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Introduction
Corporations were not always private as they are today
o
Law was passed in 1819 establishing that property of corporation is
private and entitled to protection under constitution
o
Protection from property seizure by the state or federal government
1.1 Four Types of Firms
Sole proprietorship
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Business owned and run by one person
o
Most common type of firm in the world
o
Dont generate that much revenue
o
Key characteristics:
Straightforward to set up
trasnfer ownership)
o
Disadvantages generally outweigh advantages
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If firm reaches point where it can borrow without owner agreeing to be
personally liable, owners typically convert business into a form that limits
owner's liability
Partnership
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Identical to sole proprietorship but more than one owner
o
Key characteristics:
All partners liable for firm's debt (any partner may be required to
pay debt
Partnership ends on death/withdrawal of any single partner (can
Interest is transferable
No management authority
o
Limited partnership without a general partner
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All owners have limited liability, but can still run the business
Corporations
o
Legally defined, artificial being separate from its owners
o
Has many legal power that people have
Can enter into contracts, acquire assets, incur obligations
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Owners (employees, customers, etc.) not liable for any obligations the
corporation enters into
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Corporation not liable for any personal obligations of its owners
o
Formation
Must be legally formed (state gives a charter)
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Ownership
No limit on owners
economy
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First, corporation pays tax on profits
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Then when remaining proftis distrivuted to shareholders, shareholders
pay their own personal income tox on this income
S corporations
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Exempt from double taxation
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S corporations are corporations that elect subchapter S tax
treamtmnet
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Firm's porfits are not subject to corporate taxes, but instead are
allocated directly to shareholders based on their ownership share
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Shareholders must include profits as income on individual tax returns
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Less than 1/4 of all corporate revenue
C corporations
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Majority of corporations
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Subject to corporate taxes
1.2 Ownership versus Control of Corporations
Direct control and ownership are separate- too many owners
owners
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Financing decisions
Decide how to pay for investments
o
Cash management
Must ensure enough cash on hand to meet day to day
better off if management makes decisions that increase the value of their
shares
The Firm and Society
Increasing value of equity is good for society (ex. iPhone)
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Managers, despite being hired as agents of shareholders, put their own
self interest ahead of interest of shareholders
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Solution is to minize number of decisions managers must make for
shareholders
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Ex. Manager compensation contracts (top manager salaries are usually
tied to corporation's porfits or stock price)
large fraction of the stock and acquire enough votes to replace the
board of directors and CEO
Usually threat of being removed is often enough to discipline
bad manager
o
When a corporation is doing well, more people want to buy their stock,
which drives stock price up- this gives opinion to corporate leaders of their
performcance
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Corporate bankruptcy
When corporation is in debt, holders of the firm's debt also
ownership of the firm with control passing from equity holders to debt
holders
Bankruptcy doesnt need to result in liquidation of the firm
o
Determine a market price for company's shares
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Investment is liquid if it is possible to sell quickly and easily for a price
close to what you bought it for
o
Liquidity attractive to outside investors because it provides flexibility
regarding timing and duration of investment in the firm
Research and trading of participatns in these markets gives rise to share
prices
Primary market: when a corp issues new shares of stock and sells them to
investors
Secondary market: where stock is traded after initial transaction
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Ex. When you buy SBUX shares, you buy from someone who already
held shares not Starbucks itself
Traditional Trading Venues
Firm chooses one stock exchange on which to list its stock
Because computers now math buy and sell orders, anyone can make a
market in a stock by posting a limit order (an order to buy or sell a set amount
at a fixed price)
Bid ask spread determined by outstanding limit orders
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Limit sell order with lowest price is ask price
o
Limit buy order with the highest price is the bid price
Limit order book: collection of all limit orders
Exchanges make limit order books public so investors can see best bid and
ask prices
Traders who post limit orders provide market with liquidity
Traders who place market orders (order that trade immediately at the best
many times per second in response to new information and other orders,
profiting both from providing liquidy and taking advantage of stale limit orders
Dark
Pools
Alternative trading system
Don't make their limit order books visible
Offer investors ability to trade at better price
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Tradeoff is the order might not be filled if an excess of either buy or sell
orders is received
Liquidity is the key factor
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Markets experimenting with how to promote liquidity
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Encourage traders who provide liquidity
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Discourage traders who take advantage of stale limit orders