Business owners: Looking to be more competitive? Try changing your organizational structure

GAINESVILLE, Fla. – Whole Foods versus your local grocery store. Applebee’s versus your favorite mom-and-pop restaurant. Bank of America versus your local banking institution. What do these businesses have in common? Each is an example of a competitor within their respective industries. This competition, some would argue, has made each of these companies better by driving each to out-innovate, out-serve and out-differentiate from the other.

But how does your local business compete with the big brands? According to new research from the Warrington College of Business at the University of Florida, the organizational structure might actually be the key.

According to research from Jack Kramer Term Assistant Professor Michael Mayberry, organizational structure has many effects on a business, especially its taxes, which can have a significant impact on profits.

Specifically, Mayberry, along with Michael Donohoe (BSAc ’01, Ph.D. ’11) of the University of Illinois at Urbana-Champaign and Petro Lisowsky of Boston University, found that firms that enjoy the tax advantages of being organizationally structured as S-corporations are able to set more competitive prices and advertise more aggressively than other firms that have to pay a corporate-level tax, like C-corporations.

In their study, “The effects of competition from S-corporations on the organizational form choice of rival C-corporations,” Mayberry and colleagues focused on commercial banks to identify how competition from tax-advantaged S-corporations affected the organizational form choices of tax-disadvantaged C-corporations.

“Firms, including banks, regularly compete for customers and capital,” Mayberry, Donohoe and Lisowsky write. “In our setting, a Subchapter S election can provide a competitive advantage of higher after-tax cash flow by removing the entity-level tax of Subchapter C. Because higher cash flow can be used to attract customers and capital, the relativeadvantages of Subchapter S increase as other banks in the same market operate as C-corporations.”

They continue, “That is, S-corporation banks’ higher after-tax cash flow can hinder C-corporation banks’ ability to maintain a competitive advantage parity. This relative disadvantage for C banks worsens as more rivals elect S status, even though C banks’ absolute taxes do not change.”

While the researchers show that there are competitive benefits to being an S-corporation, they argue the recent Tax Cuts and Jobs Act of 2017 will have an opposite effect on these businesses. While S-corporations have historically enjoyed a tax advantage, they will now suffer from a tax disadvantage due to the latest tax reform. Mayberry suggests that this may cause smaller businesses to raise their prices.

This research is forthcoming in Contemporary Accounting Research.