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Business Associations/Corporations
South Texas College of Law Houston
McGovern, Bruce A.

Spring 2004 – Professor McGovern

Chapter 1: Introduction
· Four basic attributes of a corporation:
o (1) Separate entity with perpetual existence
o (2) Limited liability
o (3) Centralized management
o (4) Transferability of ownership interests

Chapter 2: Introduction to the Economics of the Firm
· Business Risks
o Two categories:
§ (1) Non-controllable
· The weather, the state of the economy, the level of interest rates, market prices, etc
· They cannot be completely eliminated
· Ways to limit non-controllable risks
o (1) They could pool the cost of these risks with others who also bear them – by purchasing insurance, for example
o (2) To participate in numerous ventures, each involving risks different from the others
o (3) To allocate the burden (and benefits) of the risk to the person most willing to bear it – which may well turn on who is in a better position to insure or diversify
§ (2) Controllable
· Relates to the specific business: its competitive position, its product line, the quality of its management, the adequacy of its physical plant, etc
· Are those which the parties, by acting or not acting, can affect
· Shirking – When a person does less than is optimal to control a risk
· Moral hazard – The danger that a person who does not bear a risk will not take steps to control that risk
· To avoid the agent’s self-interested shirking, the principal must monitor the agent to ensure that he takes risk reducing precautions
o Risk Preference
§ (1) Risk Neutral
· Make decisions based solely on expected returns (the sum of each possible return multiplied by the probability of that return)
§ (2) Risk Averse
· A risk averse person takes the magnitude of risk (along with expected return) into account when making a decision
§ Risk Premium – How much a risk avoider would pay to obtain certainty
§ (3) Risk Loving
· Takes the magnitude of risk (along with the expected return) into account
· Allocating Business Risks Within the Firm
o Allocating risks to the principal
o Allocating risks to the agent
o Searching for a middle ground
· The Role of Law in Allocating Business Risks
o Mandatory and Default Rules
§ Defaults specify the parties’ relationship, unless they provide otherwise.
§ Enabling rules
· The parties can take them or not
· Significantly lower the costs of entering into a firm relationship by providing the rules that the parties presumably would have identified and negotiated for themselves
o Types of Default Rules
§ Majo

§ Stockholders or shareholders – Own the corporation
§ Board of directors – Responsible for managing or supervising the corporation’s business
· Inside directors – Individuals who are corporate employees and affiliates
· Outside directors – Individuals who generally have no other affiliation with the corporation
· When directors act in their capacity as directors, they are supposed to represent the interests of the corporation and are not considered employees of the corporation.
o 6. Corporate securities
§ Common stock
§ Preferred stock
· Represent financial rights with certain priorities over the common stock
§ The corporation’s articles of incorporation specify how many shares of common and preferred stock the corporation is authorized to issue
§ More stock can be issued only if the articles are amended
§ The portion of the authorized stock that has been sold and remains in the hands of stockholders is the stock outstanding
A corporation’s board of directors generally is free to s