Investments in labour-sponsored funds: the tax credits are unjustified

    MONTREAL, May 13 /CNW Telbec/ - Tax credits provided on investments in
labour-sponsored venture capital funds no longer have a justification. These
programs have been called into question in several other provinces. In its
first two decades, the program under which they operate led to tax
expenditures which can be estimated at about $2.7 billion for Quebec alone.
Although investing in these funds may initially seem attractive for
individuals receiving tax credits, they have low returns, high operating costs
and negative effects on the supply of venture capital.
    In an Economic Note published by the Montreal Economic Institute,
Jean-Marc Suret, a professor at Université Laval's School of Accounting,
provides a synthesis of studies on this type of program in Canada. He explains
that these funds "are derived from an obsolete model of intervention, since
venture capital requirements have changed." The study's main conclusions are
based on Canadian labour funds as a whole.

    Unsufficient returns, high costs to the public treasury

    The cumulative cost of labour-sponsored venture capital corporations
programs in Canada reached $5.4 billion in 2003, with half of this,
$2.7 billion, emanating from Quebec. These subsidized funds have shown
abnormally low returns: from 1992 to 2002, the average return was 2.5% a year,
less than Treasury bills. This may be explained in part by the fact that the
companies financed under this program are, for the most part, inefficient in
creating value and innovation.
    Eligible investments in labour-sponsored funds include categories for
which government assistance is hard to justify: real estate, investments in
publicly traded or foreign firms, companies with assets of up to $350 million.
The portion of capital devoted to sectors truly in need of financing is
diminished, going instead to more remunerative, less risky investments. The
favoured funds merely displace private capital rather than increasing the
available financing.
    The management fees of these labour-sponsored corporations are abnormally
high. They run from 4.2% to more than 4.5%, compared to 2.6% for other
small-cap funds. The fixed amounts paid to executives represent more than 3.1%
of assets, indicating that management fees are not indexed to returns,
contrary to the rule in the industry.

    An outdated approach

    Changes in public equity markets and the supply of venture capital
challenge the usefulness of tax expenditures in this area. New rules and
practices on the stock market make it easier for growing companies to get
listed and to obtain financing, at an early stage, even before they produce
income.
    Moreover, venture capital is already quite abundant in Canada.
Labour-sponsored venture capital corporations collect about $1 billion a year
in Quebec, 10 times the province's total needs in start-up capital. This large
excess of venture capital may explain in part the industry's low returns. The
law allows these corporations little time to invest the amounts they collect,
often leading them to finance unprofitable projects.
    In addition, the unions appoint a majority of the board members of these
corporations without actually investing in them. Executives' management
mandates are thus not even negotiated with shareholder representatives. This
organizational structure generates high agency costs. Weak governance is
aggravated by the fact that shareholders, in Quebec, cannot withdraw the money
they have invested if they are unhappy. The managers therefore do not have to
face an assessment of their results.
    The Economic Note titled Labour-sponsored venture capital funds: time for
a reassessment, was prepared by Jean-Marc Suret, professor at the School of
Accounting at Université Laval, and CIRANO fellow. He also holds a Ph. D. in
finance from Université Laval.
    The full text is available free of charge at www.iedm.org

    The Montreal Economic Institute is an independent, non-partisan,
non-profit body that takes part in public policy debate in Quebec and across
Canada, offering wealth creation solutions on matters of taxation, regulation,
and reform of health and education systems. Its publications since 2000 have
included the Report Card on Quebec's Secondary Schools. In 2004 it won a
Templeton Freedom Award for Institute Excellence for the quality of its
management and public relations.

For further information: and interview requests: André Valiquette,
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