Taxes and the Relative Valuation of S Corporations and C Corporations

Abstract

We analyze the net tax advantage of S corporations relative to C corporations. Our analysis indicates that the net tax advantage is economically important; it varies directly with the company's payout ratio, the marginal corporate tax rate, and the capital gains rate of the marginal investor; and it varies inversely with the personal tax rate of the marginal investor. The analysis predicts that the fair market value of an S corporation will exceed that of an otherwise identical C corporation. This prediction holds even in the case of an acquisition of an S corporation. Consistent with our predictions, we find that publicly traded master limited partnerships, which enjoy net tax advantages in the early 1980s, are valued at a premium relative to taxable corporations operating in the same industry.

Keywords: S corporation valuation

JEL Classification: H25, G12