The Effects of Competition from S Corporations on the Organizational Form Choice of Rival C Corporations

Subchapter C of the U.S. Internal Revenue Code levies an entity-level tax on corporate profits, whereas Subchapter S allows corporations meeting specific criteria to elect out of this tax. Despite these differences, C and S corporations regularly compete for customers and capital. We examine whether and the extent to which competition from S corporations influences the future organizational form choice of rival C corporations and explore outcomes of this choice. Using data for 4,462 private U.S. commercial banks grouped by Metropolitan Statistical Area during 1997–2010, we find that greater competition from S corporation banks increases the likelihood that rival C corporation banks convert to Subchapter S status. We estimate that the aggregate first-year tax savings from S conversion exceed $372 million. Consistent with these savings being used to maintain competitive parity with rivals, we find that converting banks increase their interest rates on customer deposits and advertising intensity. Our findings provide insight into whether competition from tax-advantaged firms influences the organizational form choice of rival tax-disadvantaged firms.