Mod 4 Flashcards
Nexus of Contracts
The view that a firm creates a web of contracts with its owners, lenders, customers, employees, suppliers, and other counterparties as it pursues value creation
Residual Claimant
Owner who has the lowest priority claim on the cash flow of the firm
Sole Proprietorship
A business owned by a single individual
Sole Proprietorship Advantages
Easy to start
Little reguation
Owner makes all of the decisions
Owner gets all the profit
Business income taxed as personal income
Sole Proprietorship Disadvantages
Unlimited liability
Don’t benefit from specialization
Difficult to transfer ownership
Mortality of owner
Limited access to capital
Unlimited Liability
Creditors can look beyond the business assets to the proprietor’s personal assets for payment
Illiquidity
Inability to sell an asset quickly at its fair market value
Problem of Asymmetric Information
Transaction where the buyer and seller have different information sets.
When one party has superior info and the other inferior, it can be difficult and costly to arrive at mutually agreeable terms
Coincidence of Skills
Must find someone who has the necessary skills to operate the business
Partnership
A business formed by 2 or more individuals or entities
General Partnership
All partners share in the gains and losses
All have unlimited liability for all partnership debts
Limited Partnership
A special type of partnership with 2 types of partners
General Partner
General partners contribute money and make business decisions. They face unlimited liability
Limited Partner
Limited partners provide capital to the business but don’t participate in day-to-day decisions. They have limited liability
Partnership Agreement
A contract that outlines the rules under which a partnership operates.
Includes provisions for the distribution of profits, obligations of partners, procedures for selling ownership interest, and mechanisms for conflict resolution
Partnership Advantages
Profits taxed at personal rate
Gains from specialization
Increased access to capital
Partnership Disadvantages
Unlimited liability
Difficult to transfer ownership
Bylaws
Rules and procedures that govern the operation of the business
Board of Directors
The elected representatives of the shareholders who have a fiduciary obligation to act in the interest of the stockholders
Stockholders
Owners of a corporation
Limited Liability
When the maximum loss an owner can realize is their investment in the business
Liquidity
Increased liquidity
Corporation Advantages
Limited liability
Ability to raise lots of capital
Unlimited life
Increased liquidity
Specialization
Double Taxation
Profits pay corporate income tax and dividends to shareholders are taxed at the personal level
Agency Relationship
The principal hires an agent to act in their best interest
Public Company
Company whose shares trade on at least 1 stock exchange
S Corporation
Corporation with 100 or fewer owners
Taxed at the personal rate
C Corporation
Corporation with more than 100 owners
Pay corporate income tax and dividend distributions are taxed at the personal level
Corporation Disadvantages
Double taxation
Increased regulation
Agency costs
Goal of the firm
Maximize value for the firm
Value
What a business is worth
How to Create Value
Make good long term investments
Finance investments in an optimal way
Well run day-to-day operations
Agent
Party in an agency relationship hired to act in the principals best interest
Principal
The party in an agency relationship who hires an agent to act in their best interest
Agent Principal Problem
Possibility of a conflict of interest between the principal and the agent
Mitigate Agent Principal Problem
Executive compensation
Take over threat and market for executive talent
Regulation
Sarbanes Oxley Act (SOX)
US law designed to improve the reliability of financial statements of public companies and increase the penalties to company executives for fraudulent financials
Stakeholder
Someone other than a stockholder who potentially has a claim on the cash flows of the firm
Debt
Funding of a business enterprise that comes from lenders
Dividend
When a corporation disgorges its profits to stockholders
Buyback
When a corporation uses profits to buy its shares in secondary markets
Capital Budgeting
Process of planning and managing a firm’s long term investments
Capital Structure
Mixture of debt and equity maintained by a firm
Equity
Funding of a business enterprise that comes from owners
Primary Market
Capital market where an economic agent issues new securities in return for cash
Original sale of securities by governments and corporations
Secondary Market
Capital market where existing securities trade between parties but the cash does not flow back to the issuer of the security
Contract
A binding written or oral agreement between 2 or more parties
Corporation
A business created as a distinct legal entity from the owners, stockholders, or shareholders.
The corporation is liable for the claims of creditors, not owners, providing the shareholders limited liability
Initial Public Offering
When shares of a corporation become available to the public at large for the first time
Market Capitalization
Market value of a corporation
Price per share x # of shares outstanding
Monitoring
Principals spend time, money, and effort to watch the activities of their agents in order to alleviate agency problems
Securities and Exchange Commission
A federal gov body whose mandate is to protect investors and promote fair well-functioning markets
Shares of Stock
Standardized ownership claims on a corporation which convey certain rights to the shareholders, such as voting on the board of directors and sharing in dividends
Volume
Number of secondary market trades take place over a period of time
