Johnson on Desirability of Corporate Form

Monday, May 24, 2004

Calvin Johnson (Texas) has posted The Incredible Shrinking Domain of Corporate Stock on SSRN. Here is the abstract:

Twenty-five years ago, the best tax vehicle for a business enterprise was clearly growth stock, in which the corporation accumulated its earnings. The growth stock strategy was so advantageous that shareholders could tolerate managers taking rents out of the corporation in excess of the value they added. With the drop in individual rates, however, using a corporation subject to section 11 tax is getting very hard to justify. Corporate stock is clearly rational only as an estate-planning device for investments that will benefit from the step-up in basis at death. For very-long-term investments, Johnson explains, corporate stock might be justified if it causes sufficiently higher pretax return to the enterprise, if it convinces investors to accept sufficiently lower after-tax returns, or if corporations have sufficiently better access to tax shelters. As the term of the investment gets shorter, however, the tax barriers to use of corporate stock get higher. At investment terms of, say, five years, Johnson concludes that the barriers to use of the corporate form look insurmountable.