Intro to Bus. Entities Flashcards
Classic Firm and Entrepreneur responsibilities
a. Classical Firm: Owned & Managed by one person; sole proprietorship
b. Entrepreneur: Directs the business and exercises the ultimate business judgement; Unlimited liability.
i. Has 2 tasks;
1. Direct the business, and exercise the ultimate business judgment
a. Not simply reacting to what a consumer wants but rather forecasting whether, at what price and in what quantities consumers would be willing to buy a particular product or service if it were to be produced and made available to the marked
b. Forecasting whether and how employees need to be hired and whether there will be profit
2. Accepting full responsibility of his or her business decision by being the residual guarantor and claimant
Coasean Perspective
The firm is what we call the set of relations that arise when the entrepreneur allocates resources via commands to her employees rather than the set of relations that arise when an entrepreneur allocates resources via market transactions with outsiders.
i. Essence of the firm=entrepreneur’s management and conscious direction of resource allocation decisions.
Business Association
Jointly owned firm.
i. 2 entrepreneurs combining their firms = business association
ii. Closely held: small number of owners
iii. Publicly traded: thousands of capital providers/employees
Berle & Means’ View
i. The Modern corporation destroyed the theoretical underpinnings of the free enterprise system.
ii. 3 Possible Responses to the Economic Power of the Modern Corporation and its Managers:
1. Society could bend corp. to the will of the shareholders (shareholders act as real owners)
2. Society recognizes that corp. managers have absolute power.
3. Treat interests of both managers and shareholders as subordinate to paramount claims of society.
a. Generally enforced by federal law and policies (ex. Pollution laws etc)
Separation of ownership and control & Agency costs
i. Shareholder are the owners (or principals)
ii. Managers are shareholders’ agents
iii. Principals and agents contract with each other to determine how much control the principal will retain and how much control will be ceded to the agent
Agency – cost limiting devices include:
- Direct monitoring of managers actions
- Bonding agreement by managers that there will be penalties if specific objective events do not occur
- Incentives schemes to alight managers interests w/ those of shareholders
The Role of the Corporate Lawyer in Organizing a Firm:
i. Assists In creation of an appropriate initial governance structure and will assist in adapting the organization as required by changed circumstances.
ii. Is a transaction-cost engineer
Transaction Cost
i. Bounded Rationality: While individuals intend to act rationally, there are cognitive limits, or bounds on their ability to do so.
ii. Opportunism: Individuals pursue their own self-interest in economic matters
1. Simple (Open) Self-Interest Seeking: Actors prefer their own interests to those of other economic actors but do so while being honest and above board in their dealings
2. Opportunism: Actors who act to further their own ends by taking advantage of the information deficits of those with whom they deal. “Opportunism refers to the incomplete or distorted disclosure of information, especially to calculated efforts to mislead, distort, disguise, obfuscate, or otherwise confuse.”
Team Specific Investment
When a person or asset has a higher value in its current team use than its value in its next best use, the person or asset is said to have team-specific value.
a. Example: Sharon operates a brewery and buys beer from Jack who sells beers to multiple breweries. If their relationship ends they can both buy and sell beer from others = not team specific
b. But if Sharon sells special beer that only Jack produces and Sharon and Sharon is the only one who sells it then it is team specific value.
Discrete Contracting:
Where parties have no preexisting obligations to each other, as they approach the contemplated venture, they negotiate a contract that anticipates and provides a rule governing all contingencies. Nothing is left to be worked out in the future.
Relational Contracting
Response to the defects of discrete contracting; parties attempt to build a governance structure that will allow them to solve problems when and if they arise
II. State Provided Governance Structures:
a. Employer/Employee Relationship, Corporation, Partnership, LLC
b. Provide parties with default rules that govern the relationships unless the parties provide otherwise “Off the Shelf Contractual Device”
c. Majoritarian Rules: Designed to provide investors with the result that most similarly situated parties would prefer.
d. Penalty-Default-Rules: Designed to motivate one or more contracting parties to contract around the default. The goal is to force the parties to specify their own rules instead of relying on a default rule provided by law.
