circumstances other than resignation or removal. For example, insolvency, or even equity
values below a certain threshold, may disqualify the entity from serving as trustee.
The approaches to trustees' duties of care and loyalty are very similar in the CBCA and
DOTs. The duties are found in s. 122(1)(a) (loyalty) and s. 122(1)(b) (care) of the CBCA.
33/186 of DOTs reproduced the exact language of the CBCA on these duties. Even more
tellingly, 121/186 reproduced the language of the CBCA and moreover, for greater certainty,
17
incorporated the duties provided in the CBCA (or cognate statutes, such as the various provincial
corporate statutes) by reference. Thus, 154/186 adopted the duties in the CBCA.
The DOTs that did not incorporate the duties of care and loyalty typically deviated by
requiring trustees to exercise the care, diligence and skill that a reasonably prudent "trustee"
would exercise, rather than a reasonably prudent "person," as is found the statute. This might be
interpreted to be an explicit choice by a minority of trusts to ratchet up the standard of care.
There have been debates in recent decades in Canada about whether the CBCA should adopt a
"reasonably prudent director" standard, and these deviations from the CBCA in DOTs may thus
reflect an attempt to depart from the status quo. Such an interpretation would suggest that for a
significant minority of trusts, the provided mandatory term is inconsistent with their preferences,
suggesting tension with the transaction costs and triviality theories. Such an interpretation,
however, may be overdrawn. It turns out that of the 32 DOTs that include the "reasonably
prudent trustee" standard, 31 also designate a non-natural person as the trustee. The language of
"trustee" may simply reflect the different status of the trustee from a natural person. In any
event, it is clear that the increased standards, if that is what they are, would not increase the risk
of liability for any individual trustee, thus casting some doubt on their significance (even apart
from the relatively small number of DOTs that adopt this approach).
The CBCA creates a safe harbour against claims for breach of the director's duties if the
director relied "in good faith" on a report by a professional person. 167/185 of the DOTs, in
contrast, broaden the safe harbour to provide trustees immunity where trustees have relied on an
expert's advice so long as that advice is reasonable. Such an approach avoids disputes about the
bona fides of a director who has received expert advice. It suggests that the (mandatory) law in
the CBCA is not generally reflective of market preferences, and thus is not consistent with the
18
transaction cost or triviality theories, though the latter may hold if in practice there is little
difference between the CBCA and DOT safe harbours.
In general, the data on the duties of care and loyalty in DOTs offer support for the
network theory. Network effects are likely to be more important for standards than rules, the
latter being susceptible of relatively precise interpretation. The large number of trusts that not
only adopt the exact language of the CBCA but also explicitly incorporate the CBCA by
reference suggests that, at least with respect to these provisions, network effects matter. If the
law were trivial in the sense that it only provides what market actors want in any event, then we
may observe high rates of adoption of similar language in the DOTs as in the CBCA, but not
necessarily the incorporation by reference. Incorporation by reference, often explicitly "for
greater certainty," is suggestive of a desire to benefit from established understandings of the
CBCA, which is consistent with network theory.
While the adoption of the general language of the CBCA duties of loyalty and care is
overwhelmingly common, there is greater departure on one aspect of the duty of loyalty that is
more precisely codified in the CBCA. Section 120 of the CBCA sets out a relatively detailed
regime for regulating material transactions between the corporation and a director. The
interested director must disclose the interest and cannot vote on the transaction. Again, a
significant majority of income trusts opt for the CBCA's approach, with 67/185 adopting
identical language in their DOTs, and another 58/185 adopting functionally similar language.
On the other hand, 14/185 DOTs are simply silent on the matter. In addition, 46/185 explicitly
opt out of the CBCA's approach and tend to take a more permissive approach to self-dealing that
relaxes categorical, procedural restrictions. The reason for this may be less interesting than a
first glance would suggest. It turns out that 43/46 trusts that opt out are trusts that have a single,
19
non-natural person as their trustee: disclosure and disinterested voting regimes do not obviously
function well with a single trustee. The trusts that opt out of the self-dealing regime maintain the
general duty of loyalty. Because circumstances may not allow a vote of informed, disinterested
directors, some trusts with sole trustees fall back to the position that self-dealing is not per se a
breach of the duty of loyalty, and presumably leave enforcement to future interpretation. In this
respect a minority of trusts appear to have chosen to risk losing network benefits by leaving
significant matters open to general interpretation. Consideration of self-dealing reinforces the
conclusion above that opting for a single, non-natural trustee sits uncomfortably with network
theory – not only is the board structure unconventional, it is potentially incompatible with the
self-dealing regime established by the CBCA. Having a single trustee compels reliance on
unconventional standards to address self-dealing.
Finally, s. 119 of the CBCA establishes joint and several personal liability for directors
for the corporation's unpaid wages for up to 6 months wages per employee, assuming that the
employee has exhausted other means of recovery from the corporation. Not a single DOT adopts
a similar provision, suggesting that the CBCA is clearly not mimicking private choices. This
evidence casts significant doubt on any argument that s. 119 efficiently replicates a desirable
contractual term that commits directors to look out for employee's interests.
b) Shareholder Rights
We also examined DOTs for their content on a variety of shareholder rights. Provisions
concerning the timing and content of shareholder meetings were similar in DOTs. 183/186 trusts
adopted identical language to the CBCA s. 133 in requiring directors to call annual meetings
regularly and in authorizing directors to call special meetings from time to time. 138/185 DOTs
require the election of trustees at annual meetings by a majority of votes cast in a manner
20
identical to CBCA s. 106(3); those that do not have such a requirement tended to have non-
natural trustees. 163/186 DOTs require unitholders to vote for auditors at the annual meeting,
and authorize the removal of an auditor by majority vote, in a manner identical to the CBCA ss.
62 and 165 respectively. 185/186 trusts explicitly provide for voting by proxy in a manner
identical to the CBCA, s. 148 (one trust is silent on proxy voting). The strong similarities
between the CBCA and private choices on the form and content of meetings provide support for
both the transaction cost and triviality theories.
The procedures concerning the conduct of a meeting are also similar in the CBCA and
DOTs. 185/186 trusts, for example, adopt notice provisions within the mandatory range
provided by the CBCA. S. 135 (21 days minimum; 60 days maximum), suggesting that the
mandatory constraints in the CBCA are trivial in the sense that they rarely bind.
There are, however, some potentially important differences between DOTs and some
mandatory rules concerning shareholder rights found in the CBCA. Under s. 143 of the CBCA, a
shareholder or shareholders representing 5% of the votes can requisition a special meeting of
shareholders for the purposes set out in the requisition. While 35/186 trusts adopt a similar
approach, 150/186 deviate from the CBCA, with many trusts setting a higher threshold of votes
to be eligible (10-20% being common figures). One trust has no provision for a unitholder to call
a meeting at all.
While this represents a rebuke to the transaction cost hypothesis, since the parties
generally depart from the CBCA's mandatory rule, perhaps a more striking observation concerns
shareholder proposals. Under CBCA s. 137 and related regulations, shareholders who have
owned at least 1% of the outstanding voting shares or such shares worth $2000, whichever is
less, for at least six months may make shareholder proposals that directors must circulate, with
21
only some exceptions. There are also explicit provisions allowing shareholders to propose by-
laws (CBCA, s. 103(5)) and charter amendments (CBCA, s. 175(1)). But 181/185 DOTs
establish no procedure for unitholders to make proposals. This datum is obviously inconsistent
with the transaction cost hypothesis. To the extent that shareholder proposals rarely result in any
changes and that the threat of shareholder proposals does not affect behaviour, the departure in
DOTs may be a trivial difference in practice, but there is overwhelming evidence that unitholder
democracy is not wanted in the income trust realm.
Another departure between DOTs and the CBCA concerns the capacity of shareholders to
pass a resolution in writing in lieu of a meeting. Under the CBCA s. 142, a shareholder
resolution outside a formal meeting requires all of the voting shareholders' signatures to pass,
while only 15/185 DOTs take the same approach. 36/185 take an even more restrictive
approach, making no provision for unitholder resolutions outside formal meetings, though this
difference is more formal than substantive given that gathering all signatures in a public
corporation setting is effectively impossible. In contrast, 134/185 DOTs provide that a
resolution can pass with signatures representing units with voting rights sufficient to pass the
motion. This is a difference with meaning if there is a majority unitholder, which some trusts
have and others could have in the event of a successful takeover bid. Again, this is inconsistent
with the transaction cost theory of corporate law, and does not sit well with triviality: the
existence of a majority unitholder could reduce reliance on meetings (though the outcome of
those meetings would presumably not be in doubt in the presence of such a unitholder).
An important shareholder right is that to vote on amendments to the articles of
incorporation (charter) found in s. 173 of the CBCA. Such amendments require 2/3 of votes cast
in favour. 186/186 DOTs adopt functionally the same rules, though almost all trusts create some
22
exceptions for trustee-made amendments to the DOT on a variety of technical grounds, including
compliance with the law. These provisions provide support for the transaction cost and triviality
hypotheses, as well as the network theory in that the consequences of two-thirds requirement are
familiar to investors.
c) Transactions
Another grouping of provisions concern procedures for approving transactions. Here the
results are more uniform, revealing consistent similarities between private choices in trusts and
the CBCA. The results are generally supportive of the transaction cost hypothesis, network
hypothesis and the triviality hypothesis. To approve the sale of all or substantially all of the
assets under s. 189 of the CBCA, for example, requires a vote with 2/3 of votes cast in favour;
174/185 DOTs have identical language to the CBCA, while 2 are functionally similar. Oddly,
some DOTs do not specify the percentage of votes required to approve such a sale, only that a
vote is necessary.
The CBCA, s. 206(2) provides for compulsory acquisitions in which a takeover bidder
that has acquired in a bid at least 90% of a corporation's shares can compel the sale of the
remaining shares. 98/186 DOTs adopt an identical provision, and 88/186 adopt substantively
similar provisions, varying time requirements for the follow-up bid.6
We note in passing one other observation concerning transactions and DOTs. Consistent
with results in the U.S. on corporate IPOs (Daines and Klausner, Field and Karpoff), a
significant majority of DOTs explicitly confer authority on the board of trustees to adopt poison
pills (129/186). Query whether explicit authority for defences is even required, given the broad
6 The time period in the CBCA is 120 days. The trusts that differ from the CBCA all adopt a shorter time period for compulsory acquisitions.
23
scope for trustee discretion elsewhere in the DOT and a background of Ontario securities law
that takes a permissive approach, within limits, to pills. In contrast, not a single DOT restricted
adoption of poison pills.
d) Shareholder Remedies
Some of the most interesting results are found in the establishment, or non-establishment,
of unitholder remedies in DOTs that are analogous to shareholder remedies found in the CBCA.
There are some striking dissimilarities in DOTs and the CBCA.
First, DOTs contain a much more limited right to dissent than the CBCA. S. 190(1) of
the CBCA permits a shareholder to dissent from a wide variety of fundamental changes, which
requires the corporation to buy the dissenter's shares back at the fair value of the shares that
prevailed before the change was adopted. Only 12/186 trusts adopt an identical approach to
dissenting. A full 44/186 of the DOTs do not even contemplate dissent, while the remaining
130/186 contemplate a more limited scope for a unitholder to dissent, typically restricting
dissenting to changes involving the acquisition of units and excluding changes like DOT
amendments. Significantly, only 17/186 trusts adopt the CBCA's s. 190(16) appraisal remedy
that permits a unitholder to apply to court to fix fair value where the unitholder and the trust
cannot agree on fair value. 169/186 DOTs do not have any appraisal remedy. Given that the
offer by the trust to dissenting unitholders will be undertaken in the shadow of the appraisal
remedy, the absence of the appraisal remedy surely affects the substance of the right to dissent.
A dissenter would be required to bring an action for breach of the DOT rather than apply to the
court for appraisal.
24
Drawing inferences about the implications of the absence of appraisal in private DOTs is
perilous, and the reasons for the peril are suggestive of an often overlooked role of corporate law.
On the one hand, the absence of appraisal in private DOTs suggests that corporate law imposes
unpopular terms on parties, which is inconsistent with the transaction cost theory and, depending
on the importance in practice of appraisal, the triviality hypothesis. But on the other hand, it is
not clear how much freedom of contract exists on such a matter. The appraisal remedy
procedurally involves an application to the court to fix the fair value of the corporation's shares
as of a certain date. It is not clear how a private DOT could replicate this remedial provision,
given that it is not clear how the DOT can establish a procedure that binds the court.7 There is no
reason for the court to decide that it must accept the complaint on the basis of an application as
opposed to an action for breach of the DOT, for example, nor is there reason for the court to
decide that it is restricted to examining fair value. The income trust could argue, for example,
that it complied with the terms of the trust by offering fair value to a dissenter, and thus that a
full-blown appraisal hearing would be inappropriate. Of course, courts may want to conduct
something like an appraisal hearing to determine whether the dissenting rights were upheld, but
the adoption of the appraisal remedy provision itself would not necessarily inform the court's
procedural or substantive approach.
This suggests that corporate law may play a valuable role in ordering affairs that is often
missing from standard understandings. Statutes can establish binding court procedures; private
contracts cannot. Thus, the CBCA can establish appraisal, DOTs cannot (though this did not
stop 17/186 trusts from attempting to do so). The fact that trusts often provide for dissent, and
7 Arbitration is a possibility but this is not the same as an application to a court. For example, if a plaintiff in a given case is motivated by legal fees as much as good corporate governance, there might be concern about implicit or explicit collusion between the plaintiff and the firm in selecting an arbitrator. We never observed a DOT term relying on arbitration.
25
the right to be purchased at fair value, but do not provide appraisal rights may say more about the
shortcomings of private contracting than an intention to avoid establishing appraisal rights.
Put another way, the dissent/appraisal dichotomy in DOTs is inconsistent with the
network, transaction costs and triviality hypotheses, but not for the conventional reason that
parties do not want what corporate law gives them. Rather, the dichotomy points to the obstacles
private parties face in establishing procedural rules, which suggests that corporate law, which
can establish such rules, is doing something more than mimicking private choices.
Two other remedial provisions established by the CBCA are not found in DOTs. S. 239
of the CBCA establishes a derivative action procedure for corporations: a complainant (typically
a shareholder) may apply to the court for leave to bring an action in the name of the corporation
if certain conditions precedent are met. Specifically, the court may grant leave if the
complainant has given notice to the directors, who have not pursued the complaint, the
complainant is acting in good faith and it appears to be in the interests of the corporation to bring
the complaint. Not a single income trust out of our sample of 186 adopts a derivative action
procedure. At least part of the explanation for the stark contrast again depends on the procedural
role of corporate law. For a derivative action under the CBCA to commence, the complainant
must apply to the court for leave. A private party could not obviously create a similar procedure
that would bind the court to exercise its judgment about the merits of a potential derivative
action. Alternatives to leave, such as Delaware's demand procedure, likely also depend on the
court as a potential overseer of the board's decisions. Yet a blanket permission to unitholders to
bring actions in the name of the income trust risk severe overinclusiveness, and intermediate
bright line, non-discretionary rules, like a majority vote to approve the action, have proved their
ineffectiveness under the common law rule in Foss v. Harbottle. Rather than attempting to craft
26
such intermediate rules, trusts implicitly choose to rely on class actions as an enforcement
mechanism. This does not necessarily imply that they prefer class actions to the derivative
action, which conclusion would suggest that corporate law is failing to mimic private choices,
but rather may demonstrate that the derivative action is difficult to recreate by private agreement.
Perhaps the most emphatic departure from the CBCA is found in the approach to the
oppression remedy. S. 241 of the CBCA allows complainants to apply to a court for an order
that would remedy any action of a corporation, its affiliates or its directors that is "oppressive or
unfairly prejudicial to or that unfairly disregards the interests of any security holder, creditor,
director or officer." This provision has a profound influence in Canadian corporate law both
procedurally and substantively. Yet 0/186 of the DOTs in our sample adopt it.
The procedural elements of the oppression remedy may be difficult to replicate privately.
The remedy allows a complainant simply to proceed by way of application to the court, avoiding
a full trial unless the court orders one having read the written materials and concludes that one is
necessary. The procedural impact of the oppression remedy has been significant, particularly
since courts have held that it encompasses remedies for derivative harms to the corporation as a
whole (see, e.g., Iacobucci and Davis). It is the procedural avenue of choice for most corporate
complaints. Given that private parties cannot compel the court to allow proceedings on the basis
of an application, the absence of the procedural aspect of the oppression remedy in DOTs is not
overly significant in drawing inferences about private preferences from DOTs.
On the other hand, the oppression remedy has had an enormous impact substantively as
well. It has been described as the most powerful corporate law remedy in the common law world
(Beck). Courts will order remedies where a shareholder's, or even a creditor's, "reasonable
27
expectations" have been breached (see, e.g., Diligenti v RWMD8), even if the complainant's legal
rights have been upheld. While the majority of these claims arise in closely held corporations,
courts grant remedies in publicly held corporations on the same basis (see, e.g., Westfair Foods
v. Watt9). The absence of the oppression remedy in DOTs represents an important departure
from Canadian corporate law.
The inference to be drawn from the DOTs is that the oppression remedy emphatically
does not, as some scholars have argued, mimic what the parties themselves would have wanted
given the incompleteness of their other contractual rights. Corporate law in this respect is neither
trivial, in that it opens up avenues of complaint that private parties willingly close, nor does it
facilitate network economies or reduce transaction costs. This result is the most important of any
of our observations.
e) Summary and Conclusions
In this Part we have discussed whether private choices in the business trust setting mimic
mandatory corporate law, and what the implications of these data are for various theories of
corporate law. One theory is that corporate law saves transaction costs. This theory finds some
support in the data, though it is far from uniform. There are several provisions in the CBCA that
DOTs adopt explicitly, but there are several others that trusts routinely avoid, adopting instead
alternatives to a mandatory rule. That is, corporate law often imposes a rule that parties do not
want and cannot contract around.
The triviality hypothesis also has mixed success. There are a significant number of
provisions that trusts either mimic exactly the CBCA provision. On the other hand, some
8 Diligenti v. RWMD Operations Kelowna Ltd. (1976), 1 B.C.L.R. 36 (S.C.). 9 1998 ABCA 337.
28
potentially important CBCA provisions are not adopted by trusts, particularly with respect to
remedies, though also on some other matters like non-natural trustees. Most significantly, in our
view, not one trust attempts to recreate the oppression remedy.
The network theory also has some mixed support in the data. On a subset of matters,
small in numbers but on matters that suggest gains from greater certainty (i.e., where there are
standards and not rules), the trusts explicitly incorporate the CBCA by reference, suggesting the
desire of the parties to realize the benefits of standardization. This is most significant in the case
of trustees' duties of care and loyalty. But on some other matters, the parties demonstrate
significant willingness to depart from the conventional. For example, DOTs contemplate non-
natural trustees, something forbidden under corporate law, and a profoundly different remedial
regime.
We have not discussed the applicability of the commitment and modification theories to
this point. Both these theories are more amenable to an overview than to specific discussion of
provisions. In our view, neither theory finds much support in the data. With respect to the role
of corporate law in providing greater commitment against opportunistic, managerial-favouring
changes to the corporate charter, the DOTs clearly do not share similar benefits. The rules
binding trusts are private and thus susceptible of private changes. (Indeed, the risk of
opportunistic changes to the DOT may be more profound than that with respect to the articles of
incorporation given that under the CBCA shareholders, not just managers, can propose
amendments to the articles; in the trust context, however, almost no DOT provides for unitholder
proposals.) The prediction would be that if opportunistic amendment were a significant risk,
certain trust provisions would be more difficult to amend than others. Take the obvious matter
of trustee duties. In theory, a trust, unlike a corporation, could abolish the duties of care and
29
loyalty under the DOT. If opportunistic amendment were a significant concern, it would be
natural to expect higher thresholds for amending such a provision, yet there are none.
Alternatively, one might expect an enhanced duty of fairness in the DOT to invite closer scrutiny
of proposed DOT amendments; complainants under the oppression remedy, for example, have
successfully prevented charter amendments on the basis of their unfairness (see, e.g., Ferguson v.
Imax10). Yet trusts have weaker fairness duties than corporate law establishes. If opportunistic
amendment is a concern in trusts, it is difficult to isolate the supporting evidence.
Similarly, the modification thesis does not find significant support. If parties wished to
defer to the state to modify their private contracts, the prediction in the trust context would be
that the DOTs would frequently adopt the CBCA rules by reference. This would result in
effective amendments to DOTs when the CBCA is amended. While on some matters there is
incorporation by reference, there is only one provision in which a majority of trusts adopt a
CBCA rule by reference: trustees' duties. This is much more likely to be explained by network
effects than future modifications.
The sharp deviation between corporate shareholder and trust unitholder remedies reveals
a possibly underappreciated role of corporate law. Corporate law may not minimize transaction
costs, facilitate network economies, provide commitment, provide an efficient modification
device or be trivial, rather it may provide something the parties cannot adopt on their own:
procedures that bind the court. This is perhaps most strongly illustrated by the observation that a
majority of trusts adopt a dissent procedure, at least for a subset of questions, but do not offer an
appraisal remedy. To the extent that appraisal proceedings are more focused and hence less
costly than class actions for breach of contract, corporate law provides something that private
contract cannot. 10 [1985] O.J. No. 190 (C.A.), application for leave to appeal dismissed [1986] S.C.C.A. No. 27.
30
V. Explaining the Differences between Trusts
In this section we leave the general question of whether income trusts imitate the CBCA
and focus on the question of whether the choice to mimic the CBCA relates to various
characteristics of the trusts in our sample. It is apparent that there are statistically significant
associations between certain characteristics and governance choices. We describe these
relationships in this section. First, we ask the question of whether the trust's characteristics are
correlated with a trust's overall governance choices. Second, [to be written] we ask whether
characteristics are correlated with a trust's adoption of a particular CBCA term in its DOT.
(a) The Trust's Character and Overall Governance Choices
There are two important classes of variables relevant to this section's analysis. We
initially establish whether a particular trust is more or less like the CBCA in its overall
governance choices. This determination is made first by asking how many CBCA provisions out
of the 26 that we examine are exactly or effectively adopted by a particular trust in its DOT. The
median number of adopted CBCA provisions is 14. Any trust with 14 or more CBCA provisions
in its DOT is characterized as more like the CBCA, while those with 13 or fewer are
characterized as less like the CBCA. This results in 86 trusts as being less like the CBCA, and
100 being more like the CBCA.
We then ask whether this "more/less like CBCA" variable is related to a variety of trust
characteristics, including: jurisdiction, law firm size, transaction by which the income trust was
formed (conversion or IPO), presence of controlling shareholder, type of trust and quoted market
value. Information relating to these characteristics is not typically found in the DOT but in
disclosure documents such as the prospectus in the case of an IPO or the management
31
information circular (or proxy circular) in the case of a conversion.11 We report the results of Chi
Square testing.
To begin, we examine the firm's jurisdiction, and in particular, the domicile of the
operating corporation. We have data on this question for 148 out of 186 trusts at this point. The
majority of trusts are located in Alberta (49), likely because of the prevalence of energy trusts,
which have been around longer than business income trusts, and Ontario (76), which may drive
the selection of jurisdiction given that it is the home of Canada’s largest capital markets and the
TSX. The remaining are in British Columbia (13), Quebec (9) and Manitoba (1).
There is a statistically significant association between jurisdiction and governance
choices.
Total Less Like
CBCA More Like
CBCA
Jurisdiction ON 17 59 76 AB 30 19 49 BC 3 10 13 QC 9 0 9 MB 1 0 1
Total 60 88 148
Pearson Chi-Square Value = 35.42(P-value=<0.001)
Ontario and B.C. tend to be in the "more like CBCA" group, while Alberta and Quebec trusts
tend to depart from the CBCA. These differences could reflect different business settings in each
province that lead to different governance concerns. This would support theories of
jurisdictional competition in corporate law that describe the merits of matching jurisdictions to
particular businesses. It may also be significant that Quebec's corporations statute departs more
11 As these documents are required disclosures under securities regulation, they are generally available on SEDAR as is the DOT.
32
significantly from the CBCA than any other province's (including Alberta's); most strikingly, it
does not include an oppression remedy. Quebec lawyers and businesspeople may therefore be
more willing than others to depart from the CBCA norm. Of course, these trusts are by
definition listed on the TSX and thus attempt to appeal to out-of-province investors. (It may be
simply a coincidence, but it is also perhaps notable that on a rough political analysis, Alberta and
Quebec are much less federally inclined as a general political matter than Ontario and to a lesser
extent B.C.)
Another characteristic that we examine is whether the trust, which by design of the
sample was first listed on the TSX between 1996 and 2005, arose as the result of a conversion of
an existing corporation or by an initial public offering (IPO).
Total
Less Like CBCA
More Like CBCA
IPO/Conversion? Conversion 35 22 57IPO 46 77 123
Total 81 99 180
Pearson Chi-Square Value = 9.06 (P-value=0.003) We observe a statistically significant association between governance choices and whether the
trust came into being as an IPO or a conversion. Conversions require a super-majority (2/3) vote
in favour under corporate law. Despite this required approval, there is room for existing
management to externalize the costs of sub-optimal governance choices in the DOT. Suppose,
for example, that the conversion is valuable to shareholders because of tax reasons. They may
vote in favour of a conversion that fails to maximize value by adopting sub-optimal governance
rules, yet is value-enhancing because of tax considerations. Management would present the
conversion and terms of the DOT as a take-it-or-leave-it offer to existing shareholders, who may
33
well vote in favour even if the change benefits management at shareholders' expense from a
governance perspective. On an IPO, in contrast, it is more reasonable to assume that the
principals behind the offering will internalize the value of their governance choices; there are no
existing shareholders to take advantage of (Jensen and Meckling, 1976). IPO choices are more
likely to be efficient than conversion choices.
It is interesting to note, then, that IPO trusts are more likely to have DOTs that resemble
the CBCA than conversion trusts. If it is correct that IPOs are more likely to adopt efficient
terms, then efficiency theories about the content of corporate law terms have some support in our
data. It could also be that conversions are less sensitive to network effects given that they are not
immediately selling securities to third parties (although we note that some conversions also on
occasion involve new issues of securities). Conversions that occur in the absence of a new issue
allow for more efficient choices in governance matters without concern for discounts from
asymmetric information between insiders and outside investors.
Another variable we consider is the nature of the law firm advising on the adoption of the
trust form. We have insufficient data to draw inferences about individual law firms' influence,
and instead ask whether DOT choices are related to the size of the law firm. In particular, we
investigate whether trusts formed on the basis of advice from one of the largest 30 law firms in
Canada differ from other trusts.
Total
Less Like CBCA
More Like CBCA
Large Law Firm? No 7 8 15Yes 76 90 166
Total 83 98 181
Pearson Chi-Square Value = 0.004 (P-value=0.948)
34
If businesspeople simply rely on their law firms to draft DOTs, and if law firms vary in their
understanding of business needs or in their willingness to adopt unconventional terms on the
basis of size, then we might have expected an association between resemblance to the CBCA and
law firm. Yet we do not observe such a correlation, which tends to undermine theories of
governance choice that assume that lawyers drive the process. However, our sample of small
law firms is small given our top 30 cut-off. We intend to investigate this relationship further
using different variables (e.g., using a top 15 cut-off).
We also investigate the relationship between the existence of a controlling unitholder and
governance choices. We present the results for two alternative definitions of control, the
existence of a 10% unitholder and the existence of a 20% unitholder.12
Total
Less Like CBCA
More Like CBCA
Controller at 10 percent? No 64 61 125Yes 22 39 61
Total 86 100 186
Pearson Chi-Square Value = 3.78 (P-value=0.052)
Total
Less Like CBCA
More Like CBCA
Controller at 20 percent? No 65 66 131 Yes 21 34 55
Total 86 100 186
Pearson Chi-Square Value =2.04 (P-value=0.153)
12 We do not investigate the ownership structure of the controlling unitholder.
35
There is a statistically significant association (at (almost) a 95% confidence level) between the
existence of a controlling unitholder and resemblance to the CBCA when control is defined at
10%, though statistical significance disappears when the 20% cut-off is used.
Controlling unitholders have significant cash flow rights in the organization, which
enhance incentives to manage or monitor management optimally. On the other hand, control can
lead to diversion of value from minority investors. Trusts with controllers tend to have DOTs
that resemble the CBCA. This may suggest that the CBCA has a comparative advantage in
constraining self-interested behaviour by controllers when compared to contract. Or put
conversely, private choices are better at disciplining widely-held managers than the CBCA. Of
course, both conclusions are doubtful if the governance choices themselves reflect agency
problems because the choosers do not internalize the consequences of their choices. Given that
IPOs and controlling shareholders are both associated with the CBCA, and given that efficient
choices are more likely in IPOs, the efficiency-based inference has some support.
Another characteristic that we investigate is the relationship between the trust's industry
and governance choices. The TSX provided us with a characterization of each trust's business
into four categories: energy trusts; real estate investment trusts; power and pipeline trusts; and
business trusts. In our sample there were 30 energy trusts, 20 REITs, 9 power and pipeline
trusts, and 120 business trusts (we are presently missing data on 7).
Total Less Like
CBCA More Like CBCA
Type of Trust Energy Trust 29 1 30 Business Trust 39 81 120 REIT 9 11 20 Power & Pipelines 6 3 9
Total 83 96 179
Pearson Chi-Square Value = 41.31 (P-value=<0.001)
36
Business trusts (81/120) and REITs (11/20) fall into the more like CBCA category, power and
pipelines trusts (6/9) are less like CBCA, and energy trusts are overwhelmingly less like the
CBCA category (1/30 more like CBCA). As these numbers suggest, the type of trust is
statistically significantly associated with resemblance to the CBCA.
The explanation of the relationship between trust type and governance choices could arise
because of idiosyncratic governance needs in the energy sectors that the CBCA does not provide.
This is plausible. Agency problems resulting from the efficient exploitation of a given energy
resource may vary considerably from those in an industry in which managers are responsible for
longer-term growth strategies. For example, an income trust whose asset is a given stock of
natural gas can focus exclusively on cost minimization and exert little effort in encouraging
demand for its commodity; a yellow pages business, on the other hand, may need to focus much
more on encouraging demand. As a consequence, energy trusts may be more transparent in their
performance than other kinds of businesses. It is conceivable that energy trusts rely on market
discipline rather than legal discipline to a greater extent than other businesses. Moreover, any
network penalties from not adopting conventional terms may be mitigated by the fact that other
firms in the industry also avoid conventional terms; that is, there may be a network effect and
consequent path-dependence among energy firms and investors.
The final variable we examine is size. We divided the total quoted market value of each
trust into quartiles and gauged this variable's relationship to overall governance choices.
37
Total Less Like
CBCA More Like
CBCA
QMV < 110M 12 31 43 QMV 110-
280M 17 30 47
QMV 280-840M
22 20 42
Quoted Market Value Quartiles
QMV > 840M 32 13 45 Total 83 94 177
Pearson Chi-Square Value = 19.5 (P-value=<0.001)
Generally, we find that smaller firms are more likely to adopt the CBCA than larger firms. This
could reflect standard governance problems at smaller firms that the CBCA is equipped to
address. Such a conclusion resonates with the claim in the corporate jurisdictional competition
literature that certain states (Delaware) are more suitable for certain sized companies (large
companies). Another possibility is network effects and conformity are more important for
smaller firms who would not expect similar investment by prospective investors in understanding
unconventional terms as a large firm might.
(b) Relationship between Trust Characteristics and Governance Provisions
[We have some important work left to do. First, we intend to conduct a multivariate
analysis of the relationship between these characteristics and overall governance choices.
Second, we intend examine the relationship between each of the individual provisions we
examine with these characteristics. E.g., what factors are associated with the adoption of a non-
natural trustee?]
VI. Conclusion
[to follow]
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References:
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