I. INTRODUCTION
a. General Characteristics of the Corporation
i. Basic Attributes of a Corporation
1. Separate Entity with Perpetual Existence
a. Entity
i. Owners (Shareholders)
ii. Operators (Management)
b. Perpetual
i. Existence continues regardless of individuals associated with it (directors die in a plane crash).
ii. May be dissolved formally, via process.
2. Limited Liability
a. Shareholders are insulated from corporation’s obligations.
b. Shareholder’s personal liability is limited to original amount of investment.
i. Narrow exceptions do exist.
3. Centralized Management
a. Many shareholders delegate operational authority to a few officers.
b. Ownership separated from management.
c. “Closely held” corporation – shareholders and officers may be the same people.
4. Transferability of Ownership Interests
a. Ownership is a property interest that may be bought and sold, or otherwise transferred.
ii. Corporations are separate from people, but may act ONLY through people.
b. Introduction to Economics of the Firm
i. The Nature of Risk (Ex: The Winery Problem – Employment vs. Tenancy arrangement)
1. Risk Preference
a. Risk Neutral
i. Makes decisions based on the “expected return” of the venture.
ii. Utilizes probability analysis.
b. Risk Averse
i. Makes decisions based on minimized risks (will pay to avoid risks).
c. Risk Premium (Risk-loving)
i. Makes decisions based on maximizing potential return, disregarding risk.
2. Ex. Class grade scenario
a. Option 1: certain grade based on perfect attendance.
b. Option 2: final exam
c. Choice depends on potential reward (“expected return”) and potential risks.
ii. Types of Risk
1. Controllable
a. Ex.: How hard Bill works.
2. Uncontrollable
a. Ex.; weather, demand.
iii. Allocation of Risk – Drives the Preferred Business Model
1. Employment
a. Bill gets paid regardless of results
b. Ann bears the risks
i. Mitigated by
1. supervision (herself or another)
2. an employment contract (w/goals and expectations)
3. incentives
4. Must encourage/require “best efforts” of Bill.
2. Tenancy
a. Bill is paid on the fruits of his labor
b. Ann is guaranteed rent
c. Bill shoulders the risk
i. Risks of his own shirking/self-enforcing incentive to produce.
d. Possible conflicts
i. Difference in timelines
1. Ann has long view.
2. Bill wants to get paid now.
3. May affect treatment of the land – growing techniques.
Employment
Tenancy
Risk to Ann
HIGH
LOW
Risk to Bill
LOW
HIGH
Bill’s Incentive
LOW
HIGH
Costs of Monitoring
HIGH
LOW
3. Hybrid – Shared Risks – Partnership
a. Shared risks and responsibilities btw parties
b. Guaranteed payments soothe risk aversion while providing sufficient incentives for performance maximization.
iv. Information Costs
1. Costs associating with discovering info on state of labor and winery
v. Contracting Costs
1. Costs associated with operation of K.
vi. Supervision Costs
1. Costs associated with supervisi
corporation are challenged, the burden is on the director not only to prove the good faith of the transaction but also to show its inherent fairness from the viewpoint of the corporation and those interested therein.”
d. Majority shareholder’s action must not be so detrimental to the corporation as to create inference that interests of the majority shareholders lie wholly outside of and in opposition to the interests of the corporation, and that their action is a wanton or a fraudulent destruction of the rights of the minority.
i. GAMBLE v. QUEENS COUNTY WATER CO., NY, 1890
1. Minority shareholders sue to block corporation’s purchase of water pipe system from a significant shareholder.
iii. Chesapeake Marine Services PROBLEM – Part I
1. Chesapeake Marine Services – Background
a. Closely-held corporation
b. Articles of Incorporation provide for 1,000 shares of stock to be available for sale.
i. Currently, all shares are owned by individuals.
ii. John Apple owns 350 shares in the company (35%). Members of the Lambert family own the other 650 shares (65%) collectively.
c. The corporation has a five-member Board of Directors including CMS President Jim Lambert, Nancy Carter, John Apple and two other members of the Lambert family.
2. PROBLEM – Company needs additional capital for equipment & facility upgrades, plus operating cash.
a. Sources of Corporate Capital
i. Equity offering – sell stock
ii. Corporate Debt –Bonds & Investment-grade debt
iii.
