MGT Notes

Reference: Corporate Finance – Ross et al, 12e, Pg 5

A Corporation is a distinct legal entity which has its own name and legal power, just like a person. It can acquire and exchange property, enter contracts, sue and be sued. It is akin to a citizen of its state of incorporation, except it cannot vote. It is more complicated to start than a sole proprietorship or a partnership.

To start, one need to prepare articles of incorporation and bylaws (rules to regulate its existence and its shareholders, directors and officers). The articles of incorporation state the corporation’s name, its intended life, its business purpose, the number of shares that will be issued with the limitations and rights of different classes of shares, the nature of shareholder rights and the number of members of the board of directors, among other items.

There are three distinct sets of interests in a corporation – the shareholders, the directors and the corporate officers. Traditionally, the shareholders control the direction of the firm, its policies and activities. Shareholders then elect a board of directors who then appoint top management who manage the operations of the firm. In a small operation, an overlap among functions is often seen.

The corporation offers advantages compared to sole proprietorships and partnerships: ownership can be transferred by stock transactions; the corporation has unlimited life, and the liability of the shareholders is limited to the price of the shares that they hold. These make it easy for a corporation to raise cash.

The corporation incurs double taxation. In addition to tax on corporate income, the shareholders are also taxed on dividend income.