Lecture 13 0308 - ORIE 350 March 8 2007 Stock...

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ORIE 350 March 8, 2007 Stock
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Stockholder’s Equity A. A corporation is a business organization authorized by the state and considered a separate legal entity from its owners. B. There are several advantages to the corporate form of business. 1. Separate legal entity. 2. Limited liability of owners. 3. Ease of capital generation. 4. Ease of transfer of ownership. 5. Lack of mutual agency. 6. Continuous existence. 7. Centralized authority and responsibility. 8. Professional management.
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Disadvantages of the Corporation 1. Double taxation. Say you own 100% of a C-corporation. The corporation’s net income is taxed. If you pay yourself a dividend, the dividends you receive as a private individual are taxed again. Hence, most small corporations will form as an S-corporation (no double tax).
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Disadvantages 2. Limited liability of owners. Example: A rich person owns a corporation. The corporation has limited assets, owes $2.5 million to a bank, and the loan is guaranteed by the Small Business Administration. In the case of a bankruptcy, the SBA pays back the bank in full, and can only claim the assets of the corporation. The SBA cannot claim the assets of the rich person. In fact, the company does go bankrupt, costing taxpayers $2.5 million. Who was it?
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Guess the Bush Family Member : It’s the President’s brother Neil (center).
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Disadvantages 3. Separation of ownership and control Occasionally, management does not act in the best interest of its owners (stockholders). Example: a corporation owns a fleet of jet planes for use by management. This is why many corporations compensate their upper management with stock, so that upper level managers become (in effect) owners as well. This always works!
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Dennis Kozlowski Tyco Ken Lay and Jeff Skilling Enron Bernard Ebbers WorldCom
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Stock F. Stockholder’s equity is composed of contributed capital and retained earnings. Authorized stock is the maximum number of shares the corporation is allowed to issue according to its corporate charter. Issued stock is the number of shares transferred (usually sold) to stockholders. Outstanding stock is the shares that have been issued and are still being held by shareholders. We use outstanding stock when calculating earnings per share. I. When only one type of stock is issued, it is called common stock . Venture capitalists demand preferred stock with special privileges and provisions.
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Preferred Stock Holders of preferred stock are given preference over holders of common stock when dividends are declared or the company is liquidated. When the preferred stock is cumulative, any unpaid dividends are carried over to future years, and the unpaid back-dividends are called dividends in arrears. You can see how this would be used to compensate venture capitalists. Once the company is profitable, all of the dividends in arrears are paid to the VC’s.
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Preferred Stock N. With non-cumulative preferred stock, the unpaid dividends are not carried over to the next period.
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