0REVIEWING THE CHAPTER
Objective 1: Identify and explain the management issues related to contributed capital.
is a business unit chartered by the state and legally separate from its owners
—the stockholders. The management of
(stockholders’ investments) is
critical to the financing of a corporation. Specifically, management must fully understand
(a) the advantages and disadvantages of incorporation, (b) the issues involved in equity
financing, (c) the business’s dividend policies, (d) the use of return on equity to evaluate
performance, and (d) the company’s stock option plans. These topics will be addressed in
the paragraphs to follow.
To form a corporation, most states require persons (called
) to sign an
application and file it with the proper state official. This application contains the
These articles become a contract between the state and the incorporators.
The company is then authorized to do business as a corporation. Because of the ease with
which a corporation can raise large amounts of capital, it is the dominant form of business
in the United States. The corporation has several advantages over the sole proprietorship
and partnership. In addition to its ability to raise large amounts of capital, it is a separate
legal entity, offers its owners limited liability, lacks the mutual agency that characterizes a
partnership, has a continuous existence, and allows for centralized authority and
responsibility, as well as for professional management. It is also easy to transfer ownership
in a corporation. However, a corporation has several disadvantages when compared with a
sole proprietorship or partnership. It is subject to greater government regulation and to
(i.e., the corporation’s income is subject to income taxes, and its
stockholders are taxed on any dividends), and the owners’ limited liability can limit the
amount a small corporation can borrow. Moreover, separation of ownership and control
may allow management to make harmful decisions.
A unit of ownership in a corporation is called a
share of stock.
Ownership in a corporation
is evidenced by a document called a
which shows the number of shares
the stockholder owns. A stockholder sells stock by endorsing the stock certificate and
sending it to the corporation’s secretary. The secretary—or in many instances, an
independent registrar or transfer agent—is responsible not only for transferring the stock,
but also for maintaining stockholders’ records, preparing a list of stockholders for
stockholders’ meetings, and paying dividends.
is an arbitrary amount assigned to
each share of stock, and it constitutes a corporation’s legal capital.
number of shares issued times the par value; it is the minimum amount that can be reported
as contributed capital. Par value bears little if any relationship to the market value or book