This summary is based on the book: Corporate Finance-Global Edition, Pearson, 5th Edition and
lecture notes.
Week 1
Lecture 1 (Videos 1-10)
The four main types of firms;
Sole Proprietorship Owned by one person and run by one person. It can have
employees but very few. Very easy to set up (just go online and set it
up in a few minutes time), however if the owner dies the business
dies. There is no separation between firm and owner so the owner
has unlimited liability.
Partnership More than one owner and all partners are liable for the firm’s debt.
General partners have unlimited liability but do have managing
power. Limited partners have limited liability but no management
authority. An example is a venture capital fund. The passive investor
has limited liability, they have the capital, they invest and let the
active investment managers do the work.
Limited Liability U.S. specific type of firm. Similar to the hybrid of partnership and
Company corporation. It has similar tax rules as a partnership as well.
Corporation A legal entity separate from its owners. It has many legal powers
(e.g. it can sign it’s own contracts, etc.). The corporation is solely
responsible for its own obligations and the ownership can transfer.
Difference between LLC and corporation;
In an LLC partners are owners, in a corp it is the shareholders. Ownership is not formally
distincted which means that in an LLC the owners have control while in a corp the shareholders
own but the CEO etc has control.
C and S Corporation;
In a ‘C’ corporation (majority of the corporations are ‘C’) you pay double taxes, a few
corporations are ‘S’ though. This means that they do not need to pay double taxes as the firm’s
profits are not subject to tax, only the stockholders’. There are very strict rules on this, hence not
many firms are ‘S’. Examples include; max 100 shareholders, all shareholders must be US
citizens, etc.
How to form a corporation?
A corporation must be legally formed, hence, it is not as cheap as forming a sole proprietorship,
some places even have minimum capital requirements. Ownership is represented by how many
shares of stock you have in the company, someone who owns shares is called a stockholder,
,shareholder or equity holder. Sum of all ownership is called equity (so if you have a 51% equity
then you own 51%). There is also no limit on how many shareholders you can have. Owners of
stocks are entitled to dividend payments.
Tax implication (double taxation);
In a corporation, since it is seen as a legal entity, the corporation must pay tax. Then once you
give dividends, the shareholders must pay tax again. In partnership or sole proprietorship, since
you are seen as one entity (not separate entities) you only need to pay tax once.
Ownership vs. Control in corporations;
In a corporation you have a management team. This consists of a board of directors who are
elected by the shareholders, this board has the ultimate decision making authority. They appoint
a Chief Executive Officer (CEO) who delegates the day to day decision making/activities. The
CEO chooses other managers like the CFO (Chief Financial Officer), etc. The Financial
manager is responsible for investment decisions, financing decisions, cash management, etc.
Wealth maximization makes the shareholders happy, however often they also ended to think
about the society. As harming the society can backfire and get lawsuits, or other hurting things
‘thrown’ at you. Hence, the government also often sets regulations. Agency problems is a term
we use which represents the case of managers acting for their own interest rather than for the
ebay interests of the shareholders. They can do this through private loans, corporate jet, etc.
Often they tie the manager’s compensation to the company’s success, this forces the manager
to do his best.
, What about corporate bankruptcy?
Bankruptcy happens when you can’t pay your debts, hence, you can only go bankrupt if you
take out a loan. If you do go bankrupt, your company dissolves. You can either do
reorganization or liquidation (depending where in the world you are).
Stock Market;
The stock market provides liquidity to shareholders, something is liquid if it provides the option
to turn an asset into cash quickly, with same price as which you can buy it. Public companies
sell stocks to the public, so anything (ofc you need to be old enough) can buy stocks. This can
be done through stock exchange systems like NASDAQ or the New York Stock Exchange. The
primary market is when the corporation itself issues new shares and the secondary market is
when the investors trade shares between each other. Market makers are people who find you
buyers for the shares you want to sell or sellers for the share you want to buy. They also often
buy it themselves to keep liquidity and then sell when they can. Private companies need to find
buyers themselves, so this process often takes longer as it is not as easy to buy or sell shares
of a private company.
Dark Pools;
When buying stocks you can buy at the ask price and sell at the bid price. The difference in
between is what the market makers typically accept. However, dark pools allow people to trade
at a better price, as you can not see the bid and ask prices. The only thing is that they run the
risk of their order not being filled. Hence, trading in dark pools is good for traders who do not
want to reveal their demand and who are willing to sacrifice the guarantee of immediacy for a
potentially better price. Nowadays there are regulations on how they should be, as there had
been issues.
