Legacy Of The Master Limited Partnership Is Felt Today

Legacy Of The Master Limited Partnership Is Felt Today

At its peak during the 1980s, the master limited partnership was the organizational choice of over 100 firms from a variety of industries.

The publicly traded partnership offered pass through tax treatment--as well as the ability to easily trade partnership interests--until tax laws turned against the master limited partnership (MLP) in 1987.

"Very few firms became master limited partnerships after 1987 and many master limited partnerships (MLP) returned to corporate status, but its legacy may bring insight into the design of a number of organizational innovations that share some of the MLP's traits," says Chris J. Muscarella, professor of finance and the L.W. "Roy" and Mary Lois Clark Teaching Fellow in Penn State's Smeal College of Business Administration.

He recently co-authored a study, "Contracts Between Managers and Investors: A Study of Master Limited Partnership Agreements," to gain insights on MLPs that could be useful in the analysis of new organizational forms, such as the limited liability company (LLC) and the limited liability partnership (LLP). Nearly one in five new business registrations nationwide in 1996 were in one of those two forms.

The study, which will appear in a forthcoming issue of The Journal of Corporate Finance , was co-authored with Conrad S. Ciccotello of the Robinson College of Business Administration at Georgia State University. The MLP research is valuable because the main obstacle faced by researchers in industrial organization is the lack of available data on contracts and activities of firms

"The MLP permits empirical research into the contracting between investors and managers that is not possible with corporate data," says Muscarella. "The obligations and rights of managers and shareholders are vague in corporate charters whereas MLP partnership agreements often specify the relationship between the general partner and the investors. In addition, the agreements are publicly available due to the disclosure requirements for public trading."

MLPs are limited partnerships with publicly traded equity interests called units. The tax incentives for cash distributions to investors provided much of the rationale for the emergency of MLPs, which were popular in industries such as oil and gas, real estate, and natural resources, says Muscarella. In the 1980s, firms in these industries often found themselves with large amounts of cash available to distribute and few profitable investment opportunities, making the partnership structure attractive.

"The Revenue Act of 1987 curtailed the MLP's tax advantages by limiting the industries, new lines of business, and income sources for which partnership tax treatments were available," says Muscarella.

In the study, Muscarella and Ciccotello analyzed a sample of 119 MLPs formed between 1981 and 1995 to examine the relationship between contract design, operating performance, and ownership structure in organizations. They analyzed each MLP partnership agreement to identify its provisions relating to matters such as allowable scope of operations, distribution policy, and management's ability to withdraw from the firm.

They found a wide variety in the design of the agreements, and many instances where the flexibility of management is strictly curtailed. Another finding is that partnerships that contractually limit their scope of operations tend to have superior industry-adjusted operating performance.

Other key findings include:

• Partnerships with agreements unfavorable to investors tend to have higher proportions of insider equity ownerships, compared to those with agreements more protective of investors.
• MLP partnership agreements written after 1987 have more requirements for general partners to distribute cash, and more incentives for those general partners to do so. These changes, Muscarella notes, may reflect a trend for the MLPs to be valued based on yield.