Corporate Tax Inversions:  The Beautiful and the Ugly

From the CFO Journal's Morning Ledger on August 27, 2015

More corporate finance divisions are looking into the details of what an inversion would actually do for their tax bill, even if their companies ultimately aren’t willing to take the plunge and decamp for a foreign country, CFOJ’s Emily Chasan reports. A foreign domicile often will mean a lower overall tax rate, but a thorough analysis must also factor the cost of moving some management overseas, reorganizing the company, the sustainability of a move and its political consequences.

And the political consequences, though at this point mostly limited to accusations of unpatriotic behavior, could become more serious if legislators make good on their threats. The Treasury Department is currently reviewing its options for limiting the tax benefits of an inversion. And since Burger King Worldwide Inc. announced its intention to relocate to Canada through a merger with Tim Hortons Inc., the iconic burger chain has come under direct criticism from lawmakers. Sen. Dick Durbin (D., Ill.) said, “I’m disappointed in Burger King’s decision to renounce their American citizenship” and added that “with every new corporate inversion, the tax burden increases on the rest of us to pay what these corporations won’t.” The companies say the deal is not about taxes, but about growth (more on that below).

But the Burger King deal highlights what chief financial officers are learning in their investigations of inversion deals: that the tax benefits are not so straightforward, and often lurk in the details. Writing for Heard on the Street, John Carney notes that Canada offers a generous tax break for profits from countries with which it has a tax treaty. These get counted as “exempt surplus,” which isn’t taxed at all by Canada. And in some of Burger King’s fastest-growing markets, a Canadian domicile would also give it the benefit of “tax sparing”—a system that credits companies even for taxes that aren’t actually paid as part of a complex incentive to invest in developing countries.

 

"Microsoft Has Nearly $93 Billion In Overseas Cash, And It's Reduced Its Tax Bill By Almost $30 Billion," by Julie Bort, Business Insider, August 23, 2014 ---
http://www.businessinsider.com/microsofts-offshore-cash-2014-8

Whopper Deal --- Burger King Headquarters May Move to Canada:  There are tax savings in addition to a purchase of Canada's Tim Horton's Inc.
From the CFO Journal's Morning Ledger on August 25, 2015

The inversion wave that overtook the pharmaceutical and drug retail industries continues to spread, and now one of America’s most storied hamburger chains is looking to decamp for a lower-tax domicile to the north.

Burger King Worldwide Inc. is in talks to buy Canadian coffee-and-doughnut chain Tim Hortons Inc. in a tax inversion that would shift the hamburger seller’s base to Canada. Canada’s federal corporate tax rate was lowered to 15% in 2012.

And despite the saber-rattling from American lawmakers who fear that such moves will drain U.S. tax coffers, Burger King is planning to make the move without the protection of a provision that would let it walk away from the deal even if the tax benefits are taken away through new legislation. That may suggest that American big business perceives the U.S. government as unwilling, or incapable, of making any serious moves to restrain inversions.

Shareholder Value --- http://en.wikipedia.org/wiki/Shareholder_value

From the CFO Journal's Morning Ledger on August 8, 2014

Boston Globe: Is Shareholder Value Bad For Business?
The decision this week by drugstore chain Walgreens to go against the will of shareholders and remain domiciled in the U.S. following its merger with a European outfit, is just one of many acts in the ongoing morality tale about what it means to run a corporation in latter-day America. Does one do ‘the right thing’ by opting for what’s best for ‘shareholder value’ or for wider ‘society’? That question is threatening to rip apart Massachusetts-based, family-owned grocery store chain Market Basket, whose unfolding story is being told in the Boston Globe.  Operating across three New England states, Market Basket board members dismissed the popular company CEO Arthur T. Demoulas and two executives on June 23. Loyal staff and sympathetic customers didn’t like that: so now the staff are on strike and customers have boycotted the stores, threatening the business’ very existence. “This controversy is the tip of an iceberg,” said James Post, coauthor of the 2002 book “Redefining the Corporation” and a professor emeritus at Boston University School of Management. “And what’s below the iceberg is a much larger debate about the relationship between shareholders and all of the other parties that help account for the success of a company.”

"Is ‘shareholder value’ bad for business?" by Leon Neyfaldi, Boston Globe, August 3, 2014 ---
http://www.bostonglobe.com/ideas/2014/08/02/shareholder-value-bad-for-business/3O4MYxjWgmJ2DOPwkeYxyN/story.html

It sounds like great management philosophy—but critics say we need to get back to a broader vision of the purpose of corporations

The uprising against the owners of Market Basket that’s been unfolding over the past several weeks looks at first like a classic showdown between the powers that be and the little guys who would. In one corner stands a coalition of board members and major shareholders who think it should be returning higher profits; in the other, a crowd of employees fiercely devoted to the recently fired CEO, who won their loyalty by paying high wages, providing generous benefits, and handing out regular bonuses. Amazingly, even customers have joined the revolt, turning Market Basket stores into ghost towns and costing the company millions of dollars in losses.

There’s something heartwarming about workers risking their necks in the name of a beloved former boss. But to observers who know how modern corporations work, the protests can seem a little naive: After all, everybody knows that a corporation is an entity whose first job is to maximize profits and deliver the highest return possible to its owners. As some commentators have noted, Market Basket is a business, and demanding that its investors forgo profits in service of some greater good goes against everything we know about the natural laws of capitalism.

Unless, of course, it doesn’t. Related

Timeline of Market Basket events

Experts on the history of business say the Market Basket saga is a window onto something deeper than a power struggle among the Demoulas clan that owns it. They see it as emblematic of a war over the future of the American corporation—what its purpose is, how it should be run, and whom it should be engineered to benefit. They argue that maximizing profit and shareholder value—an approach to running companies that drives investment on Wall Street and serves as the closest thing to modern management gospel—is only one way of defining corporate success, and a fairly new one at that.

“This controversy is the tip of an iceberg,” said James Post, coauthor of the 2002 book “Redefining the Corporation” and a professor emeritus at Boston University School of Management. “And what’s below the iceberg is a much larger debate about the relationship between shareholders and all of the other parties that help account for the success of a company.”

A company like IBM or General Motors could be the heart of an entire ecosystem of suppliers, investors, and even civic institutions.

Quote Icon

Post and others argue that a well-run company can—and should—be managed in a way that benefits not just the investors who own its stock, but a wide range of constituents. As opposed to “shareholders,” they call these people “stakeholders”: a group that includes employees, customers, suppliers, and creditors, as well as the broader community in which the company operates, and even the country that it calls home. According to that view, Market Basket’s employees and customers are essential to the firm’s success and, thus, rightful beneficiaries of its prosperity.

Importantly, it’s not just antimarket leftists who are making this point: It’s pro-business thinkers who want to see a more competitive future for American corporations. Critics like Post argue that the singleminded emphasis on profits and shareholder value—which took hold in the corporate world during the 1980s—has actually hurt corporations in a number of ways, giving their leaders the wrong kinds of incentives, gutting their future in pursuit of short-term profits, and often draining them of their real value and putting them at odds with their communities.

To take seriously the idea of a “stakeholder”-oriented corporation is to realize that firms like Market Basket, which we rely on in our daily lives and which rely on us in return, don’t have a fixed role in a capitalist society, but rather exist as tools that can serve a variety of functions. While “shareholder value” is attractive in its simplicity, a look at its track record suggests it might be an idea that has reached its sell-by date.

***

Today, it’s widely taken for granted that the American corporation functions as a standalone, self-interested entity responsible exclusively to its investors. But it wasn’t always this way. “The early corporations were chartered by the state to meet a social purpose,” Post said. “Sometimes it was to build highways, sometimes it was to run banks, but there was always public purpose that went with the grant of a charter.” The message was straightforward: People who owned incorporated companies ran them at the pleasure of the state, and, in exchange for various legal protections, had a responsibility to do more than enrich themselves.

Though such demanding legislative charters had long fallen out of use by the mid-20th century, when American corporations entered what is widely considered their golden age, historians say that many executives nevertheless held onto the notion that they were overseeing entities with a role in society, and were responsible for creating more than the value that existed on paper. “They viewed their job as a sort of stewardship of an economic and social institution,” said Lynn Stout, a professor at Cornell University Law School and the author of “The Myth of Shareholder Value.”

During this era of so-called managerial capitalism, which began roughly in the 1920s, corporations were seen by both their managers and much of the American public as institutions that mattered in themselves: They produced useful products, gave workers and their families a stable and often long-term source of income, and played a role in the cities and towns where they did business. A company like IBM or General Motors could be the heart of an entire ecosystem of suppliers, investors, and even civic institutions.

But a change was coming to American capitalism. Facing unprecedented competition from Europe and Asia, these long-stable firms began to look like sleepy behemoths. And economists had begun to worry that top executives had become so powerful they were running companies with their own personal interests at heart, lining their pockets at the expense of the stockholders who, in theory, should have been benefiting in proportion to the company’s success.

The solution to all these problems, famously articulated by the University of Chicago free market economist Milton Friedman in a 1970 New York Times article, was an elegant one: By framing the corporation purely in terms of its monetary value to shareholders, and setting aside the notion that it might be a valuable entity in and of itself by virtue of what it did, corporate America suddenly had an easy way to measure performance. The scheme had a kind of moral clarity: The risk of operating a company is borne by stockholders, so they’re the ones who deserve to reap the rewards.

A well-managed company, then, would have a high stock price that reflected the best possible use of its assets. A poorly managed one was a target for a new class of investor—the corporate raider—who saw big companies as collections of assets that could be bought, broken up, and sold at a profit.

CEOs got the message: The point of running a company was to keep the share price high. And to keep their eyes on the target, boards started tying executive pay to the share price, by paying CEOs with stock options that were much more valuable than their paper salary. In the wake of the “shareholder value” revolution, everything except the value of a company’s stock—including its impact on the lives of its employees, its contracts with suppliers and retailers, whether it was liked or hated by its customers—came to be seen as almost irrelevant. Everything you needed to know about how a company was doing was believed to be reflected in its share price.

By the 1990s, the notion that a CEO had an obligation to maximize shareholder value had become an unquestioned mantra taught in business schools; ordinary people assumed it was simply the way of the world. “People think it was brought down from Mount Sinai by Moses, as the 11th Commandment,” said Richard Sylla, a professor who specializes in the history of financial institutions at NYU Stern School of Business, and the coauthor of a recent article in the journal Daedalus critiquing the notion of shareholder supremacy. “If you’re younger than 50 or 60, you’ve lived in a world where everyone taught you that this is what a corporation is supposed to do—maximize profit and shareholder value. But the world used to be different.”

The philosophy of shareholder supremacy, initially a reform to curb irresponsibility in managers, has ended up causing significant problems of its own, say Sylla and other critics. CEOs became obsessed with stock price at the expense of all other considerations. Some, like the executives at Enron, went so far as to defraud their own stockholders by engineering bogus profits. Countless others made short-sighted decisions intended to goose earnings, keep investors happy, and enrich themselves—all without regard for the long-term health of their companies.

The broader social effects of the shift toward shareholder value are clear, critics say, with wages stagnating and unemployment remaining stubbornly high even as the stock market has rebounded after the recession. Meanwhile, if the point was to benefit shareholders, it’s not clear that worked either. Roger Martin, the former dean of the Rotman School of Management at the University of Toronto, points out in his 2011 book, “Fixing the Game,” that from 1933 to 1976, returns on investment in the S&P 500—the decades immediately before the “shareholder value” took hold—were actually higher than they have been since. And Stout notes that in the 20 years after 1993, when a change to the tax code encouraged corporations to tie executive compensation to share price, investors in the S&P 500 saw returns that were slightly worse than what they were getting during the 40 years prior. The life expectancy of S&P 500 companies, meanwhile, has been cut dramatically—from around 70 years in the 1920s to 15 years today.

“We have been dosing our public corporations with the medicine of shareholder value thinking for at least two decades now,” Stout has written. “The patient seems, if anything, to be getting worse.”

As the effects of shareholder supremacy have begun to make themselves evident—Stout points to Sears and Motorola as examples of companies that have been hollowed out in the name of stoking share prices—an alternative approach to running a corporation, known as the stakeholder model, began gaining purchase among academics and business leaders. This model, as described by its proponents, recommends taking a less simplistic and short-term view of what makes a company successful, and calls for measuring its value not just in terms of profits and stock price, but the total impact it has on the lives of people who come into contact with it. There are clear reasons this might be better for employees, customers, and their communities. In the long run, say thinkers like Stout and Post, it is going to be better for the competitiveness of the American company. Pointing to firms like Market Basket, they argue that stakeholder-focused companies are ultimately more stable and financially healthy—a win, ultimately, for the very shareholders being forced to make room at the trough for other interested parties.

***

Though lots of prominent companies now take pains to cultivate reputations as conscientious corporate citizens, would-be reformers want something more. “All that stuff is just window dressing,” said Stout, referring to philanthropic programs financed by big corporations in the name of good PR. “Corporate social responsibility means running a business that contributes to public welfare—that’s the moral defense of capitalism. Business should be a force for good, not for the enrichment of a few small individuals.”

Continued in article

Jensen Comment
It would seem that anything that is bad for business adversely affects shareholder value. However, is the opposite the case. Is everything good for increasing shareholder value good for business. Most of the debate hinges on long-term versus short-term values.

Miltoton Friedman argued that the only responsibility of business should be making profits while abiding by all laws ---
http://www.bostonglobe.com/ideas/2014/08/02/shareholder-value-bad-for-business/3O4MYxjWgmJ2DOPwkeYxyN/story.html
This is of course difficult when laws are conflicting or unclear --- as is often the case. One example is affirmative action where the laws are sometimes vague or conflicting. Adverse publicity can sometimes cut on both sides of the sword.

A classic problem is when tax laws and regulations allow companies to avoid taxes in a way that hurts them with adverse publicity such as when Walgreens contemplated moving its headquarters across the Atlantic Ocean --- a decision that the company has since rescinded due to both bad publicity and governmental pressures. The company would have benefitted in the short run by this inversion, but it's not at all clear that the long-term benefits would have been positive.

It's clear that the private sector differs greatly from the public sector in terms of social responsibilities. For example, the government is ideally subjected to the democratic voting process with respect to controversial decisions such as banning genetic modification certain food products. A company deciding to modify or not modify its products via genetic modification is not directly subjected to the will of the people except via government intervention.

Highly controversial decisions that are on surface socially responsible have many possible favorable and adverse externalities. For example, if an enormous electric power company elects to substitute coal and nuclear power generation with solar, wind, and hydo power (as is the case with the power generating companies in Vermont) there are many possible externalities for which government would be accountable but not the power companies themselves. For example, enormous increases in the cost of power may cause a spike in unemployment and huge losses of tax revenues from businesses depending on cheap power. In fact power-intensive companies may move to another state where power is cheaper.

At the moment, there's huge political fight in New Hampshire over what is termed the northern pass ---
 http://en.wikipedia.org/wiki/Northern_Pass_transmission_line
 Power companies want to destroy a significant portion of our forests for enormous (80-foot) transmission towers to bring in hydro power from Quebec. What is profitable for the power companies has adverse externalities on life in the forests as well as life in Quebec if more and more land is flooded for newer and larger hydro dams. But those are Canadians who are hurt. Why should our USA companies care about Canadians if the Northern Pass transmission lines add shareholder value to USA power companies.?

How to Mislead With Governmental Accounting
"How Much Do We Really Owe?," by John Goodman, Forbes, August 7, 2014 ---
http://www.forbes.com/sites/johngoodman/2014/08/07/how-much-do-we-really-owe/

First the good news: the official federal deficit is only 3% of GDP – way below the 10% figure it reached only a few years ago. Now the bad news: The real deficit is more than ten times that amount.

The U.S. government’s deficit is expected to be $514 billion this year, according to the Congressional Budget Office (CBO). That’s the number you get when you look at cash flow. It means the government will spend $514 billion more than it takes in during the 2014 fiscal year.

But this kind of accounting ignores federal government liabilities that will become due in future years. For example, over the course of a year millions of people earn Social Security and Medicare benefits as well as other government entitlement benefits that will have to be paid in future years. When you total all that up (and subtract expected future revenues to pay those benefits), we added $5 trillion in debt last year according to Boston University economist Larry Kotlikoff.

Another way to look at the problem is to consider not just one year’s deficit, but the total amount of debt that government has accumulated. US debt held by the public is currently $12.6 trillion, or about 75% of the size of our economy the way the CBO measures things. But in arriving at that number, the CBO doesn’t recognize promises to pay Social Security checks and medical bills as real obligations.

Take a senior citizen who is expecting an interest payment on a government bond next month and who is also expecting a Social Security check. The way the CBO looks at the world, the interest payment on the bond is a real obligation of the government. But the Social Security check isn’t.

That’s a strange way of accounting and Kotlikoff and his colleagues reject it. Instead they project the value of all the promises we have made under Social Security and other entitlement programs – benefits that ordinary citizens believe they have earned – and subtract expected future revenues, given the current tax law. The difference is an unfunded liability that is every bit as real as promises to make future interest payments on bonds and Treasury bills.

Calculating obligations in this way, Kotlikoff estimates that the total unfunded liability of the federal government is $210 trillion, or about 12 times the size of our economy. Writing in The New York Times, Kotlikoff says:

“The fiscal gap — the difference between our government’s projected financial obligations and the present value of all projected future tax and other receipts — is, effectively, our nation’s credit card bill. Eliminating it, would require an immediate, permanent 59 percent increase in federal tax revenue. An immediate, permanent 38 percent cut in federal spending would also suffice. The longer we wait, the worse the pain. If, for example, we do nothing for 20 years, the requisite federal tax increase would be 70 percent, or the requisite spending cut, 43 percent.”

And the tax increase, by the way, doesn’t work unless the money is sequestered and invested. It can’t just be deposited in the Treasury’s bank account and spent on other things.

Bob Jensen's threads on the USA's entitlements disaster ---
http://www.trinity.edu/rjensen/Entitlements.htm

Bob Jensen's threads on the sad state of governmental accounting ---
http://www.trinity.edu/rjensen/Theory02.htm#GovernmentalAccounting

There has been a distinctive odor of hype lately about the national jobs report for June. Most people will have the impression that the 288,000 jobs created last month were full-time. Not so.

The Obama administration and much of the media trumpeting the figure overlooked that the government numbers didn't distinguish between new part-time and full-time jobs. Full-time jobs last month plunged by 523,000, according to the Bureau of Labor Statistics. What has increased are part-time jobs. They soared by about 800,000 to more than 28 million. Just think of all those Americans working part time, no doubt glad to have the work but also contending with lower pay, diminished benefits and little job security.

On July 2 President Obama boasted that the jobs report "showed the sixth straight month of job growth" in the private economy. "Make no mistake," he said. "We are headed in the right direction." What he failed to mention is that only 47.7% of adults in the U.S. are working full time. Yes, the percentage of unemployed has fallen, but that's worth barely a Bronx cheer. It reflects the bleak fact that 2.4 million Americans have become discouraged and dropped out of the workforce. You might as well say that the unemployment rate would be zero if everyone quit looking for work.

Last month involuntary part-timers swelled to 7.5 million, compared with 4.4 million in 2007. Way too many adults now depend on the low-wage, part-time jobs that teenagers would normally fill. Federal Reserve Chair Janet Yellen had it right in March when she said: "The existence of such a large pool of partly unemployed workers is a sign that labor conditions are worse than indicated by the unemployment rate."

There are a number of reasons for our predicament, most importantly a historically low growth rate for an economic "recovery." Gross domestic product growth in 2013 was a feeble 1.9%, and it fell at a seasonally adjusted annual rate of 2.9% in the first quarter of 2014.

But there is one clear political contribution to the dismal jobs trend. Many employers cut workers' hours to avoid the Affordable Care Act's mandate to provide health insurance to anyone working 30 hours a week or more. The unintended consequence of President Obama's "signature legislation"? Fewer full-time workers. In many cases two people are working the same number of hours that one had previously worked.

Since mid-2007 the U.S. population has grown by 17.2 million, according to the Census Bureau, but we have 374,000 fewer jobs since a November 2007 peak and are 10 million jobs shy of where we should be. It is particularly upsetting that our current high unemployment is concentrated in the oldest and youngest workers. Older workers have been phased out as new technologies improve productivity, and young adults who lack skills are struggling to find entry-level jobs with advancement opportunities. In the process, they are losing critical time to develop workplace habits, contacts and new skills.

Most Americans wouldn't call this an economic recovery. Yes, we're not technically in a recession as the recovery began in mid-2009, but high-wage industries have lost a million positions since 2007. Low-paying jobs are gaining and now account for 44% of all employment growth since employment hit bottom in February 2010, with by far the most growth—3.8 million jobs—in low-wage industries. The number of long-term unemployed remains at historically high levels, standing at more than three million in June. The proportion of Americans in the labor force is at a 36-year low, 62.8%, down from 66% in 2008.

Part-time jobs are no longer the domain of the young. Many are taken by adults in their prime working years—25 to 54 years of age—and many are single men and women without high-school diplomas. Why is this happening? It can't all be attributed to the unforeseen consequences of the Affordable Care Act. The longer workers have been out of a job, the more likely they are to take a part-time job to make ends meet.

The result: Faith in the American dream is eroding fast. The feeling is that the rules aren't fair and the system has been rigged in favor of business and against the average person. The share of financial compensation and outputs going to labor has dropped to less than 60% today from about 65% before 1980.

Why haven't increases in labor productivity translated into higher household income in private employment? In part because of very low rates of capital spending on new plant and equipment over the past five years. In the 1960s, only one in 20 American men between the ages of 25 and 54 was not working. According to former Treasury Secretary Larry Summers, in 10 years that number will be one in seven.

The lack of breadwinners working full time is a burgeoning disaster. There are 48 million people in the U.S. in low-wage jobs. Those workers won't be able to spend what is necessary in an economy that is mostly based on consumer spending, and this will put further pressure on growth. What we have is a very high unemployment rate, a slow recovery and across-the-board wage stagnation (except for the top few percent). According to the Bureau of Labor Statistics, almost 91 million people over age 16 aren't working, a record high. When Barack Obama became president, that figure was nearly 10 million lower.

The great American job machine is spluttering. We are going through the weakest post-recession recovery the U.S. has ever experienced, with growth half of what it was after four previous recessions. And that's despite the most expansive monetary policy in history and the largest fiscal stimulus since World War II.

Continued in article

"Obamacare by the Numbers A state-by-state analysis of failed health care exchanges," by Peter Suderman, Reason Magazine, August/September 2014 ---
http://reason.com/archives/2014/07/01/obamacare-by-the-numbers