Choice of Form and Network Externalities

Abstract

This Article provides the first detailed empirical analysis of firms' choice of organizational form. It provides important evidence on whether there is an efficient market in organizational forms or firms' choice of form is impeded by network externalities. We focus on formations of limited liability partnerships (LLPs) and limited liability companies (LLCs) in examining the effect of various factors on firms' cho ice of business form. Our data provides important evidence against the network externalities hypothesis. Because the LLP and LLC forms are similar except for the LLP's link to the existing "network" of partnership law, firms would prefer the LLP to the LLC form if network externalities mattered. In fact, we find that firms prefer the LLC form. Moreover, the reduced relative popularity of LLCs in states that impose entity taxes on LLCs but not LLPs, and the increased relative popularity of LLCs in states and years in which LLCs have particular inherent advantages, provide further evidence that the inherent characteristics of the two business forms, rather than network externalities, are driving choice of form.