A Blog by Jonathan Low


Oct 26, 2016

The Golden West: Why Do Companies Want To Be Headquartered In A High Tax State Like California?

Iconic former Citibank CEO Walter Wriston once said that 'capital goes where it's welcome and stays where it's well treated.' That was a concise distillation of basic economic theory, suggesting that money and those who invest it seek the highest return.

So the reason why so many companies are seemingly defying that logic and locating - or even re-locating - in a high tax, heavily regulated and expensive cost-of-living  state like California is indicative of how the growing power of intangibles has changed the nature of the investment calculation in the digital era.

Taxes are but one consideration. Of equal and possibly greater concern is the availability of talent; of savvy investors and venture capitalists who better understand the attendant risks and are willing to assess them; and of the network effect generated by the concentration of knowledge, intellectual, human and social capital which combines to create billion dollar 'unicorn' startups and winner-take-all enterprises.  And yes, the weather's pretty awesome, too.

The reality is that just as technology has reshaped how we live and work, so has it reframed our thinking about the measures that matter. JL

Steven Solomon reports in the New York Times:

One might have expected that high-regulation, high-cost, high-tax states like California would decline over time as companies migrated. (But) one out of five companies on the New York Stock Exchange and the Nasdaq stock market hail from that state. What appears is a winner-take-all system because it already has a significant base of growth companies attracting yet more people to feed off the infrastructure and then create yet more new, big companies.
California is the capital of American business. One out of five companies on the New York Stock Exchange and the Nasdaq stock market hail from that state, according to my recent assessment of relevant data.
The figures show that when it comes to formation of public companies, the rich states are getting richer while the rest are in slow decline.
Compiling data from public filings and adding in missing data from SDC Platinum and CRSP/Compustat, databases that track headquarters information, I examined where public companies had their headquarters from 1965 through 2013. From 1965 through 1979, 10.07 percent of public companies were based in California. The number has continued to grow, so that from 2000-13, 19.46 percent of public companies had their headquarters in California.
That’s an astounding number. A state with 12 percent of our population now accounts for a fifth of all public companies. (In the 1970s, California was about 10 percent of the United States population.)
Other states, meanwhile, are in decline. Ohio had 5.58 percent and Pennsylvania had 5.9 percent of public listings in the 1965-79 period. But from 2000 through 2013, Ohio had 2.58 percent and Pennsylvania 3.78 percent of public company headquarters.
Illinois’s decline was even starker, as it slid to 3.62 percent from 6.42 percent of public company headquarters. The reason for the decline may be obvious as the old manufacturing base went into decline. The appellation Rust Belt rings true to a large degree for these states as old companies disappear and are not replaced with new ones.
Yet the decline is not just in the industrial Midwest. New York and New Jersey also fell. New York fell to 8.31 percent of public company listings from 11.32 percent, while New Jersey slipped to 4.53 percent from 5.62 percent.
Other states have had growth. Texas rose to 10.26 percent of public companies from 8.38 percent. Massachusetts climbed to 5.12 percent from 3.95 percent. The state is home to technology and pharmaceuticals, two of the biggest growth industries in the United States.
Still, the concentration of American corporate might is stark. Nearly 40 percent of all public companies are in just four states: California, Massachusetts, New York and Texas. Three of them — California, New York and Texas — account for a third of the Fortune 500.
And the trend is accelerating. In the last 12 months, California, Massachusetts, New York and Texas accounted for 50 percent of all initial public offerings by operating companies, according to Standard & Poor’s Global Market Intelligence.
The geographical shift reflects a changing world. The five biggest companies in the United States by market value are all technology companies — Apple, Amazon, Facebook, Google and Microsoft — three of them with headquarters in California. Not one existed in 1965. The tech phenomenon has benefited California more than all other states, a rise that seems to be unabated.
The continued emergence of biotechnology as the other main growth engine of new public company formation appears to be helping California, Massachusetts and Texas, the three states that have long held the lead in this industry.
These three stand out as the winners. Why would three very different states perform so well?
One might have expected that high-regulation, high-cost, high-tax states like California would decline over time as companies migrated. Texas, of course, offers a different situation. Yet it is not alone among states offering lower taxes and lower regulatory costs.
And then what is one to make of Massachusetts, a relatively small state that is punching above its weight? It has regulation and taxes, and yet also business competitiveness.
There is no special formula for states to be homes to companies. Instead, what appears to be going on is a winner-take-all system.
California is a good example. It is a state burdened with a high tax rate, significant regulation and extreme housing costs. It is the type of place that you would think would lose business. But instead, California is winning at creating public companies. This may be because it already has a significant base of growth companies attracting yet more people to feed off the infrastructure and then create yet more new, big companies. Similar arguments can be made about Massachusetts and the natural network that its biotechnology companies and universities create.
Compare this with Texas, which is known for having good hospitals and generates companies in more divergent fields. This may indeed be helped by a more business-friendly environment, but it is more likely a result of the centers that have developed in these fields.
New York is increasingly the home of finance companies with a sprinkling of health care companies. But its people’s skills are more associated with media, fashion, finance and consumer companies. Gone are the days when any big corporation would make New York its home because that was the place to be.
This is not to say that other states are not successful in business. South Carolina and Alabama, for example, have successfully created manufacturing hubs by creating nonunion, business-friendly environments.
Nor does it mean that these states are entrepreneurial. The Kauffman Index of Start-Up Activity tracks new business formation. It lists Texas, Florida, California, New York and Colorado as those with the most activity. There is some overlap here, but entrepreneurial bent does not mean success at creating public companies.
There needs to be more study of why certain states nurture and attract public companies.
For these states, the economic benefits are not just from those companies alone. There are also secondary effects. The advisers to these companies — the lawyers, the bankers
will increasingly be pulled from their New York homes, particularly to the West Coast. As the new crop of unicorns — start-ups valued at more than $1 billion — goes public, even at reduced valuations, this pull will continue and the big services that are the specialization of New York are likely to spread out even more to these other states.
The country is still going West, it seems.


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