Organizational form choice and the valuation of oil and gas producers

Abstract

SYNOPSIS AND INTRODUCTION: The Tax Reform Act of 1986 reduced individual income tax rates below that of corporations. The fear that this would lead to a systematic disincorporation has not apparently materialized since the major stock exchanges report that only about 100 partnerships were traded during the next five years.1 Scholes and Wolfson (1992) suggest that this result is predictable because of the additional nontax costs of operating as a partnership, which include increased transactions costs, more restricted access to capital markets, and less control over management. Guenther (1992) and Terando and Omer (1992) provide evidence that firms must have considered both tax and nontax costs when choosing organizational form. This study examines whether the factors taken into consideration in organizational form choice also affected the market value of a sample of firms in the oil and gas industry during the period 1985-1988. We chose for our tests a valuation model used by Harris and Ohlson (1987) and others2 since many of the publicly traded (master limited) partnerships (MLPs) were created in the oil industry. The studies by Guenther (1992) and Terando and Omer (1992) show that MLPs generally had only one line of business, less debt, and higher dividend yields than their corporate counterparts. These differences are predictable in view of the tax consequences of operating in the partnership form. Guenther also finds MLPs to be less profitable, which is consistent with higher nontax costs of the partnership form. We show that MLPs in-

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