Lecture 17: Firms in the Real World

Outline:

1. Forms of business organization

i. proprietorships

ii. partnerships

iii. corporations

2. How do corporations operate?

3. Rise of the modern corporation

4. Financing of firms:

i. Equity

ii. Debt

5. Take-overs and economic efficiency

6. Foreign Investment

i. Transnational corporations (TNCs)

ii. Costs and Benefits of TNCs

7. Dollars and Sense: Article 20

8. New Field Guide: 9.11, 9.13, 9.14, 9.15, 9.16, 10.10.

1. Forms of business organization:

1. Single proprietorships

2. Partnerships

3. Corporations

Question: What are the characteristics of each of these forms of business organization?

Question: What are the advantages/disadvantages of the different forms of business organization from the perspective of the owner of the firm?

2. How do corporations operate?

* The corporation is a legal entity unto itself - it exists independently of its owners.

* Most corporations are publically held and traded, although some are privately held.

* Ownership of a corporation takes the form of owning shares of stock in the company.

* The shareholders of the corporation elect a Board of Directors and the Board appoints a manager to run the corporation.

* Profits of the corporation are either

(a) Reinvested in the corporation (Retained Earnings)

or (b) Paid out to the shareholders (Dividends)

3. The Rise of the Modern Corporation:

* Large scale production (mass production) required large amounts of money to finance a firm.

* Corporations developed as a form of business that could mobilize those large sums of money needed to finance the firm.

* Some history - the origins of corporations go back to the 16^th century in England - the first corporate charters in America were granted by the King of England - a corporate charter was granted on the condition that the firm agree to operate in a way that "serves the public interest" - the idea was that a corporate charter could be revoked in a case where the public interest was not being served by a firm. Over time this has all but disappeared and the modern corporation has acquired many of the rights of individual citizens.

Aside: A good book if your are interested: David Korten When Corporations Rule the World

4. Financing of Firms:

Financial Capital = the money that a firm raises to carry out its business

Note: Financial capital (money) is different from physical capital (buildings, equipment, factories)

Question: How do firm's raise financial capital?

i. Equity financing - this involves selling ownership rights to the firm:

(a) Retained earnings - profits that are not distributed to shareholders but instead reinvested in the firm.

(b) Issuing new shares - selling new ownership rights to the firm.

Stocks/Shares - pay dividends to the stock holders, which are a share of the firm's profits.

ii. Debt financing - this does not involve selling any ownership rights to the firm, it involves taking out loans :

(a) Loans from financial institutions - the firm borrows from a bank for example.

(b) Issuing bonds - the firm issues a promise to pay a certain amount in the future to the bearer of the bond.

Bonds - pay principal and interest (a percentage of the principal) and at the end of the loan term, to the bearer of the bond.

Note: The people/institutions holding the firm's debt are called its "creditors".

Question: In the event of bankruptcy who gets paid first - bondholders or shareholders?

5. Take-overs and economic efficiency:

* Take-overs may or may not improve economic efficiency.

* Take-overs will improve economic efficiency if the new management that is instituted is more efficient than the old management - that is the new management can reorganize the firm's assets in such a way that they can produce more.

* Many take-overs do not improve economic efficiency - many are motivated by short-term gains - many involve taking-over a company and then selling off its assets for immediate income.

6. Foreign Investment:

* Historically - foreign investment involved investors in one country investing in foreign owned companies.

* Today - the majority of foreign investment involves the business conducted by Transnational Corporations (TNCs)

TNCs are firms that have production facilities in a number of different countries.

* The rise of TNC s has to do with increased international mobility of financial capital.

* The power of TNCs lies in their ability to locate production in any part of the world where they can earn the highest profits.

* That power has implications for the ability of national governments to conduct economic policy - as the power of TNCs increases the power of national governments over their own economies decreases.

Question: HOW?

* The same is true for labor - workers are less mobile than financial capital and they face potential job loss with any relocation of a TNC - as the power of the TNC increases, the power of labor over wages and working conditions decreases.

Questions: HOW?

Costs and Benefits of TNCs pages 290-292 in your textbook for more details.