THE CORPORATION The Financial Cycle The Four Legal Forms of Firms 1 2 3 4 Sole Proprietorships Partnerships and Limited Partnerships Limited Liability Companies Corporations Main differences along two dimensions Liability Taxation of profits Types of U S Firms Source www bizstats com Forming a Corporation A corporation is a legally defined artificial being separate from its owners Must be legally formed incorporated many in Delaware Corporate charter specifies the initial rules that govern how the corporation is run A corporation is solely responsible for its own obligations Limited liability for owners Ownership of a Corporation The entire ownership stake of a corporation is divided into shares forms the equity of the corporation Shareholders are entitled to dividend payments Shareholders have voting rights Larger ownership usually means larger share of dividends and more votes Tax Implications for Corporations A corporation s profits are subject to taxation separate from its owners tax obligations Shareholders of a corporation pay taxes twice double taxation The corporation pays tax on its profits When remaining profits are distributed to the shareholders the shareholders pay personal taxes on these dividends Exception S Corporations Example You are a shareholder in a corporation that earns 4 per share before taxes Once it has paid taxes it distributes the rest of its earnings to you as a dividend The corporate tax rate is 34 and the personal tax rate on dividend income is 15 How much is left for you after all taxes are paid Solution The earned 4 per share but must pay 0 34 4 1 36 to the government in corporate taxes That leaves 2 64 to distribute Next you must pay 0 25 2 64 0 396 in income taxes which leaves leaving 2 64 0 396 2 244 per share Thus your total effective tax rate is 1 756 4 43 9 Private or Public Corporations can be private or public A private corporation has a limited number of owners and there is no organized market for its shares A public corporation has many owners and its shares trade on an organized market e g NYSE NASDAQ Ownership versus Control In a corporation ownership and direct control are typically separate Shareholders have no direct control Board of Directors Elected by shareholders Have ultimate decision making authority Among main tasks hiring and firing CEO Chief Executive Officer CEO Board typically delegates day to day decision making to the CEO Organizational Chart of a Typical Corporation Ownership versus Control cont Goal of owners shareholders Shareholders want management to make decisions that maximizes the value of their shares Agency Problems Managers may act in their own interest rather than in the best interest of the shareholders How can the interests be better aligned