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The Corporate Pyramid Fable

By Harvard Law School Program on Corporate Governance

In our paper, The Corporate Pyramid Fable, which was recently published on SSRN, we investigate the impact intercorporate taxation of dividends had on corporate pyramids. Intercorporate taxation of dividends became a permanent feature of the U.S. tax landscape in 1935. Correspondingly, to assess the impact of this change, we rely on a pioneering hand-collected dataset based on filings made between 1936 and 1938 with the Securities and Exchange Commission by investors owning 10% or more of shares of corporations registered with the Commission. To the extent that the received wisdom concerning tax and corporate pyramids is correct, the introduction of taxation on intercorporate dividends in 1935 should have prompted the rapid unwinding of corporate-held ownership blocks in public companies, thus causing the simplification of complex group structures, including pyramidal arrangements.

Our results indicate matters worked out much differently. Although politicians may have supported the intercorporate dividends tax because they believed that it would induce corporations to unwind stakes held in other publicly traded corporations, tax reform apparently did not have that effect. Corporations that owned large stakes in publicly traded firms rarely sought to exit in the years immediately following the introduction of intercorporate taxation of dividends, and many corporations even increased their ownership stakes in other corporations. A key reason the introduction of intercorporate taxation of dividends did not have the anticipated impact was that the tax burden was so modest. Although dividends by one corporation to another corporation were no longer completely tax-free, they remained largely exempt.

If the thesis that tax caused the dismantling of pyramidal arrangements ultimately is more fable than truth, why are complex corporate groups apparently so rare in the U.S.? History likely played an important role. There is a dearth of pre-1935 data on the extent to which corporations were major holders of stock in publicly traded firms. However, the available evidence suggests that, the utilities sector aside, corporate pyramids were not an endemic feature of corporate ownership in the U.S. prior to the introduction of intercorporate dividend taxation. Correspondingly, there simply were not a large number of corporate pyramids for tax to hit and those that did exist were typically dismantled as a result of the Public Utility Holding Company Act of 1935.

In making this claim, we are not suggesting tax was irrelevant to the nature and extent of corporate ownership of shares. During the mid-1930s U.S. lawmakers introduced various changes to the law intended to simplify complex corporate structures and these likely did prompt a response. However, with corporate pyramids, or more correctly the lack thereof, intercorporate taxation of dividends was not a decisive factor.

The full paper is available for download here.

Full post as published by The Harvard Law School Corporate Governance Blog on March 05, 2010 (boomark / email).