The Fable of the B.A.'s: Network Externalities and the Choice of Business Form


Recent papers have asserted the applicability of the "network externalities" literature to the choice of business form. This paper critically examines these claims. We show why network externalities theoretically should be expected to have only a minimal effect on the choice of business form. We then directly examine the empirical significance of network externalities by comparing recent formation data on limited liability companies (LLCs) and limited liability partnerships (LLPs). The two forms are close substitutes, the main exception being that the LLP is explicitly linked to the "network" of partnership law, while the LLC is not. The network externalities hypothesis predicts that LLPs would be adopted at a much greater rate than LLCs. This hypothesis is rejected, as we find that the non-linked form, the LLC, has far outperformed the LLP in terms of new formations in every state. The limited empirical relevance of network externalities is further demonstrated by the fact that the relative LLP adoption rate is significantly greater in states that tax LLCs as corporations than in states that tax LLCs and LLPs equally.