Why Corporations?

Abstract:     
This article suggests that reform of the governance of publicly held firms might appropriately include a move from the corporate to the partnership form. The corporate form is susceptible to regulation, rigidly centralized and not readily adaptable to firms' varying circumstances. These features are unsuitable for new economy firms that rely on markets and networks rather than integration. Partnership's greater flexibility and freedom from government interference arguably make it a better choice than corporation for many publicly held firms. Thus, the persistence of incorporation may owe more to politics and regulation than to efficiency. The rigidity of the corporate form makes it easier to regulate and therefore provides more rent-seeking opportunities for politicians and interest groups than if parties could freely choose their business form. Taxation of corporate distributions reduces owners' incentives to take control of corporate earnings through partnership-type firms. Also, by protecting managers' power, preserving the corporate form co-opts the interest group that is best able to lobby for change. However, new corporate tax rules, increased federal regulation of corporate governance and the changing nature of U.S. business may give firms new incentives to use the partnership form. Lawyers may be the agents of change, as they have been in promoting partnership-based business forms for closely held firms.

Keywords: corporations, partnerships, corporate governance, lawyers, public choice, tax, economic history

JEL Classifications: K0, K2, L2, N0

Accepted Paper Series