On the effects of income tax to the private businesses

Income Taxation and Business Incorporation: Evidence from the Early Twentieth Century

By Li Liu (li.liu@sbs.ox.ac.uk), Centre for Business Taxation, University of Oxford

URL: http://d.repec.org/n?u=RePEc:btx:wpaper:1205&r=his

Abstract

If the corporate income tax is set at a different rate from non-corporate income tax, it can play an important role in a firm’s choice of organizational form. The impact and interdependency of income tax incentives are crucial factors to take into account when designing efficient tax policies. In this paper I exploit the substantial variation in income taxes across U.S. states in the early twentieth century to estimate these sensitivities. The potential endogeneity of state taxes is addressed using an IV approach. The results demonstrate that the relative taxation of corporate to personal income has a significant impact on the corporate share of economic activities. Raising the entrepreneur’s tax cost of incorporation by 10% decreases the mean corporate share of economic activities by about 11-18%. In addition, higher personal tax rates may affect the share of corporate activities through tax evasion and tax progressivity.

Review by Beatriz Rodríguez-Satizábal

What are the implications of income tax on the organizations? As Li Liu claims in this paper distributed by NEP-HIS on 2012-10-20, the interplay of corporate and personal income taxes are central to tax policy design. As we have all witnessed, the new century has been marked by a turbulent corporate world. Politicians, economic-policy makers, and citizens are calling for new regulation and control over the giant corporations ruling the economies of most countries.

After almost a century of dealing with corporations, the issue is still which is the best way to keep the corporations within the limits of what is right for a country’s economy without having a negative effect on the firm’s growing path. The fact that the taxation lies in the heart of the relation between the businesses and the rest of the society, implies that its understanding needs both sides of the story (even shown from different perspectives): the policy-maker decision on how, when, and whom to tax; and, the effects of taxation in the structure, productivity, and revenues of the firm. The former commonly studied, and the latest still open to include case studies of firms and countries.

Studying the case of the United States during the first two decades of the twentieth century, Liu brings together a period of tremendous changes in the income regimes –including the introduction of the income taxes (corporate in 1909, personal in 1913)- with the appearance of the first well-known big corporations. In other words, this paper is a step forward to fill the gap in the literature on the contribution of income taxes in the spread of corporate forms during an early period.

Using a dataset that includes the tax rates, the corporate share of establishment, employment, and production in the manufacturing sector, Liu builds a theoretical framework that starts with a simple model to illustrate how firms make decisions about whether to incorporate based on comparison of the profits they are likely to obtain from each organizational form (p. 7). This offers a result that shows the complexity of the business decisions and the reality which the policy-maker has to deal with: the taxation of firms differs by organizational form.

Interestingly, Liu adds to the discussion the degree of incorporation making a case on the economic importance of corporations and the fact that a great number of firms incorporate in response to tax incentives, rather than productivity options. Therefore, there is a strong relationship between business incorporation and income taxes when the big transformation occurred.

In other words, firms were not keeping it simple for the policy-maker! As a dynamic unit, the decision on the organizational form they were going to take while growing depended not only on the complexity of the production, the financial options available, or the size of the markets, but also on how they relate with the taxation system that at the end could increase or decrease the degree of incorporation.

Being this intuition not new for those who study the evolution of firms, this paper adds data to a methodological approach that combines the advances of the corporate governance on the structure of the firm and the accounting concern on how to deal with what they have to give back to the society.

Successful Entrepreneurship: A Matter of Location?

Entrepreneurship and Geography: An Evolutionary Perspective

By Erik Stam (Utrecht University)

URL: http://d.repec.org/n?u=RePEc:wiw:wiwrsa:ersa10p1267&r=his

Abstract

This paper is an inquiry into the role of entrepreneurship in evolutionary economic geography. The focus is on how and why entrepreneurship is a distinctly spatially uneven process. We will start with a discussion on the role of entrepreneurship in the theory of economic evolution. Next, we will review the empirical literature on the geography of entrepreneurship. The paper concludes with a discussion of a future agenda for the study of entrepreneurship within evolutionary economic geography.

Review by Beatriz Rodríguez-Satizábal

This paper was distributed by NEP-HIS on 2012-07-29. For the business historians immerse in the research of the history of entrepreneurship, this paper by Erik Stam is a piece to read. The thoughtful review of the challenges that the relation between entrepreneurship and geography present to future research invites to open the discussion on the differences among countries based on the characteristics of the entrepreneur’s location rather than only on its cultural values and the institutional environment.

Stam challenges the growing view of entrepreneurship as a subject exclusively to be deal by management scholars. The paper brings the history back to the discussion and innovates in the use of evolutionary economic geography. As Jones and Wadwhani (2006) explain, the historical research on entrepreneurship has been particularly concerned with understanding the process of structural change and development within economies using Schumpeter’s approach to innovation.

Understanding the importance of the newcomers is beyond the focus of only one discipline and the use of economic geography will allow the researcher to deal with the question on how the location increases the chances to have entrepreneurs that introduce organizational and product innovations, without falling in the vicious cycle of explaining the increase of entrepreneurs exclusively by social variables such as religion, family values, or networks.

Moreover, by explaining that the entrepreneurs are hardly lone individuals who rely primarily on their extraordinary efforts and talents to overcome difficulties, Stam introduces the argument that for nascent entrepreneurs the focal choice is what kind of firm to start given their location, not so much choosing a location for a given firm. Therefore, it deals with the concern on the spatial distribution of entrepreneurship by searching the aspects of the interaction between the newcomers and the geographical distribution.

Stam claims that “in order to improve the insights in the spatial variations of entrepreneurship, we need to specify the type of entrepreneurship” (p. 10). Although, this is not new for those who study entrepreneurship, Stam’s proposition to include evolutionary geography gives space to a new research agenda. In the future the study of entrepreneurship should take into account the spatial concentration of the industry, the combined use of the entrepreneur and the firm as a unit of analysis, and the study of the exit of young firms to accomplish a deep analysis of the role of entrepreneurs in economic development.

Who’s Who in Spanish Corporate Governance?

Corporate Structure and Interlocking Directorates in Spanish Firms, 1917 – 1970

By Juan Antonio Rubio-Mondéjar  and Josean Garrués-Irurzun (Universidad de Granada)

URL: http://d.repec.org/n?u=RePEc:gra:fegper:01/12&r=his

Abstract

This paper analyses some of the characteristics of Spanish capitalism between 1917 and 1970. For that purpose, we resort to the technique known as interlocking directorates and applies the methodology of social network analysis (SNA) to the board of directors of the 210 largest Spanish companies, in a benchmark dates (1917, 1930, 1948 and 1970). The results allow us to answer the questions of what has been the evolution of the Spanish business structure over the twentieth century and which sectors have been central to each of the moments analysed. At the same time, we identify the main groups of companies, and the links established among them, assessing the role of financial sector in the national economic structure. Based on the relationships between the members of the Board of Directors and social capital theory, the second objective identifies the circle of Spanish economic power, quantifies the degree of cohesion, and follow its evolution over time, confirming its continuity/ disappearance.

Review by Beatriz Rodríguez-Satizábal

This paper was distributed by NEP-HIS on 2012-05-22. Juan Antonio Rubio-Mondéjar and Josean Garrués-Irurzun offer a striking overview of the corporate structure in Spain during the twentieth century following up the work by Carreras and Tafunnel published in the early 1990s.  Using Social Network Analysis (SNA), the authors build the interlocking directorates of the 210 largest firms by assets (manufacture -200- and insurance -10-) based on information collected from the Anuarios Financieros de Bilbao and Anuario Financiero y de Sociedades Anónimas de España. The examination of the characteristics of the corporate governance seems to be now one of the issues that require a long-term view, this paper offers a general approach to the Spanish case.

The paper is divided in four sections. The first presents a review of the theoretical literature on corporate governance and economic entrenchment, including an overview of the literature on Spanish capitalism. The next two sections discuss the methodological approach and the results of building the interlocking directorates for 1917, 1930, 1948, and 1970. The final section is a short conclusion that opens a discussion regarding the proliferation of business groups and the role of the board members.

Firms network in 1917 (p. 49)

The paper strikes the reader in two ways. First, the discussion on the theoretical approach to interlocking directorates presents the importance of identifying the networks in order to prove the existence of a traditional business elite. This follows the sociological approach on the role of the elites, but do not include the recently findings on the rise of business groups as an organizational form to increase the entrenchment of the business people. It is shown that between 1917 and 1970 the members of the boards in the largest Spanish firms were related and share common professions and family names. Moreover, the names collected proved that there have been only small changes in the corporate governance among the twentieth century. The old families remained and only a few new names appeared after 1948. However, there is no discussion in regards to the family businesses, an issue that has been well studied in the last decade by the likes of Paloma Fernández, Jesús Valdaliso, Eugenio Torres, Nuria Puig and others.

Secondly, Rubio-Mondéjar and Garrués-Irurzun introduce a hypothesis on the importance of the interlocking directorates among the largest firms as an answer to the close relationship between the industry and the banks. The result is that the interlocking directorates affected more than 80 per cent of the firms studied, with the majority of the members linked in both the manufacture industry and the banks. This brings back the discussion on the role of banks in development started by Alexander Gerschenkron, but also poses into discussion the relationship between politicians and businessmen. There is a novelty approach to the former, the results show that there is no a unique network that linked all the firms together and the banks did not used a collusive strategy; could this mean that the firms used other ways to increase their market power and keep their ownership control; or, maybe, there are some regional differences. In the case of the later, the results are a surprise for those who use Spain as a comparative case with the Latin American countries: differently from what is expected, a politician usually became a member of the board, but not the other way around. This gives a new meaning to the professional lobbying and poses a question on the links between the political and business elites, traditionally assumed as the same.

This paper brings a discussion on the literature on Spanish corporate governance that could be useful for those studying other countries. The methodological approach combines the use of historical data with the social network analysis, bringing the question of who is who to the understanding of the economic development of a late development country. Moreover, it leaves questions open for future research such as the relation between the changes in the economic and social environment with the interlocking directorates.

When Accountants Come to Power

Management From Hell: How Financial Investor Logic Hijacked Firm Governance
By Robert R. Locke (lockerobert3@aol.com)
Paris: Boostzone Editions, 2012
57, ebook, ASIN: B007MOYC56 (RRP €5.50 – £4.42)

Abstract – Corporate governance now is strongly controlled by a «caste» of financial investors that forgets employees and other stakeholders as well as society at large. This control is a major cause of our current crisis and of a growing disbelief in modern capitalism. Why and how did this happen? A renowned American historian of management, Robert R. Locke, develops a well-argued and powerful point of view about the limits of financial investor capitalism and shows that more balanced models should be explored, like family business as well as Geman and/or Japanese corporate governance.

URL – www.boostzone-editions.fr

Review by H. Thomas Johnson
(Professor of Business Administration at Portland State University in Oregon and Distinguished Consulting Professor of Sustainable Business at Bainbridge Graduate Institute in Washington)

In Management From Hell, Robert Locke offers an alternative to the belief that the purpose of a business is to enrich a small elite caste of investor-capitalists who use financial markets and business institutions to trade the future of humanity and non-human life for unlimited personal financial gain. That alternative is the entity view of business in which the purpose of a business is to flourish for the indefinite future and serve the well-being of society as a whole by providing gainful employment to people (employees and suppliers) whose job is to sustainably supply the economic needs of other people (customers). The book begins by examining the impact on large corporations since the late 1970s of “investor capitalism,” a “proprietary” view of business that sees the activities and the capital of a corporation as controlled by its owner-investors and managed by their hired agents, all for the purpose of maximizing its financial returns, to which they – the investor-owners – claim exclusive rights. Locke draws on extensive historical research to show how advocates of investor capitalism used modern academic theories of economics and finance to justify the morally dubious claim that a corporation’s sole concern is to maximize the financial returns to its investor-owners and their delegated agents, without regard for how its activities affect other constituencies such as employees, customers, suppliers and non-human members of Earth’s life-sustaining biosystem.

Robert R. (Bob) Locke

During the 1980s and 1990s top corporate managers, despite their role as the investor-owners’ agents, gained effective control over corporate boards of directors and, implicitly, the power to set their own personal compensation. The spectacular rise in corporate CEO, CFO and other C-level compensation in the last 20 or so years (from salaries, bonuses and stock options) relative to the compensation of lower-level managers, employees and even investor-owners is well known and does not require further documentation here. Locke shows in Management From Hell and at greater length in his co-authored book with J.-C. Spender, Confronting Managerialism (Zedbooks, 2011) that top managers accomplished this change by gradually shifting strategic decision-making power to themselves and away from owners. They achieved that shift largely by promoting the claim that their special post-graduate business education (especially in MBA programs of elite U.S. business schools) put them in exclusive possession of special knowledge and expertise needed to efficiently run today’s complex, global corporations.

As a consequence of successfully marketing their supposedly unique management expertise gained from exclusive access to the nation’s most elite graduate business schools, top managers in the last generation ran large American corporations with impunity. Almost never were they held accountable for the social costs of the management practices they pursued to maximize financial returns for the personal gain of the owners and their “elite” agents. In retrospect it seems clear that many of those practices seriously impaired the vitality and strength of the American economy in the past 30 or so years.

Locke demonstrates persuasively that the damaging consequences of these investor-capitalist management practices were not experienced to the same degree outside America, where management practices were guided by alternative economic philosophies that viewed the purpose of a business in terms of the interests of a much broader constituency than just investor-capitalists and their manager-agents, and not just in terms of maximizing immediate financial returns. He shows how large corporations in Germany and Japan are managed from an “entity” perspective that views success as ensuring the corporation’s long-term survival and sustainability on behalf of all its constituents – employees, customers, suppliers, communities and shareholder/owners — not just owners and their manager-agents. A firm run from an entity as opposed to a proprietary perspective measures success in terms of conditions that contribute to firm sustainability – e.g., average longevity of employees (presumes that returns on investment in humans increase with tenure of employment), employee training, customer satisfaction, reputation, quality of design and delivery, and financial returns (sufficient to flourish and develop over many generations, not maximum short-term profits).

H. Thomas Johnson

Locke cites research findings showing that American firms that are run from a proprietary perspective do report higher financial returns in the short run than do firms run from an entity perspective. In Germany or Japan, however, the entity firms, although earning less spectacular short-term returns, do earn respectable returns, and they live much, much longer. To indicate the long-term consequence of this difference, Locke cites a 2001 book by Richard Fosterand Sarah Kaplan entitled Creative Destruction: Why Companies That Are Built to Last Underperform the Market–And How to Successfully Transform Them. The authors of this book interpret the increasingly rapid rise and fall (turnover) of large corporations on American financial markets in the 20th century as evidence that the markets weed out less efficient firms by rewarding current financial performance over firm longevity. Although the authors view this outcome favorably, Locke points out that their conclusion begs the question,

“At what cost to individuals, society and Earth’s life-support system do markets achieve such outcomes?”

Indeed, in the post-1970s era of investor capitalism the “leaders” of American corporations (whether top managers working from inside a firm as agents for the investor-owners or take-over operators working for themselves from outside a firm) have pursued the goal of maximum financial returns at increasingly heavy cost to workers, communities, and government. It is not an exaggeration to say that top managers or investors no longer view a business corporation as a community of people (employees, managers, investor-owners, suppliers) serving people (customers and communities) for the economic well-being of society. Instead, they view a business corporation as a commodity with a market value/price set by traders in global financial markets. In other words, a corporation is viewed as a pool of investors’ financial capital seeking maximum returns, if not in one enterprise then by liquidating that enterprise and re-investing the capital in another enterprise ad infinitum.

Because it is assumed that financial markets obey the dogma of financial economics and value corporations according to their discounted current and expected future financial returns, then top management’s job inside a firm is to maximize those returns even if the steps management takes to do so destroy the firm by, say, off-shoring work to lower-wage countries, outsourcing supply purchases to force down prices of non-labor inputs, re-locating headquarters and bank accounts in other countries to reduce taxes and so forth. No different in principle, even if the steps taken are often more extreme, are the steps taken by an outside private equity firm that borrows funds in order to purchase a target corporation, take control and then pursue steps to increase the target firm’s market value by, say, cutting costs via layoffs, revising labor contracts to reduce wages, terminating employee pension contracts and so forth. In addition, private equity take-over firms often use their legal control of the target firm to pay themselves hefty management fees and other forms of compensation. They also borrow against the firm’s assets and draw out cash from its employee pension funds, and then use that cash to pay back the loans they borrowed to purchase the target firm originally. Eventually the private equity firm hopes to cut costs and raise the financial returns of the target firm sufficiently to re-sell it for more than their purchase price, pocket the difference, and walk away much richer. They leave behind a financially-strapped community of unemployed workers, bankrupt suppliers and tax-starved public services. In several chapters Locke enlivens his discussion of these practices with references to specific private equity take-over firms, especially Bain & Co., an example of the industrial-capitalist spirit at its most socially destructive and immoral, particularly its activities conducted in the 1980s and 1990s by Bain’s most famous partner, former Massachusetts Governor and 2012 Republican candidate for U.S. President, Mitt Romney.

This book is for anyone who is concerned about the precarious state of the US economy, including those who are, or plan to be, employed by large corporate businesses. Implicit in the book’s message is the conclusion that investor-capitalist management of “corporations-as-financial-commodities” is an important cause of the growing inequality of wealth and income in the American economy. The huge private fortunes amassed as a consequence of this inequality are being used increasingly to control elections and legislatures in the United States, threatening to replace democratic governance in American society with plutocratic control by a handful of unimaginably rich individuals, almost all of whom view the economy and society through the nineteenth-century liberal ideology of individualism and free markets.

N.B. See also the review by Dominique Turcq (Editor)

The Pure Logic of Accounting

The Pure Logic of Accounting: A Critique of the Fair Value Revolution

Yuri Biondi (yuri.biondi@free.fr)

URL: http://EconPapers.repec.org/RePEc:hal:journl:hal-00561894

Abstract

When international accounting standards were renamed to become international financial reporting standards, this seemed to imply that accounting no longer needed to exist, but rather had to be reconsidered as a part of financial communication and advertising. Does traditional accountability no longer matter? Betrayed investors and globalized stakeholders would dissent. A difference of nature continues to exist between fair values disclosed by managers and certified by auditors, and the actual performance generated by the enterprise entity through time, space, and interaction. In a world shaped by complex organizations facing unfolding changes, hazard and limited knowledge, the quest for fundamental principles of accounting is not academic. Accounting principles constitute a primary way that the creation and allocation of business incomes is governed; that is, fairly managed and regulated in the public interest, having respect to “other people interests.” This article adopts a dualistic posture that opposes the accounting conceptual frameworks based on fair value (market basis) and historical cost and revenue (process basis). The fundamental premises about the underlying economics of the enterprise entity are discussed, including the representation of the business and the concepts of asset and liability. References are made to the case of accounting for intangibles, and to the distinction between equities and liabilities. The cost and revenue accounting perspective is then defended in terms of accountability, but also from the informational viewpoint: historical accounting information plays a special role as a lighthouse in the dynamic and strategic setting of the Share Exchange. In particular, two refinements of the historical cost (and revenue) accounting model are suggested. The first one regards the treatment of earned revenues from continuing operations, and the second, the recognition of shareholders’ equity interest computed on the actual funds provided in the past, coupled with the distinction between shareholders’ equity and entity equity.

Review by: Masayoshi Noguchi

This is an interesting piece of work distributed by NEP-HIS on 2011-02-19. Historians commonly use certain indications when they specify objects, organisations or periods to be analysed. Accounting income is one such indicator in accounting, business and economic history. But it is often assumed that firms gained their income through its main business activities. However, this is not always the case. More and more so, firms diversify and generate profitability from non-core activities (such as financial transactions). In the not so distant future, historians will have to face this and therefore, pay greater attention to the accounting assumption made by specific enterprises.

Yuri Biondi

This paper is not an historical study but makes timely comments on fair value accounting as represented by International Financial Reporting Standards (IFRS), under which an accounting income is assumed to be measured though changes in the market price of net assets. The author’s attempt is in fact a rehabilitation of cost-based accounting. An approach which builds on transaction-based measurements. This paper thus adopts the so-called ‘a dualistic approach’ (p. 3) or one that contrasts results from cost-based and fair value-based approaches. It is certain that papers like this will serve as a useful frame of reference for historical research.

Bondi criticises fair value accounting which, according to him, adopts ‘a market view’:

‘The underlying economics of the business firm is not considered by measuring the entrusted wealth and related (quasi-)rents (i.e., changes of value), but instead by representing its economic and monetary process as an enterprise entity’ (p. 7).

This view assumes that ‘the business entity is framed in a world of market forces capable of addressing and solving its accounting issues’ (p. 7). Bondi adds that ‘[t]he preference for fair value is motivated by this piecemeal valuation which does not consider the whole entity and the overall representation of business capital and income to the firm’ (p. 14). Furthermore that ‘[t]he fair value perspective appears to be at odds with the nature and role of enterprise entities that actually are socio-economic systems involving continuing relationships among interested parties and which raise public interest concerns’ (p. 10).For Bondi there main problem of fair value accounting is that it might lead to ‘inconsistencies’(p. 34).

At the same time, however, the advocates of fair value accounting are not so naïve and do recognise some of its limitations. And to be fair, assume a form of market behaviour much more complex than that Bondi has represented. In a way Bondi oversimplifies assumptions of market behaviour by stating that ‘[f]air value relies on perfect and complete financial markets’ (p. 33).

Bondi insists on the rehabilitation of cost-based accounting by stating that ‘the classic accounting principles fit a broader “accountability” framework that recognises the socio-economic nature of business entities’ (p. 10). From this perspective, ‘[a]ccounting is then understood as a mode of representing, organising and regulating these socio-economic systems and their institutional, organisational, and cognitive patterns and interactions’ (p.10).

However, the criticism to fair value accounting and the support for cost-based accounting do not necessarily mean that the latter comes out as the best choice. Bondi acknowledges that cost-based accounting is in need of reform. Specifically in the areas of intangibles and shareholders’ equity.

Bondi’s ultimate goal is to contribute to the ‘ongoing effort of conceptual clarification by drawing upon theoretical debates that have been going on for at least a century with respect to fair (current) value versus historical cost accounting’ (p. 3). But as of today it is far from clear there has been substantial progress on this debate.