Corporations

1
Corporations

• G751
• Eric Rasmusen, erasmuse_at_indiana.edu
• March 4, 2014

2

• The Textbook Firm
• Fixed cost, rising MC. Possibly sharp capacity.
• Other firms can enter in the long run.
• Rents and quasi-rents.
• Viners LR cost curves, including the U-shaped
  one and the CRS one.
• Natural monopoly.

3

• The Size of a Firm--- Coase
• Transaction costs vs. management costs.
• Why not one big firm?

4
Classic Papers

• Ronald H. Coase, The Nature of the Firm, 4
  ECONOMICA 386 (1937).
• Armen A. Alchian Harold Demsetz, Production,
  Information Costs, and Economic Organization, 62
  AM. ECON. REV. 777 (1972).
• Michael C. Jensen William H. Meckling, The
  Theory of the Firm Managerial Behavior, Agency
  Costs, and Ownership Structure, 3 J. FIN. ECON.
  305 (1976).
• Sanford J. Grossman Oliver D. Hart, The Costs
  and Benefits of Ownership A Theory of Vertical
  and Lateral Integration, 94 J. POL. ECON. 691
  (1986) (a firm consists of "those assets that it
  owns or over which it has control")

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What is a firm?

• Knight Assets with a residual claimant, in a
  risky situation.
• Coase A collection of assets ruled by authority.
  
• Alchian-Demsetz Monitoring framework.
• Jensen and Meckling A Nexus of Contracts. The
  shareholders arent the owners. They arent
  special.
• Hart Property owned in a particular way to avoid
  The hold-up problem.
• Me a collection of assets with the same owners
  that are used for earning money, as well,
  perhaps, as for other things. Boring, noneconomic
  definition.

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• Dimensions
• 1. Register with the state?
• 2. Required governance structure?
• 3. Legal Personality?
• 4. Limited Liability?
• 5. Tradeable ownership?
• 6. Perpetual Life?

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Entity Type Sole Proprietorship General Partnership Limited Partnership (LP) C Corporation S Corporation Limited Liability Company (LLC)
Formation No state filing required Agreement between two or more parties. No state filing required. Certificate of Formation Articles of Incorporation Articles of Incorporation (S Small Business Tax Election for the Corporation) Articles of Organization (Formation)
Duration of existence Dissolved if entity ceases doing business or upon death of the sole proprietor Dissolves upon death or withdrawal of a partner, unless agreement Perpetual Perpetual Perpetual (S Election can be terminated in which case reverts to C Corporation) Dependent on the requirements imposed by the state of formation
Liability Sole proprietor has unlimited liability Partners have unlimited liability At least one general partner has unlimited liability Shareholders are typically not responsible for the debts of the corporation Shareholders are typically not responsible for the debts of the corporation Members are not typically responsible for the debts of the LLC
Operational Requirement Relatively few legal requirements Relatively few legal requirements Some formal requirements, but less formal than corporations Board of Directors, annual meetings, and annual reporting Board of Directors, annual meetings, and annual reporting Some states impose formal requirements, but generally less formal than corporations
Management Sole proprietor has full control of management and operations Typically each partner has an equal voice, unless otherwise arranged Limited partners are excluded from management unless they serve on the Board of Directors Managed by directors who are elected by shareholders Managed by directors who are elected by shareholders Members usually have an operating agreement that outlines management can be member managed or manager managed
Taxation Not a taxable entity. Sole proprietor pays all taxes Not a taxable entity. Each partner pays tax on his/her share of income and can deduct losses against other sources of income Files taxes as a separate entity and must meet certain criteria to avoid being taxed as a corporation Taxed at the entity level. If dividends are distributed to shareholders, dividends are also taxed at the individual level. (DOUBLE TAXATION) No tax at the entity level. Income / loss is passed through to shareholders. 1-100 shareholders No non-resident aliens If properly structured, there is no tax at the entity level. Income / loss is passed through to members. IRS Default for single-member LLC is disregarded entity (pass-through) default for two or more members is partnership taxation. (NOTE entity can also elect corporate taxation (C or S-Corp)
Pass through income/loss Yes Yes Yes, if requirements are fulfilled No Yes Yes
Transferability of interest No No Yes, pending approval Shares of stock are easily transferred Yes, observing IRS regulations Possible, dependent on operating agreement restrictions

• Sole Proprietorship, Partnership
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• Trusts
• These are NOT contracts.
• The grantor gives property to the trust, under
  care of a trustee. The trustee has legal title
  (ownership). The grantor says who the beneficiary
  is--- who has the equitable title.
• The trust pays tax, but is not a legal
  person---it cannot sue. No registration with the
  state is needed, unless it is a charity.
• Civil law countries dont have trusts.

9

• Nonprofit Corporations and Charitable Tursts
• They raise capital through donations.
• They may or may not be tax exempt--- they are if
  they are a nonpolitical charity.
• They file form 990.
• http//www.rockefellerfoundation.org/uploads/files
  /27cb690a-bfce-4ff9-a839-80bca57ee49a.pdf

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• Corporate Objectives
• To help shareholders? Stakeholders?
• Profit? Religion? Daytime Baseball?
• Duty of Loyalty
• Duty of Care
• Business Judgement Rule

11

• Hansmann and Reinier Kraakman,
• Henry Hansmann and Reinier Kraakman, The End of
  History for Corporate Law, 89 GEORGETOWN L. J.
  439 (2001)
• Henry Hansmann and Reinier Kraakman, REFLECTIONS
  ON THE END OF HISTORY FOR CORPORATE LAW, August
  2011 http//ssrn.com/abstract2095419
  Forthcoming in Abdul Rasheed and Toru Yoshikawa,
  eds., Convergence of Corporate Governance
  Promise and Prospects (Palgrave-MacMillan 2012).

12

• Eisenberg
• Melvin A. Eisenberg, The Conception That the
  Corporation Is a Nexus of Contracts, and the Dual
  Nature of the Firm , 24 J. Corp. L. 819 (1998),
  http//scholarship.law.berkeley.edu/facpubs/547