Characteristics of a Corporation - Online Tutor, Practice Problems & Exam Prep

A corporation is a distinct legal entity separate from its owners, offering advantages like unlimited life, easy transferability of ownership, and limited liability for debts. However, it faces double taxation and extensive government regulation. Stockholders possess rights such as voting for the board of directors, receiving dividends, and maintaining ownership percentage through preemptive rights when new shares are issued. The authority structure includes stockholders, a board of directors, and management roles like CEO and COO, ensuring effective governance and operational oversight.

Corporations:Advantages and Disadvantages

Throughout this course, our focus has mainly been on a corporation as the business organization. Let's go into a little bit more details about the corporation. You may have heard a lot of this stuff before, but let's just go through it real quick. A corporation is a separate legal entity from the owners of the business, okay? So the corporation is separate from the owners of the business. Let's go through some of the main advantages and disadvantages of setting up as a corporation.

What we hear as advantages: well, they have an unlimited life. Right? And this comes from the easy transferability of ownership. The reason they have an unlimited life, well, think about common stock here. Right? The shares of common stock, the ownership is split up into these shares of common stock. So whoever owns the common stock is an owner of the corporation. And think about any stock on the market, right? Maybe you want to buy shares of Apple stock; well, that's very easy to do, right? You just go to the stock exchange, and you can buy shares of stock from someone willing to sell it. So this transferability of ownership, it's very easy and it happens all the time. Right? And that has no effect on the day-to-day business of the corporation. Right? If you go and buy a share of stock, that's not going to affect what they're doing to run the business itself. And that goes with this last advantage here: owners have limited liability for the debts of the business, okay? And the idea here is, let's say, that you bought shares of Apple stock, and now Apple stock gets into a lawsuit, and they lose the lawsuit. Well, it's not like whoever's going to collect from Apple can come to you personally and knock on your door and say, "Hey, Apple company lost money, you need to pay us." No. Apple Corporation itself is what's going to pay them, and if they run out of money, that's it. That's your limited liability. You don't have to pay anything on top of what you've invested in the business. That's all you're liable to lose is your investment. Okay? So that's that limited liability, which is a huge advantage of a corporation compared to other business organizations.

So let's go through these disadvantages real quick. One you might have heard of is this double taxation. Double taxation means that corporate owners are taxed twice on the earnings. The first one is when the corporation itself pays taxes. Right? So, if you think about it, the corporation is going to have their revenue minus expenses, and they're going to come up with some amount of taxable income, right? So, they're going to pay their taxes on this taxable income over here, right? So the corporation pays taxes, and then when they go ahead and this leftover income, what they pay out to the stockholders as dividends? Well, the stockholders are going to have to pay taxes when they receive dividends. Okay? So when you receive a dividend as the owner of a corporation, you're going to have to put it on your tax return as earnings, and you're going to pay taxes on it, so there are two taxes. The corporation itself and then the stockholders paying taxes on the dividends received. Okay? Another main disadvantage is there's a lot of government regulation surrounding corporate life forms. And finally, this one can actually be a benefit or a loss or disadvantage is the separation of ownership and management. Right? This goes with the idea that the owners of the business aren't involved in the day-to-day operation. So the advantage there is that you don't have to be as an owner, don't have to be business savvy. You don't have to be business savvy to invest in a corporation. If you say, "Hey, I think Apple is going to do great," and you invest in Apple stock, well, there you go. You don't really have to know the ins and outs of the tech business to own the business. And the management you can hire I guess this should be not business savvy. Managers can be the business savvy ones, right, and they understand the business. So that sounds like an advantage, but at the same time, it's a disadvantage because you're disconnected from the day-to-day operation of the business. As the owner, you don't really get a say in what's happening in the day-to-day business and that can be seen as a disadvantage as well. Okay? So this could be kind of a good thing and a bad thing, based on how you look at it, right?

So that's about it for the advantages and disadvantages. Let's move on to how we create a corporation and the structure. The authority structure of a corporation. We'll do that in the next video.

Corporations:Creation and Authority Structure

So the creation of a corporation is not some very magical event; it's pretty standard. There's going to be some paperwork to fill out. What we have is, we're going to have the incorporators, which are basically the founders of the company. They're going to pay some fees, they're going to sign a charter, they're going to file some paperwork with the state. Notice that there's going to be a state of incorporation. Even though the corporation might do business nationwide or worldwide, there's a specific state where they follow the laws of that state of the corporation. You see a lot of times the state of Delaware is one of the main states that has a lot of corporations have their headquarters in that state because they have some of the laxest laws for corporations. So it ends up being the state of incorporation. Okay? So pretty simple stuff. Fill out some paperwork, sign some documents, and then we're going to agree on a set of bylaws. They're called bylaws and this is basically the constitution, the rules of the corporation whenever there's any sort of issue, we can go to the bylaws and see what the bylaws say for the corporation. For the most part, these are going to be standard across different corporations. Okay?

So let's look at the authority within a corporation right here. At the top, notice that it's the stockholders. The stockholders are the owners. Right? They are the owners of the corporation and what they're going to do is elect the board of directors. This board of directors, they are the head decision-making body of the corporation. It's usually somewhere between 7 to 9 people on the board and these are going to be executives and people who know the industry and people like the CEO that might be involved in the day-to-day operations of the building of the corporation, excuse me. So the board of directors is going to elect that chairperson of the board, which will be the CEO right there, and the CEO, and here the COO, chief operating officer. The chief executive officer, he's kind of like the head of management, right, the CEO, you hear this all the time. And then the chief operating officer, well, depending on the size of the corporation, you might have a chief operating officer who then leads a lot of the other managers who lead controllers, and you see it's a kind of hierarchy throughout the corporation here. We've got vice presidents after the chief operating officers, secretaries, the CFO here, and then the accounting officer, and the treasurer. Right? And they're going to have different departments under them as well. So notice at the top here, we do have the owners, the stockholders who are at the top of this food chain by electing the board of directors. By controlling who's on the board of directors, you can control what else is happening in the management of the corporation. Cool? You don't have to know so much about this chart. It's kind of just to show the flow of authority within a corporation. Cool? On the next page, we're going to continue talking about some more details about the stockholders themselves. So let's go into that, in the next video.

Corporations:Stockholders' Rights

So let's discuss some of the rights of a stockholder. When you own shares of stock in a company, that comes with some rights that you have. The first one here is voting rights. You have the right to elect the board of directors. If you own one share of stock, that's worth one vote in the vote for the board of directors. You can imagine the more shares of stock you have, the more weight you have in electing the board of directors. This is why someone who owns 50%, 51%, or 75% of a company has complete control and can elect everyone they want on the board of directors. The main thing that voting rights are for is electing the board of directors, but it also comes up for other important things such as a merger. If they're going to merge companies, they usually take it to the stockholders and have a vote on important issues like that.

The next right is dividends. We've talked about dividends before. You have the right to receive dividends. You receive your proportionate share of dividends. If you own 10% of the company, you get 10% of the dividends. The same thing applies to liquidation. If the company was going to end, they're going to say, "It's over here. We're going to liquidate the company." What they're going to do is pay off all their liabilities and what's left over is shared between the stockholders. You would imagine that they've made some money over the years, and what's left over gets paid out to the stockholders at liquidation. This is obviously a rare scenario because corporations have an unlimited life, and they tend to continue operating. You don't see liquidation happen too much unless a stock company is going into bankruptcy or something similar.

Finally, you have the preemptive right. They love to talk about the preemptive right because this is your option to maintain your proportionate share when new shares are issued. Let's discuss this preemptive right with an example. Johnny Clutch owns 1,000 shares of the outstanding 100,000 shares of ABC Company. In this instance, he owns 1,000 out of the 100,000 shares, which means he owned 1% of the company. Now ABC Company issues 50,000 new shares, aiming to raise additional capital. The preemptive right gives Johnny the option to purchase shares to keep his proportion of ownership consistent. Since there are 50,000 new shares, he should be given the right to purchase 1% of them, maintaining his ownership. So, 50,000 times 1% results in an additional 500 shares, right? Johnny is given the option to purchase these 500 additional shares, and if he does, he will own the original 1,000 plus the new 500. The total shares outstanding would be 150,000. His ownership remains at 1%, since he has 1,500 of the 150,000 shares.

Let's see what happens if he doesn't use his preemptive right. If he doesn't buy them, he now only has 1,000 of the 150,000 total shares. His ownership would then decrease to approximately 0.67% of the company. Remember, he isn't obligated to use his preemptive right; they just have to offer him the option to purchase the shares to maintain his 1% ownership.

All of the following are true regarding corporations, except:

• A. The board of directors is in charge of creating policies in the corporation
• B. A stockholder in a corporation is generally not involved in the day-to-day operations of a corporation
• C. Stockholders must pay taxes on any dividends received from the corporation
• D. A corporation is a separate legal entity from its owners
• E. All of the above are true regarding corporations

All of the following are advantages of corporations, except:

• A. The ease of transferring ownership
• B. Owners of the company have unlimited liability for the corporation's debts
• C. Corporations have unlimited lives
• D. Corporations can raise more capital than a proprietorship or partnership
• E. All of the above are advantages of the corporate form

Here’s what students ask on this topic:

What are the main advantages of setting up a corporation?

The main advantages of setting up a corporation include unlimited life, easy transferability of ownership, and limited liability for the debts of the business. Unlimited life means the corporation can continue indefinitely, regardless of changes in ownership. Easy transferability of ownership allows shareholders to buy and sell shares without affecting the corporation's operations. Limited liability protects shareholders from being personally responsible for the corporation's debts, meaning they can only lose the amount they invested in the corporation.

What is double taxation in the context of a corporation?

Double taxation refers to the taxation process where corporate earnings are taxed twice. First, the corporation pays taxes on its taxable income (revenue minus expenses). Then, when the corporation distributes dividends to its shareholders, the shareholders must pay taxes on the dividends they receive. This results in the same income being taxed at both the corporate and individual levels.

What are the rights of a stockholder in a corporation?

Stockholders in a corporation have several rights, including voting rights, the right to receive dividends, the right to a proportionate share of assets upon liquidation, and preemptive rights. Voting rights allow stockholders to elect the board of directors. The right to receive dividends means stockholders get a share of the corporation's profits. In liquidation, stockholders receive a share of the remaining assets after liabilities are paid. Preemptive rights allow stockholders to maintain their ownership percentage when new shares are issued.

How is a corporation created and what is its authority structure?

Creating a corporation involves incorporators (founders) filling out paperwork, paying fees, signing a charter, and filing documents with the state of incorporation. The authority structure starts with stockholders, who elect the board of directors. The board of directors, typically 7-9 members, makes major decisions and elects the CEO. The CEO oversees management, including roles like the COO, CFO, and other vice presidents, ensuring effective governance and operational oversight.

What is the separation of ownership and management in a corporation?

The separation of ownership and management in a corporation means that the owners (stockholders) are not involved in the day-to-day operations of the business. Instead, they elect a board of directors to make major decisions and hire managers to run the company. This allows stockholders to invest without needing business expertise, but it also means they have limited control over daily operations, which can be seen as both an advantage and a disadvantage.