CHAPTER6Firms, the Stock Market.and Corporate GovernanceChapterOutlineandLearningObjectivesehn6.1TypesofFirms6.2The Structure ofCorporations and thePrincipal-Agent Problem6.3HowFirms RaiseFunds6.4UsingFinancial StatementstoAnalyze a Corporation6.5Corporate GovernanceNASDAOPolicy and theFinancialCrisisof2007-2009Appendix:ToolstoAnalyzeFirms'Financial Information
1 Chapter Outline and Learning Objectives 6.1 Types of Firms 6.2 The Structure of Corporations and the Principal-Agent Problem 6.3 How Firms Raise Funds 6.4 Using Financial Statements to Analyze a Corporation 6.5 Corporate Governance Policy and the Financial Crisis of 2007-2009 Appendix: Tools to Analyze Firms’ Financial Information CHAPTER 6 CHAPTER Firms, the Stock Market, and Corporate Governance
WhyFirmStructure,Finance,andGovernance?In this chapter we will examine how firms are run:Howtheyareorganized,.How they obtain financing,How they convey information to the public, andWhether they act in the best interest of their owners.Each of theseitems affecthowfirmsbehave,and whattheiroverallimpact on the economy will be.@2015PearsonEducation,Inc
© 2015 Pearson Education, Inc. 2 Why Firm Structure, Finance, and Governance? In this chapter we will examine how firms are run: • How they are organized, • How they obtain financing, • How they convey information to the public, and • Whether they act in the best interest of their owners. Each of these items affect how firms behave, and what their overall impact on the economy will be
TypesofFirms6.1LEARNINGOBJECTIVECategorizethemajortypesoffirmsintheUnitedStates@2015PearsonEducation,lnc3
LEARNING OBJECTIVE © 2015 Pearson Education, Inc. 3 Types of Firms 6.1 Categorize the major types of firms in the United States
TheTypes of FirmsFirms are legally categorized in the U.S. as one of the following:SoleproprietorshipA firm owned by a single individual and not organized as acorporation.Partnership:A firm owned jointly by two or more persons and not organized as acorporation.Corporation:A legal form of business that provides owners with protection fromlosing more than their investment should the business fail.@2015PearsonEducation,Inc
© 2015 Pearson Education, Inc. 4 The Types of Firms Firms are legally categorized in the U.S. as one of the following: Sole proprietorship: A firm owned by a single individual and not organized as a corporation. Partnership: A firm owned jointly by two or more persons and not organized as a corporation. Corporation: A legal form of business that provides owners with protection from losing more than their investment should the business fail
WhoIs Liable?Limited and Unlimited LiabilityIn soleproprietorships and partnerships,no legal distinction ismadebetween the assets of the firm and the assets of its owner(s).Asset:Anythingofvalueownedbyapersonorafirm.This is not the case for corporations. The owners of corporationshave limited liability, a legal provision shielding owners of thecorporation from losing more than they have invested inthe firmLimited liability makes raising funds easier for a firm; it also makesinvestinginfirmseasierforindividuals2015PearsonEducation,Inc
© 2015 Pearson Education, Inc. 5 Who Is Liable? Limited and Unlimited Liability In sole proprietorships and partnerships, no legal distinction is made between the assets of the firm and the assets of its owner(s). Asset: Anything of value owned by a person or a firm. This is not the case for corporations. The owners of corporations have limited liability, a legal provision shielding owners of the corporation from losing more than they have invested in the firm. Limited liability makes raising funds easier for a firm; it also makes investing in firms easier for individuals
DifferencesamongBusinessOrganizationsCorporationSoleProprietorshipPartnershipAdvantages.Control byowner Limited personal·Ability to shareworkliability·No layers of·Ability to share risks.Greater ability tomanagementraisefundss.Unlimitedpersonal. Unlimited personalDisadvantages· Costly to organizeliabilityliability.Limited ability to· Limited ability to raise·Possibledoublefundsraisefundstaxation ofincomeTable 6.1Differences amongbusiness organizationsThereisnotauniquebestbusinessstructure.Corporations benefit from limited liability but are expensive toorganize.Also, their profits may be taxed twice: once as corporate profits andagain when the profits are disbursed to investors.6@2015PearsonEducation,lnc
© 2015 Pearson Education, Inc. 6 Differences among Business Organizations There is not a unique best business structure. Corporations benefit from limited liability but are expensive to organize. Also, their profits may be taxed twice: once as corporate profits and again when the profits are disbursed to investors. Differences among business organizations Table 6.1 Sole Proprietorship Partnership Corporation Advantages • Control by owner • No layers of management • Ability to share work • Ability to share risks • Limited personal liability • Greater ability to raise funds Disadvantages • Unlimited personal liability • Unlimited personal liability • Costly to organize • Limited ability to raise funds • Limited ability to raise funds • Possible double taxation of income
Proportionsof BusinessOrganizationsSoleproprietorships4%SoleSoleproprietorshipsPartnershipsCorporationsproprietorships14%14%18%72%PartnershipsPartnerships10%26%CorporationsCorporations82%60%(a)Numberoffirms(c) Profits(b) RevenueFigure 6.1Business organizations:soleproprietorships,partnershipsandcorporationsNearly/of firms aresoleproprietorships, and just one insixis acorporationBut since larger firms tend to be corporations, most economic activitytakes placethrough them@2015PearsonEducation,Inc
© 2015 Pearson Education, Inc. 7 Proportions of Business Organizations Nearly ¾ of firms are sole proprietorships, and just one in six is a corporation. But since larger firms tend to be corporations, most economic activity takes place through them. Business organizations: sole proprietorships, partnerships, and corporations Figure 6.1 (a) Number of firms (b) Revenue (c) Profits
MakingTheImportanceof Small BusinesstheConnectionMost economistsPrivate 55,000employmentargue that smallbyfirmsize500ormoreemployees(thousands 50.000ofworkers)firms are vital45,000to the healthof the economy.40,00035,000In a typical year,1-49employeesnewsmall firms30,000create 3.3 million25,00050-499employeesjobs—40% of all20,00019901995200020052010new jobscreated.Similarly, while large firms may be good at improving existingproducts, small firms are often better at creating new and innovativeproducts and services.Also, small firms are less likely to lay off workers during a recession(red bars on the graph)2015PearsonEducation,Inc.8
© 2015 Pearson Education, Inc. 8 Making the Connection The Importance of Small Business Most economists argue that small firms are vital to the health of the economy. • In a typical year, new small firms create 3.3 million jobs—40% of all new jobs created. Similarly, while large firms may be good at improving existing products, small firms are often better at creating new and innovative products and services. Also, small firms are less likely to lay off workers during a recession (red bars on the graph)
TheStructureofCorporationsandthePrincipal-AgentProblem6.2LEARNINGOBJECTIVEDescribethetypicalmanagementstructureofcorporationsandunderstandtheconceptsofseparation of ownershipfromcontrol andtheprincipal-agentproblem.@2015PearsonEducafion,lnc
LEARNING OBJECTIVE © 2015 Pearson Education, Inc. 9 The Structure of Corporations and the Principal–Agent Problem 6.2 Describe the typical management structure of corporations and understand the concepts of separation of ownership from control and the principal–agent problem
Corporate Structureand Corporate GovernanceIn soleproprietorshipsand partnerships, theowners of thefirmaretypically involved in day-to-day decisions at the firm.This is not the case for larger corporations; they usually haveseparation of ownership from control.Separation of ownership from control:a situation in a corporationin which the top management, rather than the shareholders, controlsday-to-dayoperations.Owners designate a board of directors,who appoint a chiefexecutiveofficer (CEO)to oversee day-to-day operations,perhaps along withothermembersoftopmanagement.102015PearsonEducation,Inc
© 2015 Pearson Education, Inc. 10 Corporate Structure and Corporate Governance In sole proprietorships and partnerships, the owners of the firm are typically involved in day-to-day decisions at the firm. This is not the case for larger corporations; they usually have separation of ownership from control. Separation of ownership from control: a situation in a corporation in which the top management, rather than the shareholders, controls day-to-day operations. Owners designate a board of directors, who appoint a chief executive officer (CEO) to oversee day-to-day operations, perhaps along with other members of top management