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

CORPORATIONS OUTLINE
 
I.                    GENERAL
a.      Features of a Corporation
                                                              i.      Separate entity
1.       Independent
a.      Can be sued, sue, hold property independent from shareholders/directors
2.      Taxation
a.      Must pay independent tax
                                                                                                                                      i.      Note: This leads to double taxation when dividends get taxed again when sent to ind.
3.      Vs. Partnership
a.      Dependant relationship. If partner leaves, entity dissolves
b.      Only personal tax to each partner
                                                           ii.      Limited Liability
1.       Shareholders not responsible for debts
2.      Vs. Partnership
a.      Partners responsible for anyone’s debt
                                                         iii.      Centralized Management
1.       Shareholders vote on centralized board who designates officials
2.      Vs. Partnership
a.      Decentralized so that any partner can enter into business on behalf of partnership
b.      History
                                                              i.      Companies given charters to run colonies (eg East Indian Co.)
                                                           ii.      Trend towards enabling charters so that only a form need to be filled out
1.       Prevented inefficient controlled capital by government, but created corruption by less government control
a.      Created current corporation scheme where a corporation is a privilege that is subject to gov conditions
                                                         iii.      Wonnell Approach
1.       Rules are necessary to prevent abuse of limited liability (eg capitalization minimum and insurance minimum)
2.      However, too many rules create inefficient capital movement
c.       Setting Up
                                                              i.      Usually in DE although can be in any state
1.       DE had reduced restrictions and so now has certain law
2.      Criticisms
a.      Corp in DE even if no assets/locations there?
b.      Race to the bottom to reduce restrictions
                                                                                                                                      i.      Federal corporation solution?
                                                                                                                                   ii.      OK b/c competition makes efficient law
d.      Regulating the Corporation
                                                              i.      Contract Model vs. Social Institutions?
                                                           ii.      Consumer regulation
1.       Exit strategy – corp must be accountable to retain consumer
2.      Voice strategy – giving members a voice to prevent problems that corp would be accountable for
a.      Complementary b/c if consumers can leave then they will get a voice to have their concerns heard
                                                                                                                                      i.      Argument that if shareholders can leave then they will before they voice their opinion
                                                         iii.      Internal Regulation
1.       Voting rights
a.      Problem: Sometimes not worth small shareholders time
2.      Right to sell
a.      Selling reduces a stocks value
                                                                                                                                      i.      Hurts managers with option contracts
                                                                                                                                   ii.      Raising capital difficult when no one buying
3.      Fiduciary Duty
a.      Shareholders can sue for breach of legal duty owed
e.       Risk
                                                              i.      Goal: Balancing optimal risk allocation with agency costs
                                                           ii.      Adverse v. Neutral
1.       Most people risk adverse
a.      Diminishing Marginal Utility of Income (DMUI)
                                                                                                                                      i.      More utility from money if income is small. Leads to more risk aversion
2.      Risk neutral
a.      Will pay only the minimum to cover the risk
b.      Someone who is more diversified/wealthier
                                                         iii.      Optimal Risk Allocation
1.       Controllable risk
a.       Person who can more easily bear/control the risk should
2.      Non controllable risk
a.      Who should bear this risk?
                                                                                                                                      i.      Risk neutral person should bear the risk (ie gambler rather than averter)
1.       Wealthier person (less marginal utility)
2.      Diversified person
                                                          iv.      Agency Costs
1.       Costs of monitoring (ie contracts/enforcement) associated with risk of shirking/stealing
a.      Without monitoring the manager will not bear the risk, but will shift it to the investors in hopes of large profits
2.      Constrained through Reputation
a.      Time Horizon – Less monitoring needed of younger managers who don’t want to blow a good thing
b.      Forfeiting specific capital
 
 
II.                  CORPORATIONS vs. OTHER ENTITIES
a.      Formation
                                                              i.      Corporations
1.       Articles of Incorporation (§2.01 & §2.02)
a.      (a) Required Provisions
                                                                                                                                      i.      Name and address, number of shares to be authorized/issued, name and address of people incorporating
                                                           ii.      Partnerships
1.       No statute
2.      Group of people in business together for common profit even if they don’t claim they are a partnership
                                                         iii.      Limited Partnerships
1.       Forms with name, etc to be filed with Secretary of State to put creditors on awareness of limited liability
                                                          iv.      Limited Liability Company
1.       Articles of Organization (§203)
a.      Must declare whether member managed (decentralized/partnership-like) or manager managed (centralized/corporation-like)
b.      Liability
                                                              i.      Corporations
1.       No liability for shareholders
                                                           ii.      General Partnership
1.       §306 – Joint and Several liability unless creditor agrees otherwise
                                                         iii.      Limited Partnership
1.       §303
a.      (a) General Partner personally liable if exercising control over partnership
                                                                                                                                      i.      Limited partner non liable (worse that can happen is they lose their partnership)
                                                                                                                                   ii.      Strategy of setting up corporation to be the sole general partner and everyone is just limited
                                                          iv.      Limited Liability Companies
1.       §303 (ULLCA) – No liability solely by member status, but still can be personally liable
c.       Managing and Control
                                                              i.      Corporation
1.       §7.28 – Shareholders elect directors through majority vote creating centralized government
a.      Requirements: Notice (10 days), quorum, majority present
                    

        FINANCIAL ACCOUNTING
a.      BALANCE SHEET(Snapshot of the corporation, Assets = Liabilities + Equity) (when liabilities are greater than assets the corp becomes insolvent)
                                                              i.      Assets
1.       Current/Short Term Assets (can be liquidated easily/within year)
a.      Accounts Receivable (outstanding bills owed to corp)
b.      Prepaid Expenses (paid goods yet to be consumed, like rent)
c.       Inventories (goods on the way to being sold)
                                                                                                                                      i.      Accounting conventions (GAAP, ‘generally accepted accounting principles’ to determine value)
1.       FIFO (values the first shipment in)
a.      Good for in inflationary period because goods purchased at a lower price earlier now have a greater value
2.      LIFO (values the last shipment received)
a.      Bad in inflation (inverse of FIFO)
3.      Average Cost (value of wholesale price of serial numbered good)
2.      Fixed Assets/Long Term (can’t be easily turned into cash)
a.      Land
                                                                                                                                      i.      GAAP requires valuation at  historical value
1.       Original purchase price with no adjustment for increase in land value
2.      Rationale: Less accurate, but prevents manipulability of balance sheet
3.      Exception: Some assets are determined by fair market value instead (eg securities)
b.      Buildings, machinery, office equipment
                                                                                                                                      i.      Accounts for Depreciation (acct convention)
1.       Historical value minus deterioration value of current year
a.      Ex: If something has a life of 10 years then 1/10 of the previous years value is subtracted to determine following year value
3.      Goodwill
a.      The value of a company’s reputation
b.      The amount added to assets so they equal liability (ie what is left over after subtracting equity and liabilities from assets)
                                                           ii.      Liabilities
1.       Current Liabilities
a.      Accounts Payable (outstanding bills owed to clients)
b.      Notes Payable (money owed through promissory notes)
c.       Stock Options (NOT ON BALANCE SHEET)
                                                                                                                                      i.      Some corps are listing on balance sheet since it provides an opportunity to managers to manipulate
2.      Long Term Liabilities
a.      Bonds that have yet to mature
                                                         iii.      Stockholder Equity
1.       Common Stock
a.      ‘Paid in capital’
                                                                                                                                      i.      Total amount paid for authorized stock
                                                                                                                                   ii.      Used in RMBCA
b.      ‘Stated Capital’ (surplus)
Extra capital created