Corporations
Professor Wonnell
Spring 2012
University of San Diego
Class 1
Readings
a. 1-15
Ch.1 Economics of the Firm
i. A: Risk
1. Risk: introduction
a. Risk = quantifiable uncertainty
b. 2 kinds
i. Controllable and non-controllable
c. Expected Return = weighted average return based on the probabilities of events
i. Ex: 1/3 chance of making $6 = $2 EV
2. Risk Preference
a. Risk averse
b. People are generally more risk taking when it comes to losses
c. Risk neutral person = always takes the positive EV or neutral EV
3. Non-Controllable Risks
a. Managing risks
i. Insurance
ii. Diversification
b. Who should bear risk?
i. Person best able to bear it?
ii. Person best able to control it?
4. Controllable Risks
a. Shirking = when a person does less than is optimal to control a risk (moral hazard)
b. Monitoring and disciplining devices
ii. B: Allocating risk to the owner
1. Monitoring and disciplining costs
a. Owner must decide what constitutes optimal performance by the employee (ex ante/before)
b. Owner must determine whether the desired level of performance is occurring or has occurred (ex post/after)
2. Devices
a. Employement contracts
iii. C: allocating risks to the employee
1. Reputation = a self monitoring device
iv. D: Middle ground solution
1. Problems
a. Employee becomes more concerned about control since his returns are dependent on the business
b. Employee builds specialized skills over time and may demand higher pay or independence
v. E: what else is there?
1. Law and human relationships
2. Beyond agency costs
a. The big question:
i. Does and should corporate law go beyond agency costs?
Chapter 5: The choice of organizational Form p.122-144
3. Introduction
a. Principle forms
i. Corporation
1. Legal entity distinct from its owners
2. Governed by the corporate law of the state in which it is incorporated
3. Management o the corporation is centralized in a board of directors
4. Shareholders’ liability does not extend to any debts of or liabilities that the corporation incurs
ii. LLC
1. Legal entity distinct from its owners, who are called members
2. Can elect to be taxed as a partnership
3. State laws vary more than the other 2 orgs
4. Uniform Limited Liability Company Act has led to increasing uniformity
iii. Partnership
1. General
a. Entity where all partners have unlimited liability, and equal voice in management and the authority to act as agents for the partnership and incur obligations that will bind all the partners
2. Limited
a. Combines elements of a corporation and general partnership
b. Must have one general partner
3. Governance
a. By state laws which are based on uniform statutes
4. B: Default Rules
a. Formation
i. Corp
1. File articles of incorporation
ii. General Partnership (GP)
1. Requires no filing with state
2. Created when 2 or more persons enter into a contract
3. May be created by operation of law
iii. Limited Partnership (LP)
1. Requires filing with the state of a certificate of partnership
iv. LLC
1. Requires filing of articles of organization
b. Limited liability
i. When shareholders of a Corp are liable
1. Where the corporation is not properly formed
2. For unpaid capital contributions that they have agreed to make
3. Where the veil of limited liability is pierced for equitable reasons
4. When they agree to be liable
a. Ex: a loan
ii. LP
1. Can be structured so all the partners have limited liability = by making the general partner a corporation which is liable for all unpaid obligations of the LP
iii. LLC
1. Allows members to participate in management and still receive limited liability = more attractive
c. Management and Control (continue on 126)
d. Continuity of existence
e. Transferability of interests
f. Fiduciary duties
i. Present in corp but may not be in partnership b/c the nature of t
iv. theory behind people being risk averse
b. moral hazard
i. ex: more insured houses burn down
1. some people torch em, or take less care
ii. people with health insurance see doctor more often
c. adverse selection
i. one party has better knowledge of the risk than the other
ii. insurance problems:
1. those who sign up for insurance have more exceptional need for insurance (know they are sick, know house is faulty,….)
d. who should bear non-controllable risk?
i. more risk neutral party
e. Vineyard problem p.2
II. Entities
a. Taxation distinctions
i. Corp is separate, partnership is not
b. Corp vs. partnerships (default rules)
i. Separate entity
ii. Perpetual existence
iii. Limited liability
iv. Centralized management
v. Transferability of ownership interests
c. Public corps vs. close corps
i. Close
1. Usually shareholders perform most of duties (ex: mom n pop)
ii. law generally the same for both
iii. significant difference though
d. Corporate Statutes
i. Relationship b/t internal corporate parties (officers and directors, etc. .)
ii. State law
iii. Model Business Corporation Act
iv. California and Delaware (main focus)
v. Focus on MBCA, pay attention to deviations b/t CA and DE which will be stressed in class
e. Organic Documents
i. Page 18
ii. Articles of incorporation and bylaws
iii. To change AI need both board and shareholders
iv. Bylaws
1. Easier to change (MBCA states either board or shareholders can modify)
2. Must be consistent with AI
