In government we trust: rise and fall of Canadian business income trust conversions

Purpose - The purpose of this paper is to assess the market impact of announcements that publicly traded limited liability firms would convert to business income trusts, and to test the robustness of the tax motive as the primary determinant of any conversion announcement effects by estimating the market impact of the announcement by the Canadian Federal Government that the corporate income of Canadian income trusts would be taxed at the trust level. Design/methodology/approach -Event-study methodology (including various tests of robustness) is used to examine the market impacts of the initial conversion announcement and the announcement that the corporate income of Canadian income trusts would be taxed at the trust level. Cross-sectional regressions are used to identify the determinants of the market effect associated with income trust conversion announcements. Findings -The paper finds that the market- and risk-adjusted abnormal returns (ARs) are positive and very significant on the announcement dates and not significant on the conversion effective dates. The price discovery process is not as smooth for the Canadian government's announcement after the market close on Halloween day 2006, that it would tax income trusts at the trust level. While the ARs are negative and very significant on the first and second trading days after the announcement, much of the second day ARs are reversed in the subsequent two days. Furthermore, negative and significant ARs precede the government announcement. The market impact of trust conversion announcements is primarily related to the tax savings associated with such conversions and more weakly related to potential agency problems associated with free cash flows. Research limitations/implications - The research indicates the importance of any taxation changes associated with changes in organization form on firm value. It also identifies the potential for informational leakage associated with government decisions. Originality/value -The paper highlights the importance of taxes and tax changes and organization form changes on firm valuation.