Corporate cash – a public affair?

A growing debate has sprung in Canada relating to the growing pile of cash held by Canadian corporations. Investing that cash into employment or productive capital would, says one school, stimulate the economy and aggregate demand, leading to a virtuous cycle of growth. The list of commentators on the issue has grown to include Bank of Canada Governor Mark Carney and Finance Minister Jim Flaherty and has created a stark divide between those whose who see corporations as independent entities acting in their best interests versus those who see those very corporations as failing to properly compensate the societies they are embedded in.

Fundamentally it’s hard to disagree with those, like Carney, who have pointed out that large cash balances are a potentially massive stimulus to the economy. And he’s far from the first. Two years ago I attended a speech by FT columnist Martin Wolf at the International Economic Forum for the America’s where he stated that the solution to the US demand crisis was either increased corporate spending or the repatriation of corporate cash through increased taxation.  He too viewed them as a potential means of unlocking demand.  As he walked back to the head table someone (I think a Minister from a Caribbean country) called him irresponsible!

Yet regardless of one’s ideological position on the issue, there’s no easy fix to intervening in the bank accounts of corporations. The reason corporations hold cash is to prepare for unforeseen events, potential acquisitions, and future investments. They don’t (from my knowledge) do it to screw over the unemployed or the societies they’re located in.

Nonetheless, out of curiosity I decided to take a look at the case of one of Canada’s biggest cash hoarders : Power Financial Corporation which holds over $3 billion in cash (and little debt).

For the year ended Dec 31, 2011, Power Corporation made a profit (before taxes) of $3.61 billion. On that profit, they paid $706 million in corporate income taxes. This translates to an effective taxation rate of 19.5%. Let’s say that, as some such as Jim Stanford of the CAW have proposed, we were to claw back corporate income tax cuts on the basis of some definition of “holding too much cash.” If this clawback were based on the most recent tax cut, which is done (in theory) to incent investment, Power would return the 2011 tax cut (1.5% at the Federal Level) to the CRA. For 2011, the return of the 1.5% tax cut would equate to $52 million.

Now $52 million would certainly pave a lot of roads or perhaps purchase the left wing of an F35 jet. Looking more broadly than just Power Corp, Canadian corporations on a whole took home a profit (before taxes) of $207 billion in 2011. Applying the same marginal tax rate that Power Corp pays to this bigger grouping shows a tax bill of approximately $40.6 billion. Revising/clawing back the most recent corporate tax cut of 1.5% would raise an aggregate $3 billion. This represents a significant stimulus cheque.

Yet what are the drawbacks of threatening to re-tax corporations if tax cuts aren’t spent (as Stanford proposes)? Might such a threat simply incent inefficient spending, rash investment decisions, and possibly catalyze the leakage of dollars beyond our borders. For what if Power Corp decided that rather than lose $52 million off the balance sheet they’d rather invest in real estate in the United States or Mexico? Do Canadian tax payers win? Possibly thanks to profits from those investments but certainly not in the immediate employment and investment gains that those on the Left envision.  And what if instead of that acquisition they would have rather to amass a war chest for a large domestic investment in three years hence that led to increased productivity or employment?

Corporate investment decisions don’t get made along the calendar year that our taxes get paid to the CRA and by treating them as such we risk creating long-term net negatives for the Canadian economy.

That said, the fact that rising corporate profits have not coincided with increased employment or investment (though this is debatable) should give us pause as to the merits of continued tax cuts. As I wrote back in early 2011, while there is evidence (substantial) that moving from a high tax regime to a globally competitive one yields significant employment and investment benefits, we have no proof that continued cuts will yield the same benefit.

Rather if we’re going to provide tax credits and incentives to corporations, a near-necessity in a global economy where municipalities through to Federal governments are falling over themselves to provide incentives for job creation and retention, than we need to find a way to incent growth and employment rather than allowing simply for growing profits. However in so doing we need to acknowledge that investment decisions don’t get made on a clock, and that clawing them back when not spent is not an effective solution. Rather, if we’re confident that our tax regime is already competitive (as it is) than additional incentives should come after the fact rather than before (as many our boutique tax credits for new industry are already structured). Doing so would ensure that government intervention in the affairs of corporate balance sheets don’t distort the decision-making of private actors, but rather support the strategic investment decisions by private actors that lead to job creation that everyone, left or right, desperately wants.


Defining a strategic asset – maybe.

Over the past three years foreigners seeking to invest in Canada can be excused for being confused as to what constitutes a “strategic national asset”. The phrase has been used to block the takeover of Potash by BHP Billiton, is being bandied about by the Quebec government regarding the proposed takeover of Rona by Lowes, and was a popular term used by Ontario Finance Minister Dwight Duncan related to the potential takeover of the Toronto Stock Exchange by the London Stock Exchange.  Apparently anything that’s Canadian is a priori a strategic asset –kind of maybe.[1]

So as CNOOC, China’s state-owned oil producer, came to an agreement in July 2012 to purchase Calgary-based Nexen Inc. in a friendly $15 billion takeover bid, the Canadian government was once again tasked with determining whether the deal should proceed. Doing so relies on an utterly ambiguous and ill-defined piece of policy called the Investment Canada Act.

In theory the Act facilitates a means of determining whether such transactions would constitute a “net benefit to Canada”.  In practice, however, that determination is about as clear as mud. Determining the degree of “net benefit” is based on an assessment of the following factors:

  • the effect on the level of economic activity in Canada, on employment; on resource processing; on the utilization of parts and services produced in Canada and on exports from Canada;
  • the degree and significance of participation by Canadians in the Canadian business or new Canadian business and in any industry or industries in Canada;
  • the effect of the investment on productivity, industrial efficiency, technological development, product innovation and product variety in Canada;
  • the effect of the investment on competition within any industry in Canada;
  • the compatibility of the investment with national industrial, economic and cultural policies; and
  • the contribution of the investment to Canada’s ability to compete in world markets.

The first three can be analyzed as quantitative measures, relatively easily arrived upon, albeit with some assumptions. It’s the latter three that create a great deal of ambiguity.

For example, in November 2010 Industry Minister Tony Clement announced that the $38 billion takeover of Potash Corporation of Saskatchewan by BHP Billiton Limited (of Australia) wouldn’t go ahead as it didn’t constitute a net benefit. No official line of reasoning was ever released by the Government for this decision, however it is speculated that the Federal Government simply fell in line with the wishes of Saskatchewan Premier Brad Wall who led vociferous opposition to the deal on the basis of a projected decline in tax revenues and the loss of a strategic asset.

In response to the Government’s decision, BHP stated “The company has offered to commit to legally binding undertakings that would have, among other things, increased employment, guaranteed investment and established the company’s global potash headquarters in Saskatoon.” All of which sound rather beneficial. Amongst the moves BHP was willing to tie itself to in ordre to convince both Provincial and Federal officials of the merits of its offer was a willingness to forego tax benefits of upwards of $2billion (meant to allay Provincial fears of decreased tax revenue) and the creation of a US$250 million performance bond that would be refundable only if BHP kept to its employment and investment promises.

So why weren’t such commitments enough? The commitments made by BHP would seem to adequately address factors 1-3 while the impact of the proposed acquisition on domestic competition would seem neutral given only ownership was changing hands – though one might argue that the arrival of a larger multinational would place undo pressure on other smaller players in the industry. What remains is the question of “compatibility” as it relates to national industrial, economic and cultural policies. In short, in the absence of any rational quantitative reason to object to the deal, do you want to let it go forward? Potash was subsequently defined as strategic for, one would imagine, its role in global agriculture (as a fertilizer) and the belief that markets will increasingly reward such inputs as demand for food increases. And, as it relates to culture, the desire to maintain a Canadian brand.

That deal was just the second that the Government has opposed since the legislation was introduced in 1985. The other was the proposed acquisition of MacDonald, Dettwiler and Associates Ltd. (MDA) in early 2008 by US-based Alliant Techsystems. On this occasion the deal, which would have placed intellectual property related to satellite navigation in foreign-hands and was thus nixed due to national security concerns (most countries have provisions on foreign takeovers related to national security).

Coming full circle to Nexen’s proposed takeout by CNOOC, assuming, as others have, that the company has made commitments related to employment, investment and technology, is the purchase a net benefit to Canadians? Evidently determining this is complicated by the fact that CNOOC is controlled by the Chinese Government. However while the proposed deal would be the largest Chinese entry into Canada’s resource industry, literally bigger than all others combined, it’s not China’s first step. In fact, as the following list highlights, China’s state-owned-enterprises have been busy buying Canadian assets for several years. Nexen just happens to be the biggest it has aimed for.

Between 2005 and 2012, Chinese investment in Canada through mergers and acquisitions amounted to $19 billion with an additional $22 billion spent on 21 acquisitions of Canadian assets held abroad. Not surprisingly, the oil and gas sector has attracted the most Chinese investment, totaling $14 billion between 2005 and 2012. The mining sector has more actual transactions, 29 in total, but with a total transaction value of only $4.5 billion.

The list of big acquisitions is as follows:

  • OPTI Canada Inc by CNOOC $2.1 billion July 2011
  • Daylight Energy Ltd by Sinopec $2.2 billion October 10, 2011
  • Athabasca Oil Sands Corp by Cretaceiosu Oilsands Holdings Ltd (a wholly-owned subsidiary of PetroChina International Investmented Ltd) – $1.94 billion August 2009; $680 million for remainder of project in January 2012.
  • Teck Resources by China Investment Corporation – $1.74 billion in July 2009
  • ConocoPhillips (which owned 9% of Syncrude) by Sinopec – $4.67 billion April 2010
  • PennWest Energy Co by China Investment Corp $1.25 billion May 2010
  • Royal Dutch Shell Groundbirch BC assets by PetroChina $1 billion February 2012

Based on these precedents, the fact that the Chinese government is behind CNOOC is not enough of a reason to say no. Or is it? Does a state-owned enterprise bring political and strategic implications into play that we shouldn’t overlook? Those certainly shouldn’t be underestimated however we said no to Australia which is like saying no to your better looking twin brother. What matters more in this case is size. And thus, like with Potash, this becomes a question of strategy – are the oil sands, and this significant piece of it, part of Canada’s energy and thus economic security that can’t be handed over to foreigners? That’s ultimately how we decide what is or is not a strategic asset. It means there’s no clear definition, no clear rules. Just opinions and enough ambiguity to play hardball with whoever wants to buy something in our backyard.  Roger Martin’s piece (linked below) on negotiating for reciprocity is a good start. Thus the ambiguity of the ICA is perhaps its finest feature given the bargaining power it gives us to leverage external demand for commitments related to employment and investment. What we should do is add environmental and access requirements to the Act as well.

Some will balk at the degree of intervention the Act permits the Government to take on a private sale. And while I can understand the desire to let markets work, if you believe that the space occupied within a border means something, than it does indeed fall to those who govern to possess some element of foresight as to how to influence such private deals for public good. And thus for Nexen and CNOOC what remains to be seen is whether we’ll take advantage of their demand and try to make a deal with China on investment reciprocity that leaves both parties happy. And given our need to keep the door open to 1.4 billion potential consumers, chances are good that we’ll find a way to make it work.

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[1] Too bad we didn’t think that way when Gretzky played for the Oilers or before the Expos left…