Oh Presents How Does The Corporate Tax Distort Choice Of Corporate Governance? Today At Pepperdine

Jason Oh (UCLA) presents How Does the Corporate Tax Distort Choice of Corporate Governance? at Pepperdine today as part of its Tax Policy Workshop Series hosted by Deanna Newton:

To what extent does the tax system distort the organizational governance of business entities? For non-publicly traded entities, the connection between tax treatment and governance is weak. Decisions regarding tax and governance can be made independently because of flexible modern LLC statutes and the check-the-box regime. If a business wants corporate governance but partnership tax, it can form as an LLC and adopt corporate-like governance. If a business wants non-corporate governance but corporate tax, it can choose its governance structure and check-the-box to be treated as a corporation.

However, for publicly-traded entities, the choice of tax and governance remains linked. The tax rules require that publicly-traded entities generally be taxed as corporations. There are narrow exceptions for master-limited partnerships and certain investment companies like RICs and REITs. This Article explores important governance and tax puzzles related to publicly-traded entities.

We observe that publicly-traded entities in general are still organized as corporations rather than LLCs. The tax law only dictates that they be taxed as corporations. LLC statutes offer more flexibility, and yet investors and founders eschew that flexibility. Why? The tax law allows certain publicly-traded entities to take advantage of the flexible passthrough tax regime of Subchapter K. Yet we observe relatively few of these master limited partnerships. Why? Subchapter M creates rigid requirements for registered investment companies and real estate investment trusts to achieve passthrough taxation. Despite the rigidity of the rules, RICs and REITs are hugely popular. Why?

This Article offers the homogeneity hypothesis to answer these questions. In publicly-traded entities, it is especially important for ownership interests to be as homogeneous as possible to minimize agency and monitoring costs. Publicly-traded entities do not want much of the flexibility offered by modern LLC statutes. The flexibility of Subchapter K exacerbates heterogeneity amongst different owners. The more rigid approach of Subchapter M maintains ownership homogeneity for REITs and RICs. These insights have important implications for corporate tax reform and invite a reconsideration of the interaction between agency costs and tax distortions.