Entrepreneurs’ Legal Status Choices and the C Corporation Survival Penalty
Journal of Empirical Legal Studies, Forthcoming
72 Pages Posted: 29 Jun 2018 Last revised: 15 Apr 2019
Date Written: December 4, 2018
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) dramatically shifted and complicated the choice-of-legal-status calculus and, prior to 2017, a consensus against the use of traditional C corporations by closely-held firms solidified. The C corporation, scholars argued, had fatal drawbacks despite its simplicity: 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. Have C corporations under-performed as compared to similarly-situated businesses with alternative legal statuses? This paper uses a large panel dataset that contains legal status, owner, business, financing, and other firm-specific information collected from an eight-year survey of nearly five thousand enterprises that were formed in 2004. It 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 with similar characteristics. Second, this C corporation survival penalty persists at nearly the same magnitude and significance even after a subset of “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 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 less likely to make the election, thereby remaining in C corporation status. These findings suggest that increasing legal status complexity is unlikely to be neutral from a distributive perspective.
Keywords: taxation, business law, entrepreneurship
JEL Classification: K34, K22
Suggested Citation: Suggested Citation