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Business Associations/Corporations
University of San Diego School of Law
Dallas, Lynne

Corporate Governance in the Modern Corporation
Economics of the Firm
Principals vs Agents
– involves allocation of control
–          incentives of principal
o       maximize return on business
–          incentives of agent
o       to shirk as much as possible
–          deal points
o       risk of loss
o       return
o       control
o       duration (set term of contract)
–          constraints
o       incentives are never perfectly aligned
o       can’t specify every contingency
 
Business Risks
1)      Non-Controllable Risks
a.       Weather, economy, interest rates, market prices, war
2)      Controllable Risk
a.       Risks that parties can effect (think lemonade stand)
3)      Risk Preference
a.       Risk averse: looks at magnitude of risk along w/ expected return
b.      Risk seeking: looks at magnitude of risk along w/ expected return
c.       Risk neutral: base decision solely on expected return
4)      Systematic vs diversifiable
a.       Risk can be offset by diversifying portion of risk, can’t diversify risk completely away (Systematic Risk)
 
Allocating Business Risk Within the Firm
1)      Allocating risks to the principal
a.       Usual, principal takes risk, can get big reward, agent has fixed compensation, principal can usually diversify &/or insure
b.      Agent is likely to shirk here, principal will want to monitor, has costs
2)      Allocating risks to the agent
a.       Agent could rent space, then deal w/ risk reward, principal would have fixed comp (tenancy)
b.      Profit sharing option, puts interests more in line
 
The Role of Law in Allocating Business Risks
1)      Mandatory
a.       Ie. Minimum wage – few mandatory
2)      Types of default rules
a.       Majoritarian: most would have bargained for; efficiency in common situations (employment-at-will)
b.      Tailored: they would have bargained for; reasonable under circumstances (fiduciary duty)
c.       Penalty : they would not have bargained for; motivates to bargain for party-specific solution (non-compete)
 
Sources of Corporate Law
1)      Corporate statutes
a.       MBCA (Mode Business Corporation Act)
b.      DGCL (Delaware General Corporation Law)
c.       CCC (CA Corporations Code)
2)      Judge-made corporate law
a.       ALI Principles (American Law Institute)
3)      Corporate choice of law
a.       Issues btw S/H & D/O are governed by corporate statutes & case law of state of incorporation
4)      Organic documents (private law)
a.       Articles of incorporation/charter
                                                              i.      Can’t conflict with statute under which biz is organized
b.      By-laws
5)      The Corporate Actors
a.       S/H
b.      BOD (Board of Directors)
                                                              i.      Responsible for managing or supervising corp’s biz
c.       Officers
                                                              i.      Prez, Vice-Prez, Secretary, Treasurer
6)      Corporate securities
a.       Common stock
b.      Preferred stock, certain priority over CS
7)      Fiduciary principles (come from law of trusts)
a.       Duty of care
b.      Duty of loyalty
c.       Business judgment rule
8)      Litigation by shareholder
a.       Derivative suit: action in equity brought by a shareholder on behalf of the corp. Action is brought against corp fro failure to bring action in law against 3rd party (unfaithful manager).
                                                              i.      Corp is nominal defendant
                                                            ii.      P-S/H controls the prosecution of the suit
                                                          iii.      Any recovery belongs to corp
 
Bayer v Beran, p. 37
 
Gamble v Queens County Water Co, p.44
 
Equitable Limitations on Corporate Actions
 
Schnell v Chris Craft Industries
 
Corporation & Society
1)      Berle-Dodd debate
a.       Berle: corp powers were held in trust “ at all time exercisable only for the ratable benefit of all the S/H”
b.      Dodd: biz corp was an “economic institution which has a social service as well as profit making function
c.       Friedman: by pursuing own interest, he frequently promotes that of society more effectually than when he really intends to promote it
 
Corporate Social Responsibility Trends
 
Dodge v Ford Motor Co, p. 109
–          Corporation had excessive surplus, and the failure to declare a dividend was to prevent the Dodge Bros. from having the money to build a competing business.
–          Directors have discretion to set wages; pay/not pay dividends;
–          S/H benefit must be more than merely incidental
–          Directors decision were not out of line, decision to not pay larger % as dividends was ok
 
ALI Principle

s if partner leaves
member may withdraw
Entity or Aggregation
Aggregation
Aggregation
Entity
Aggregation
Entity
Taxation
Passed on to partners
Passed on to Partners
Taxed to Corporation
Passed on to partners
Taxed to LLC
Formation
Informal
File certificate
File Art. of Incorp. & Bylaws
File Application
File Articles.
 
II.       Defective Incorporation
A.       de facto (honest mistake – usually minor, good faith effort, judges don’t hold responsible for error) vs de jure (done according to law) corporation, estoppel
B.       which errors matter?
 
III.    Pre-Incorporation Activities of Promoters
A.       General rule: promoter who contracts for benefit of an unformed corp is personally liable
B.       Parties must expressly discharge the promoter after corp is formed
C.       Key: contractual clarity
IV.    Valuation of the Corporation
 
A.       Accounting
1.         Balance Sheet – analogous to a “snapshot”
a)         The Fundamental Equation: Assets=Liabilities + Equity
b)        Assets
(1)      cash, inventory, fixed assets (buildings, equipment), intangibles (patents, goodwill), accounts receivable
(2)      current assets-assets that are likely to be converted to cash within one year
(a)      cash, inventory, securities
(3)      generally, assets on balance sheet reflect historical costs, not market value, liquidation value, or replacement value.
c)         Liabilities
(1)      current liabilities – due within the year
(2)      long-term liabilities – due in greater than one year
(a)      to the extent that assets depreciate, they represent future expenses, and so are depreciated over their useful life rather than expensed in the year purchased
(i)        whether company uses straight line or accelerated affects apparent growth – more accelerated means more growth and lower current taxes
intangibles are “amortized