Entrepreneurs’ Legal Status Choices and the C Corporation Survival Penalty

Emily A. Satterthwaite

Journal of Empirical Legal Studies, 2019, vol. 16, issue 3, 542-604

Abstract: Foundational to the American Dream is the ability to easily and rapidly start a new business. Over the past quarter‐century, the limited liability company (LLC) dramatically shifted the choice of legal status calculus for entrepreneurs, and in its wake a consensus against the use of traditional C corporations by closely‐held firms emerged. 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 underperformed as compared to similarly situated businesses with alternative legal statuses? This article exploits a large panel dataset that contains legal status, owner, business, financing, and other firm‐specific information collected from an eight‐year survey of nearly 5,000 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, nonwhite 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, nonwhite and older entrepreneurs are significantly more likely to remain in C corporation status. These findings suggest that increasing legal status complexity is unlikely to be neutral from a distributive perspective, and may be disproportionately burdensome for marginalized entrepreneurs.

Date: 2019
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https://doi.org/10.1111/jels.12227

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Persistent link: https://EconPapers.repec.org/RePEc:wly:empleg:v:16:y:2019:i:3:p:542-604

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