I.                 Nature of the Firm:
A.   Reasons to form corporation
1)Â Â Â Â Â Limited liability of shareholders (# 1 reason)
a)Â Â Â Â Â investors risk only the purchase price paid for the shares and have no additional liability
b)Â Â Â Â insulates shareholder personal assets from corporate debt
2)Â Â Â Â Â Shareholder diversification:Â ways to pool cash in multiple corps.
3)Â Â Â Â Â Perpetual existence of the corporation
a)Â Â Â Â Â legal status is not affected by death, withdrawal, insolvency of a shareholder
4)Â Â Â Â Â Easy transferability of ownership interests (liquidity)
a)Â Â Â Â Â shares are freely tradable which makes secondary mkt
5)Â Â Â Â Â Centralized management
a)Â Â Â Â Â investors delegate most authority to directors to run corp. and can only be removed for cause
6)Â Â Â Â Â Tax considerations (may be double taxed so may not form corp.)
B.    The Players:
1)Â Â Â Â Â Shareholders: stock owners (who the corporation is supposed to be ran/benefit but not much power)
a)Â Â Â Â Â 2 main responsibilities
a.     Elect and remove members of the board of directors
b.     approve or disapprove major changes in corp (mergers) presented by directors
b)Â Â Â Â Types
a.     Individual investors
b.     Institutional Investors
c)Â Â Â Â Â must have a quorum to act: majority of outstanding shares
d)    Usually control C-corp and don’t rely on directors (shareholders may be the directors)
e)Â Â Â Â Â action by shareholder cannot bind corp to 3rd party liability
f)      can’t tell directors what to do but if directors don’t do what shareholders want then the shareholders will remove the obstinate directors
2)Â Â Â Â Â Directors/Board of Directors (CEO usually chairs)
a)Â Â Â Â Â Main responsibilities
a.     formulate major policy (often must be approved by shareholders)
b.     appoint officer to carry out the policy (day to day operations)
c.      declares dividends
b)Â Â Â Â Key issue:Â What is required for directors actions to be valid?
a.     must at least have a quorum to act: majority of directors must be at meeting where all can hear each other (most state allow tele-conferences) and it takes a majority of those (in the quorum) present
                                                                                                                                     i.     look for self-interested transactions
                                                                                                                                   ii.     quorum can always ratify an action after it has occurred
c)Â Â Â Â Â traditionally had to have at least 3 directors but many state now allow you to have less than 3 so long as it is equal to the number of shareholders
d)Â Â Â Â 2 types
a.     Inside directors – employee of company (CEO)
b.     Outside directors – non- employees
                                                                                                                                     i.     still might be affiliated with corp. (attorney)
                                                                                                                                   ii.     officers of other corps, university presidents, foundation executives, former public officials, academics
e)Â Â Â Â Â shareholders cannot order board to take any specific action
f)      Don’t do much in large public corp because officers mostly run corp under supervision of directors
3)Â Â Â Â Â Managers/Officers: day to day decision making authority
a)Â Â Â Â Â Hire employees, run day to day operations (corporate managers are business executives employed to run business on full time basis)
b)Â Â Â Â Officers serve at will of the board and are agents of the board
c)Â Â Â Â Â Key issue:Â was action of officer authorized (express, implied, apparent, ratification)
4)Â Â Â Â Â Employees
5)     Others – suppliers, creditors, customers, community
C.   Conflict of interest between players
1)     Shareholders v. board or managers – (shareholders would like to keep eye on corp. but each shareholder does not have large enough stake to make it worth the hassle)
2)Â Â Â Â Â Employees v. managers; shareholders v. creditors; etc.
D.   Theories of why corporations have developed
1)Â Â Â Â Â Multidivisional Corp (M-Form Corp):Â
a)     Coase: relative transaction cost set the limits on firm size. Increase in size as long as costs of internalizing production within firm are below those of carrying on same transaction in the mkt
a.     allows money to be shifted between divisions to be most profitable
b.     mitigates problem of managerial discretion but has bias toward expansion and pursues policies that maximize corporate growth over shareholder profit
b)    Berle/Means Thesis: diffusion in shareholder ownership allows managers to pursue their own interests of increasing opportunity for promotion unconstrained by shareholder opposition – larger the firm, less likely it can be taken over
a.     Counter arguments:
                                                                                                                                     i.     mkt forces constrain management
                                                                                                                                   ii.     managers have same interest as shareholder – maximize the price of the shares
c)Â Â Â Â Â Agency cost model:Â Ways to align interest of managers and shareholders (Jensen and Meckling)
a.     Agency costs are borne by the entrepren
nd social cost (usually not true because pollution isn’t accounted for)
c.      social welfare is the net positive good that firm is doing for society
b)Â Â Â Â Shareholders need fiduciary protection because they cannot negotiate contracts like other players
a.     BUT employees have even more at risk then a diversified shareholder
c)     Employees get set amount – shareholders bear the risk and should get the left over profit
8)Â Â Â Â Â CREDITORS:Â when corp. is nearing bkrptcy it has duty to creditors instead of shareholders;
a)Â Â Â Â Â 3 stages of shifting obligations:Â Who duty runs to
a.     Clearly solvent: shareholders
b.     Vicinity of insolvency: corporate enterprise
c.      Insolvent: creditors
                                                                                                                                     i.     insolvency: debts exceed assets
b)Â Â Â Â Reasons for rule:
a.     as corp nears bkrptcy it is willing to take on more risk because they have nothing to loose – and the less risk the creditors want because they at least want to get some of their money back
b.     HYPO:
                                                                                                                                     i.     Debt of 12 M
                                                                                                                                   ii.     1 asset of 51 M judgment on appeal
1.     25% will get entire judgment (get 51 M)
2.     70% chance its modified (get 4 M)
3.     5% chance reversed (get 0)
4.     Expected value is 15.55 M
a.      25% * 51 (12.75) + 70% *4 (2.8) + 5% *0 (0) = 15.55
5.     Assume risk neutral – you would take any settlement offer above 15.55 and reject anything below
a.      Risk averse may accept an offer < 15.55
6.     Creditors would accept > 12 M
a.      rejection of the offer would only be 25% chance that they will get paid all 12 m and a 70% chance they get 4 M
b.     creditors are too conservative – only want to get paid off
7.     Shareholders would accept ?? based on risk they are willing to take
willing to take more risk at certain point because