An introduction to

corporations
 Corporate forms reduce the costs of
organising jointly owned productive
activity…
• Facilitates coordination between participants in the business

• Handles conflicts among owners, managers and third party

contractors

• Conflicts between managers and shareholders

• Conflicts among shareholders

• Conflicts between shareholders and the corporation´s creditors, employees,

etc
 Choosing the Best Business Structure:
Questions You Should Ask

• How easy is it to set up and operate?

• What are the tax advantages and disadvantages?

• What are your potential legal liabilities?

• What happens to the business if you should die?

• How easy will it be to liquidate the business?

 Basic legal features of the business
corporation
• Legal personality

• Limited liability

• Transferable shares

• Delegated / centralized management under a board structure

• Shared ownership by contributors of capital

Legal Personality
“The company is at law a different person altogether from the
subscribers to the memorandum; and, though it may be that
after incorporation the business is precisely the same as it was
before, and the same persons are managers and the same
hands receive the profits, the company is not in law the agent
of the shareholders or a trustee for them. Nor are the
subscribers as members liable, in any shape or form, except
to the extent and in the manner provided by the Act.”
Lord MacNaghten in Salomon v Salomon & Co Ltd. (1897)
 Legal personality: a firm can…
• Have rights and obligations

• Enter into contracts

• Own its own property

• Delegate authority to agents

• Sue and be sued in its own name

 Legal personality: a firm is / has…
• Network of contractual relationships

• Common counterparty in contracts with suppliers, employees, customers, etc

• Separate patrimony: pool of assets distinct (and protected) from other assets owned
by shareholders

• Rights to…

• Use the assets

• Sell the assets

• Make assets available for attachment by creditors (of the firm, not of the owners)
 Legal personality: a firm is / has…
• Protected patrimony

• Creditors of the firm have a claim –as security for the firm´s debts- over the
firm´s assets which is prior to the claims of the personal creditors of the firm´s
owners (shareholders)

• Owners of the corporation (shareholders) cannot withdraw their share of firm

assets at will

• The personal creditors of an individual owner cannot foreclose on the owner’s

share of firm assets
 Legal personality: a firm is / has…

• Contracting party

• Law has rules specifying to third parties the individuals who have authority to
buy and sell assets in the name of the firm, and to enter into contracts that
are bonded by those assets

• Law has rules specifying the procedures by which both the firm and its
counterparties can bring lawsuits on the contracts entered into in the name
of the firm
 Limited liability
• Creditors are limited to making claims against assets owned by the firm

• Law protects the assets of the firm’s owners from the claims of the
firm’s creditors

• Business assets are pledged as security to business creditors, while the

personal assets of the business’s owners are reserved for the owners’
personal creditors

• It permits firms to isolate different lines of business (subsidiaries) for the

purpose of obtaining credit
 Limited liability
• Assists in raising debt finance even in situations where there is no
need to raise additional equity capital

• Permits flexibility in the allocation of risk and return between equity-

holders and debt-holders

• Simplifies the administration of both business and individual

bankruptcy
 Limited liability

• Facilitates tradability of the firm’s shares (isolating the value of the

firm from the personal financial affairs of the firm’s owners)

• Facilitates delegated management (shifting downside business risk

from shareholders to creditors, limited liability enlists creditors as
monitors of the firm’s managers )
 Transferable shares in ownership
• Permits the firm to conduct business uninterruptedly as the identity of
its owners changes

• Enhances the liquidity of shareholders’ interests and makes it easier

for shareholders to construct and maintain diversified investment
portfolios

• Shares may not be tradable without restriction in public markets, but

rather just transferable among limited groups of individuals or with
the approval of the current shareholders or of the corporation

• Free tradability gives the firm maximal flexibility in raising capital

 Transferable shares in ownership

• Open / Public corporation: freely tradable shares

• Closed / Private corporation: restrictions on the tradability of the

shares
 Transferable shares in ownership

• Listed / Publicly traded corporation: shares of open corporations may

be listed for trading on an organized securities exchange

• Unlisted corporation
 Transferable shares in ownership

• Closely held corporation: company’s shares may be held by a small

number of individuals whose interpersonal relationships are
important to the management of the firm

• Widely held corporation

 Delegated management with a board
structure
• Differences in the allocation of control rights

• Authority to bind the firm to contracts

• Authority to exercise the powers granted to the firm by its contracts

• Authority to direct the uses made of assets owned by the firm

 Delegated management with a board
structure
• General partnership

• Majority of partners manage the firm in the ordinary course of business

• Unanimity: more fundamental decisions

• Corporations with numerous and constantly changing owners: board

of directors periodically elected by the firm’s shareholders
 Delegated management with a board
structure: the Board of directors
• Formally separate from the operational managers of the corporation

• Different allocations of power between a firm’s directors and officers

• Two-tier boards:

• Second (managing) tier: top corporate officers

• First (supervisory): nominally independent from the firm’s hired officers

• Single-tier boards: hired officers may be members of, and even dominate, the
board itself
 Delegated management with a board
structure
• Corporate decisions that do not require shareholder approval:

• Those requiring approval by the board of directors and

• Those that can be made by the firm’s hired officers on their own authority
 Delegated management with a board
structure
• Distinction between board and hired officers

• Hired officers: initiation and execution of business decisions

• Board of directors

• Monitoring and ratification of decisions, and the hiring of the officers themselves

• Check on the quality of decision-making by hired officers

• Permits third parties to rely on a well-defined institution to formally bind the firm in its transactions with
outsiders
 Delegated management with a board
structure
• The board of directors is elected by the firm´s shareholders

• Board remains responsive to the interests of the firm’s owners

• Non-profit corporations or business trusts permit or require a board

structure, but do not require election of the board by the firm’s
(beneficial) owners
 Delegated management with a board
structure
• Board is formally distinct from shareholders

• Board avoids the need to inform the firm’s ultimate owners and
obtain their consent for all but the most fundamental decisions
regarding the firm

• Board serves as a mechanism for protecting the interests of minority

shareholders and other corporate constituencies
 Delegated management with a board
structure
• Board ordinarily has multiple members, which facilitates mutual
monitoring and checks idiosyncratic decision-making

• Exceptions: single general director or one-person board

 Investor ownership
• Right to control the firm: voting in…

• the election of directors and…

• to approve major transactions

• Right to receive the firm’s net earnings (profits)

• Rights are proportional to the amount of capital contributed to the

firm
 Investor ownership
• Investors are often the most difficult participants to protect simply by
contractual means

• Investors of capital have highly homogeneous interests among

themselves, hence reducing the potential for costly conflict among
those who share governance of the firm
 Investor ownership
• Partnership: does not presume that ownership is tied to contribution
of capital (e.g. contributors of labour)

• Corporation: investors only contribute capital

• Sometimes corporate law permits creditors or employees to

participate in control and/or earnings

• Non-profit firms: no person may participate simultaneously in both

the right to control and the right to residual earnings
 Corporations: law vs contract
• Participants in a corporation are bound by charter / articles of
association

• Basic terms of the relationship among the firm’s shareholders, and between
the shareholders and the firm’s directors and other managers

• Charter can also become part of the contract between the firm and its
employees or creditors

• Shareholder´s agreements may bind some or all shareholders

• Corporate law binds everyone

 Corporate law:
mandatory laws vs default provisions
• There may be statutory provisions that govern unless the parties
explicitly provide an alternative

• Corporate law default rules simply offer a standard form contract that
the parties can adopt to simplify contracting

• Default provisions, statutory amendments, administrative rulings, and

judicial decisions can accommodate developments that cannot easily
be foreseen at the outset by adding new rules of corporate law or by
interpreting existing rules
 Corporate law:
mandatory laws vs default provisions
• Some parties might otherwise be exploited because they are not well
informed

• Collective action problems might otherwise lead to contractual

provisions that are inefficient or unfair

• Standardizing function: the benefits of compliance increase if

everyone adheres to the same provision
 Corporate law:
mandatory laws vs default provisions

• Mandatory laws create corporate forms that are to some degree

inflexible, but then permit choice among different corporate forms

• Those who deal with the firm are reassured by the inflexibility of the
corporate structure chosen
 Corporations: regulatory competition
• Organizers of a firm may be able to choose from among the laws of
different jurisdictions

• Choice of jurisdiction in which to incorporate

• Jurisdictions may attract corporations if they have strict or liberal

corporate laws, laws that protect shareholders more or less

• Place of incorporation vs place of business

 Forces that help shape corporate norms
• Dispersed share ownership vs. Controlling shareholder

• Institutional investors: mutual funds, pension funds, hedge funds,

private equity firms

• The structure of corporate law in any given country is in important

part a consequence of that country’s particular pattern of corporate
ownership
 Forces that help shape corporate law
•P
Partnership v Company

• Easy Creation More complex

• V.little Personality Separate
• Unlimited Liability Limited
•  Members 
• All pp Management Board
Partnership v Company

• Modest Raising capital good for plcs

• No fl charge Security Float Charge

• Problems Succession No problem

• Simple Administration Complex

• Partners Property Company’s