Corporations are a form of business organization where the company
is a separate legal entity from its owners.
Corperations can be classified either by purpose or by ownership type
as you can see on the slide.
The corporate form of business organization has some advantages over
other business organizations like sole- proprietorships or partnerships.
Specifically, it is a separate legal entity, so corporations can enter into contracts,
obtain financing and be sued.
Stockholders have limited liability,
so although they could lose their entire investment if a corporation goes bankrupt
none of their personal assets would be at risk.
Corporations often find it easier to obtain capital either from creditors or investors.
Corporations also have continuous life.
So when Alexander Graham Bell died, AT&T continued on as a corporation.
Finally, ease of ownership transferability is often cited as an advantage of a corporation.
This is true when an organization is publicly traded on a stock market.
It is not always true for private or closely-held corporations.
The corporate form also has some disadvantages
that sole-proprietorships and partnership don’t have.
Corporations have more government regulations than other business forms
including more required filings with various agencies.
Income earned by a corporation can be subject to double taxation.
Here's how that works.
The corporation pays income tax on its earnings, because it is a separate legal entity.
If the corporation then pays out some of those remaining after-tax earnings,
(which we call dividends) to its stockholders;
the stockholder must report the dividend as income and pay taxes on that money again.
Finally, often the managers of a corporation aren’t the owners.
Some consider this a disadvantage but this could be an advantage too.
Corporations have the following organization. The Board of Directors hires a CEO.
Which is the Chief Executive Officer or President of the company.
In turn the CEO hires other senior management which is shown on the slide.
So who does the Board of Director report too?
In theory, the board is responsible to the stockholders at large.
The board is often made up of stockholders,
and annually stockholders get to vote for who should be on the Board of Directors.
Corporations are formed by state charter.
A charter contains the by-laws of how a organization will be governed.
This slide shows a state flag of Delaware.
This is because most corporations are formed in Delaware due to favorable corporate laws.
Corporations do not have to be chartered in the state in which they are headquartered.
Stockholders are the owners of a corporation. In fact the term “shareholder” and “stockholder”
are interchangeable and it's likely that you'll hear both.
Stockholders have certain rights as shown on the slide. Let’s go over those in some detail.
Stockholders have the right to vote for the board of directors.
Usually one share of stock equals one vote.
So you can imagine that the stockholders who have the majority of stocks
often sit on the board.
Stockholders are entitled to receive dividends in proportion to their ownership.
If someone owned 5% of a company’s stock,
they would be entitled to receive 5% of the dividend declared.
The preemptive right is more of a theoretical right than one actually used in practice.
It means that, when a corporation issues additional shares of stock,
the existing stockholders have the first right to buy it before it goes on sale to the public.
Here is why it is important.
If I were a 51% stockholder in a company, I would have an absolute majority interest.
When new stock is issued, I might want to buy 51% of the new stock
so I can remain the absolute majority stockholder.
Again, in practice, that would likely become cost prohibitive.
That is why the Alexander Graham Bell estate isn’t a majority shareholder in AT&T.
It’s just too expensive to buy so much of each new stock offering.
Finally stockholders are entitled to residual income and the assets of a corporation.
Again, this doesn't really happen for publicly traded companies,
but it is possible that a privately held corporation
could shutdown and liquidate.
If that happens, the stockholders are entitled to residual claims
in the proportion to their ownership.
Finally the Stockholders' Equity section of the Balance sheet
shows the equity of the corporation,
and it's divided into two sections: Paid-in Capital and Retained Earnings.
Paid-in Capital, which is sometimes called Contributed Capital,
is the amount stockholders have contributed to the corporation.
This is the section that reports Capital Stock.
We'll learn more about stock in future video lectures.
Retained Earnings is exactly what the name implies
It is the earnings or net income of a corporation that it has retained,
rather than paid out in the form of dividends.
Here you can see an example of a Stockholders' Equity section.
Notice the two groups: Paid-in Capital and Retained Earnings.