Tuesday, November 27, 2018
Emily Satterthwaite (Toronto) presents Entrepreneurs' Legal Status Choices and the C Corporation Penalty today at Boston College today as part of its Tax Policy Workshop Series hosted by Jim Repetti, Diane Ring, and Shu-Yi Oei:
Foundational to the American Dream is the ability to easily and rapidly start a new business. Over the past quarter century, the introduction of the limited liability company (LLC) has dramatically shifted the choice-of-legal-status calculus, and in its wake a consensus against the use of traditional C corporations by non-venture-backed start-ups has emerged. The C corporation, scholars argue, has fatal drawbacks: tax disadvantages as well as governance inflexibility. Due to historically limited sources of data, there has been little empirical research on choice-of-entity generally and none that explores the anti-C corporation thesis in particular. Do C corporations under-perform as compared to similarly-situated businesses with alternative legal statuses? This paper exploits a large panel dataset that contains legal status, owner, business, financing, and other firm-specific information collected from an eight-year panel survey of nearly five thousand enterprises that were formed in 2004. The paper presents four main results.
First, C corporation status is associated with firm failure rates that are 38 percent higher (significant at 0.1 percent) than those of non-C corporations. Second, this C corporation survival penalty persists at nearly the same magnitude and significance even after a subset of sophisticated “anticipated cash-exit” C corporations with (a) venture capital investors or (b) employee stock option plans are separated out. Third, non-white and foreign-born entrepreneurs have a significantly higher likelihood of choosing (survival-penalized) C corporation status. Fourth, within the subset of firms that appear eligible to elect out of the default (subchapter C) corporate tax classification and into the tax-advantaged subchapter S classification, non-white and older entrepreneurs are significantly more likely to remain in C corporation status. The paper concludes by suggesting a range of policy interventions that may worth exploring to address the distributional non-neutrality of legal status choice.