THE EFFECT OF INCOME TAXES ON THE FORM OF BUSINESS ENTITY (ORGANIZATIONAL FORMS, PARTNERSHIPS, TAX COST, DOUBLE TAXATION)

This dissertation contributes to the literature on the theory of the firm by examining the relationship between income tax laws and organizational form. Following Scholes and Wolfson (1986, 1989), an organization's form is assumed to be chosen to minimize both tax costs and transaction costs. Alternative organizational forms available for business entities are examined, and the corporation and partnership forms are found to be the only forms available with significantly different tax treatment. Because of double taxation, the tax cost of the corporate form is predicted to be greater than the tax cost of the partnership form, and this difference in relative tax costs is predicted to increase after the 1981 Economic Recovery Tax Act. The results of empirical tests are consistent with these predictions.; In order for the corporate form to remain as the dominant form of organization in spite of greater relative tax costs, partnerships are predicted to incur greater transaction costs than corporations. Transaction cost differences are examined empirically by comparing samples of Master Limited Partnerships and corporations. The results of the empirical tests are consistent with partnerships performing poorly compared with corporations, when performance is measured by accounting based measures. However, the results are not consistent with partnerships incurring greater general and administrative expenses than corporations.; Responses of firms facing increasing relative tax costs after 1981 are predicted to be (1) increasing long term debt, (2) increasing non-dividend distributions (stock repurchases and merger payments), and (3) decreasing dividend payout ratios. The results of univariate and multivariate tests of these predictions are consistent with the hypotheses. However, the results are sensitive to the method of measuring percentage changes in dependent and independent variables. The results for merger payments are consistent with the analytical work of Petruzzi (1988).