Corporation

Business, Legal & Accounting Glossary

Definition: Corporation


Quick Summary of Corporation


A legal structure authorized by state law that allows a business to organize as a separate legal entity from its owners. A nonprofit is often referred to as an “artificial legal person,” meaning that, like an individual, it can enter into contracts, sue and be sued and do the many other things necessary to carry on a business. One advantage of incorporating is that a corporation’s owners (shareholders) are legally shielded from personal liability for the corporation’s liabilities and debts (unpaid taxes are often an exception). In theory, a corporation can be organized either for profit-making or nonprofit purposes. Most profit-making corporations are known as C corporations and are taxed separately from their owners, but those organized under subchapter S of the Internal Revenue Code are pass-through tax entities, meaning that all profits are federally taxed on the personal income tax returns of their owners.




What is the dictionary definition of Corporation?

Dictionary Definition


  1. A group of individuals, created by law or under authority of law, having a continuous existence independent of the existences of its members, and powers and liabilities distinct from those of its members.
  2. U.K. The municipal governing body of a borough or city since 1974 obsolete except in the City of London
  3. In Fascist Italy, a joint association of employers’ and workers’ representatives.

n. an organization formed with state governmental approval to act as an artificial person to carry on business (or other activities), which can sue or be sued, and (unless it is non-profit) can issue shares of stock to raise funds with which to start a business or increase its capital. One benefit is that a corporation’s liability for damages or debts is limited to its assets, so the shareholders and officers are protected from personal claims, unless they commit fraud. For private business corporations the articles of incorporation filed with the Secretary of State of the incorporating state must include certain information, including the name of the responsible party or parties (incorporators and agent for acceptance of service), the amount of stock it will be authorized to issue, and its purpose. In some states, the purpose may be a general statement of any purpose allowed by law, while others require greater specificity. Corporation shareholders elect a board of directors, which in turn adopts bylaws, chooses the officers and hires top management (which in smaller corporations are often the directors and/or shareholders). Annual meetings are required of both the shareholders and the board, and major policy decisions must be made by resolution of the board (which often delegates much authority to officers and committees). Issuance of stock of less than $300,000, with no public solicitation and relatively few shareholders, is either automatically approved by the state commissioner of corporations or requires a petition outlining the financing. Some states are considered lax in supervision, have low filing fees and corporate taxes and are popular incorporation states, but corporations must register with Secretaries of State of other states where they do substantial business as a “foreign” corporation. Larger stock offerings and/or those offered to the general public require approval by the Securities and Exchange Commission after close scrutiny and approval of a public “prospectus” which details the entire operation of the corporation. There are also non-profit (or not for profit) corporations organized for religious, educational, charitable or public service purposes. Public corporations are those formed by a municipal, state or federal government for public purposes such as operating a dam and utility project. A close corporation is made up of a handful of shareholders with a working or familial connection which is permitted to operate informally without resolutions and regular board meetings. A de jure corporation is one that is formally operated under the law, while a de facto corporation is one which operates as if it were legal, but without the articles of incorporation being valid. Corporations can range from the Corner Mini-Mart to General Electric.


Full Definition of Corporation


Today, when people talk of corporations, it is usually joint-stock limited liability corporations that they have in mind.

These share three characteristics:

  • Legal personality: Corporations are treated as artificial people, with a similar capacity for legal rights and obligations.
  • Equity financing: Ownership is securitized as stock that may be held by multiple investors and traded in secondary markets.
  • Limited liability: The liabilities of the corporation are not liabilities of its owners, who can lose nothing more than the capital they have already committed to the corporation.

But it is the first characteristic that defines a corporation.

Corporations are artificial entities that are created by state statute, and that are treated much like individuals under the law, having legally enforceable rights, the ability to acquire debt and payout profits, the ability to hold and transfer property, the ability to enter into contracts, the requirement to pay taxes, and the ability to sue and be sued.

The rights and responsibilities of a corporation are independent and distinct from the people who own or invest in the corporation. A corporation simply provides a way for individuals to run a business and share in profits and losses.

History

The concept of a corporate personality can trace its roots to Roman law, and found its way to the American colonies through the British. After gaining independence, the states, not the federal government, assumed authority over corporations.

Although corporations initially served only limited purposes, the industrial revolution spurred their development. The corporation became the ideal way to run a large enterprise, combining centralized control and direction with moderate investments by a potentially unlimited number of people.

The corporation today remains the most common form of business organization because theoretically, a corporation can exist forever and because a corporation, not its owners and investors, is liable for its contracts. But these benefits do not come free. A corporation must follow many formalities, is subject to publicity, and is governed by state and federal regulations.

Roman Corporations

It is natural to think of an organization as having a collective identity distinct from that of any particular person who owns or belongs to it. The Romans recognized this with the notion of a corporation. The word corporation derives from the Latin word corpus for body, representing a body of people authorized to act as an individual. Cities were the first entities the Romans treated as corporations. Over time, the concept was extended to certain community organizations called collegia. These included artisan associations, religious societies and social clubs formed to provide funerals for members.

Most Roman corporations served exclusively community or religious purposes. Of course, distinguishing public from private interests can be difficult. A natural tension exists between the two in any society.

The Roman Republic relied on private contractors to perform a variety of tasks. Contracts to build aqueducts, manufacture arms, construct temples, collect taxes—even feed the geese on the capital—were granted to firms called publicani. These originated as loose associations among contractors who would pool their resources to bid on contracts. Over time, the publicani evolved into permanent companies with numerous investors, only a handful of whom served as managers. Larger publicani employed thousands of workers spread across Rome’s provinces. Fragmented evidence indicates that some of these received corporate status (habere corpus), which included a grant of limited liability for investors.

The publicani were well connected and, at times, extremely influential. Collusion with government officials was a lucrative way of business. If there was public indignation, it was balanced by investment enthusiasm. Polybius reported: Polybius, book IV. See translation by Scott-Kilvert (1979), p. 316.

There is scarcely a soul, one might say, who does not have some interest in these contracts and the profits which are derived from them.

As early as records exist, the publicani were tainted by scandal. During the Second Punic War, the Republic agreed to insure the ship-borne cargoes of publicani willing to supply the legions on credit. Two years later, it came to light that old, rotting ships had been loaded with worthless goods and then scuttled at sea. The perpetrators organized a mob to disrupt a public enquiry. Eventually, it was only intervention by the Senate that brought them to justice.

Tax collecting was one of the publicani’s more controversial enterprises. Rome assessed a number of taxes, including taxes on pastures, grain and even the freeing of slaves. The publicani collected a number of these from Rome’s provinces. Essentially, they would buy future tax revenue from the state and then pocket whatever they could collect.

The system was ripe for abuse. Rome’s local governors oversaw the tax collections in each province. Some were corrupt, and the process became one of the governor and publicani together seizing whatever they could. Even when governors were honest, provincials understood they would be paying more than the percentages prescribed by law. Few governors would willingly antagonize their own financiers—publicani could work political mischief back in Rome.

Nicomedes III was king of Bithynia, a client state of Rome. When Rome’s senate asked him to contribute troops to help fight the Germans, he replied that he had none to spare. The publicani had enslaved most of his subjects! The enslavements may have been related to tax debts.

Livy commented Livy XIV, 18,4

Where there was a publicanus, there was no effective public law and no freedom for the subjects.

Under the emperors, the political landscape shifted, and the publicani were suppressed. New forms of corporations emerged. Charitable corporations were established to serve Rome’s growing indigent population. The emerging Catholic Church employed the corporate form as a vehicle for joint ownership of real estate and other property.

Trading Corporations

Roman law survived the fall of the Western Roman Empire to reemerge in aspects of the Church’s canon law and Europe’s secular bodies of law. During the Middle Ages, cities, guilds, monasteries and universities were all chartered as corporations, typically by sovereigns, local nobility or religious authorities. All served largely public or religious functions. For centuries, Europe witnessed nothing that resembled Rome’s publicani. This changed around 1600, when new business forms emerged to challenge the might of Spain and Portugal. The upstarts were chartered corporations.

There is something about representative government that allows people and their institutions to flourish. Is it a coincidence that both Rome and the United States were republics? Consider the Dutch. From 1568 to 1648, they fought the Eighty Years War to cast off their Spanish rulers. In the midst of that war, they formed their own republic. This launched a period that has come to be known as the Dutch Golden Age. Art, trade and social tolerance flourished. This was the age of Rembrandt and Vemeer. The Dutch formed the first stock exchange. They sailed all over the world, founding one outpost on the Southern tip of Manhattan Island.

Portugal had discovered the East Indies as the source of spices, and Spain was plundering the Americas for gold and silver. The Vatican legitimized this arrangement, ruling that lands discovered in the Eastern Hemisphere belonged to Portugal while lands discovered in the Western Hemisphere belonged to Spain. Holland and England flaunted the Vatican’s law. Not only did they practice a different religion, but they adopted different methods. While the Spanish and Portuguese sovereigns shouldered the expenses and risks of overseas ventures, English and Dutch traders formed corporations to challenge them.

These trading corporations had their roots in guilds. During the 14th and 15th centuries, guilds were chartered primarily to enforce a monopoly in certain businesses or geographic regions. In exchange for a grant of monopoly, a guild would make ongoing fee payments to its chartering authority. Members of a guild might compete with one another, but outsiders were excluded.

Traders also formed guilds. Their purpose was to secure from the government a grant of monopoly over trade with specific geographic regions. In England, such guilds were called regulated companies. They were often referred to by names reflecting their monopolies—the India Company, African Company, Russia Company, Turkey Company, etc.

The members of a regulated company might compete with one another, but they often formed short-term partnerships to conduct specific voyages. Also, a regulated company might sponsor voyages, which it would open to all members. Because these voyages were the company’s own ventures, participants enjoyed limited liability. Equity subscriptions were offered to members, but additional capital could be raised from outsiders, who would pay a nominal “membership fee” in addition to their investment. Members would then outfit and man the ships. Regulated companies that sponsored equity-financed voyages came to be called joint-stock companies.

Two early joint-stock companies were Holland’s and England’s respective East India Companies, which were chartered to challenge Portugal’s dominance of the spice islands. Initially, neither company had permanent equity. Each voyage would have its own equity subscription. This proved impractical, and soon capital from one voyage was being rolled over to finance subsequent voyages. In this way, the companies evolved to become much like today’s business corporations. They had separate managers and investors. Members gradually became an anachronism, taking on more the role of an employee base.

The joint-stock corporations cultivated influence at the highest levels of government. The Queen and nobility had significant investments in the English East India Company, and they looked out for the company’s interests in the halls of government. The joint-stock companies continued the guild practice of making ongoing payments to the state. In this, we may perceive the origins of corporate taxation, but the people of the day viewed it as more akin to graft.

When motivated by greed, managers’ behaviour could be deplorable. While the English East India Company was negotiating trading rights with the kingdom of Achin, that nation’s sultan suggested it would be nice if he could have a couple of European girls for his harem. The English managers felt uncomfortable facilitating polygamy, but they saw nothing wrong with presenting just one English girl for what would, in essence, be sexual slavery. One of the company’s managers offered his own daughter for this purpose. She was saved by King James II, who refused to approve the gift.

The Dutch were brutal in pursuing their trade interests. Holland was at war with Portugal, and their East India Company carried on that war. They attacked Portuguese shipping and facilities wherever they found them. England and Holland were allies, but Dutch merchants didn’t care. As Holland’s de facto representatives in the East Indies, they put profits ahead of national interest and periodically employed the threat of violence as a competitive device against English traders.

The Banda Islands, West of New Guinea, were the world’s sole source of nutmeg. In 1620, the Dutch East India Company forcibly evicted the English from this prize. They then committed genocide against the natives, killing or deporting into slavery most of the population. In 1623, on the nearby island of Amboyna, the Dutch imprisoned about 40 individuals, whom they accused of plotting against them. Among the prisoners were ten representatives of the English East India Company. The Dutch merchants brutally tortured their prisoners and then executed most of them. When word of this atrocity reached London, it almost sparked a war.

Bubbles And Abuses

Most people have heard of the Mississippi Scheme and the South Sea Bubble. They were popularized in Mackay’s (1841) Extraordinary Popular Delusions and the Madness of Crowds as early instances of speculative bubbles. What is not as widely known is the fact that these schemes—essentially frauds—were orchestrated and promoted by the French and English governments. In the early 1700s, both nations had large war debts they wanted to quickly retire. Both nations pursued a strategy of engraftment. Publicly owned government debt would be exchanged for stock in some corporation, which would then hold all the debt. The governments could then extract reduced interest rates from those corporations in exchange for generous monopoly grants. This was the theory. In practice, the French and English governments implemented their engraftment schemes with struggling corporations with questionable prospects. The French did so with the Mississippi Company, which was a struggling, mismanaged corporation with vague plans to promote emigration to the Americas and acquire a grant of monopoly over tobacco. The English did so with the South Sea Company, which was formed by the government specifically for the purpose of engraftment. It was granted certain monopolies over English trade with South America. Since Spain was in control of those regions, those monopolies were probably worthless. The Mississippi and South Sea Companies’ only valuable assets would be government debt paying reduced interest rates. To induce investors to exchange their government debt for shares in the corporations, promoters and the French and English governments had to convince them that the corporations’ franchises were valuable. They manipulated the corporations’ stock prices so they would be higher than the par value of the exchanged government debt. Investors scrambled to make the exchange, and frenzied speculators bid the corporations’ stocks even higher. Speculative bubbles developed for both corporations’ stocks. The Mississippi Company bubble burst in the Summer of 1720. Fortunes were lost, and France’s semi-feudal economy was crippled. The South Sea bubble burst soon afterwards. Its impact on the more robust English economy was not as severe, but it had repercussions across all the economies of Europe.

At the height of the South Sea bubble, England’s Parliament passed an act severely restricting the formation of new corporations. This has come to be known as the Bubble Act. There is a common misperception that it was passed as a response to the bursting of the South Seas bubble. In fact, it was passed while the bubble was forming in an attempt to block new corporations from competing with the South Seas Company for investors’ capital. For almost a hundred years following the bursting of the bubble, the Bubble Act and a general anti-corporate sentiment severely limited the formation of new English corporations.

Incorporation By Registration

A recurring theme in the history of corporations is that they should exist to serve some public purpose, and they are granted certain privileges to facilitate this. The state would charter corporations that it deemed worthy. At first, the most important privilege was a grant of some monopoly—say a monopoly over trade with some region or an exclusive right to build a certain canal. Over time, transferability of shares and limited liability became more important. These gave corporations an enormous advantage in raising capital over sole proprietorships and partnerships. Investors with modest holdings and limited liability were comfortable letting specialists run their corporations, so the separation of investors and management became one of the great strengths—and great weaknesses—of limited liability joint-stock corporations.

The building of highways, canals and railroads was a quintessential public need, and numerous corporations were chartered for these purposes. For other businesses, the state’s monopoly on granting corporate status proved onerous. When entrepreneurs tried to form a new corporation, competitors could oppose their petition for incorporation. Inevitably, the process was marked by political intrigue. When incorporation was denied, entrepreneurs had meager options. They might buy a failing corporation as a shell and then raise capital for a business unrelated to that corporation’s original monopoly. This practice was called charter abuse. With the supply of failing corporations limited, a more common solution was to simply issue stock in unincorporated companies. This legally perilous practice became widespread in England during the late 1700s. Many respectable firms were formed in this manner. In the early 1800s, competitors started challenging their legality in court.

The English industrial revolution was taking off, and the courts and governments found themselves making increasingly arbitrary decisions about which businesses to favour. Something had to be done. The solution was a new concept: incorporation by registration. In various countries, legislation was passed allowing entrepreneurs to incorporate any firm they liked by simply filing paperwork. No longer would corporations be privileged associations granted monopolies by the state to pursue some public purpose. They had become a standard business form—along with sole proprietorships and partnerships—that was available to all.

The United States emerged from its civil war in 1865 poised for growth. She was wealthy in land and natural resources. She had a well-educated populace, liberal social and legal systems and an abundance of cheap labour arriving at her shores. The industrial revolution that followed was one of explosive growth unprecedented in earlier history. Mark Twain called this America’s Gilded Age. Incorporation by registration made it easy for businessmen to form corporations and raise capital. A lack or regulation facilitated unsavoury business practices. Businessmen with the least scruples or the most vision rose to lead industry. They were disparagingly called robber barons, and came to include Andrew Carnegie, who dominated steel, Jay Gould in railroads, John D. Rockefeller in oil and John P. Morgan in banking.

Managerial Capitalism

The agency problem has existed as long as men have allowed others to act on their behalf. In corporations, it arises between stockholders and managers, and this was one of the reasons Adam Smith (1776) denounced corporation. Commenting on managers, he complainedSmith (1776), Book V, Chapter I, Part III, Article 1.

… being the managers rather of other people’s money than of their own, it cannot well be expected, that they should watch over it with the same anxious vigilance with which the partners of a private copartnery frequently watch over their own … Negligence and profusion, therefore, must always prevail, more or less, in the management of the affairs of such a company.

Writing 150 years later, Berle and Means (1932) noted a fundamental change in this agency problem. The age of the robber barons had passed, and ownership of American corporations was becoming more widely dispersed. This phenomena is called the democracy of capitalism. It meant that stock holdings were shrinking, and individual shareholders were losing the ability to influence how corporations were managed. Berle and Means noted:Berle and Means (1932), p. 8.

Under such conditions, control may be held by the directors or titular managers who can employ the proxy machinery to become a self-perpetuating body, even though as a group they own but a small fraction of the stock outstanding.

Berle and Means were witnessing the beginnings of a phenomena that Chandler (1977) has called managerial capitalism. In Adam Smith’s day, this didn’t exist. Shareholders still controlled corporations, and the agency problem was a matter of managers not exercising “anxious vigilance.” Under managerial capitalism, shareholders have surrendered control to managers, and the agency problem is one of managers enriching themselves to the extent applicable laws will allow. Berle and Means identified a variety of devices by which managers might do so. Laws have evolved since, but similar devices still exist. Perhaps the most straightforward is for managers to pay themselves exorbitant compensation.

Scholarly apologists for managerial capitalism have tried to redefine the very concept of the corporation in order to legitimize managerial abuses. Ignoring a definition that dates to Roman times, not to mention 400 years of common law, these scholars have proposed their own definition of a corporation, which is called the contracts theory of the firm. It is also called the contractarian or nexus of contracts theory of the firm. It posits that, instead of being a legal entity, a corporation is merely a collection of contracts—contracts between shareholders, board members, managers, employees, suppliers and customers. Under this theory, shareholders don’t own corporation, because there is nothing to own! Instead, shareholders’ stock represents a contract under which they provide capital to board members and receive dividends in return. There is much wrong with this reinterpretation of the corporation. Perhaps the fatal flaw is the fact that not all corporate obligations are contractual. Board members have always had a fiduciary- as opposed to a contractual – obligation to shareholders.

Corporate Governance Movement

Managerial capitalism spread during the 20th century. As it did so, boards lost relevance. Many CEOs had themselves appointed chairman of the board. Managers took board seats for themselves. On many boards, they took most of the seats. Short of setting strategy and overseeing managers, boards were increasingly becoming appendages to management.

There is an old joke about two campers who are startled by a bear. When one of the campers starts lacing up his running shoes, his partner asks “What are you doing? You can’t outrun a bear.” The other camper responds “I don’t have to. I just have to outrun you!”

Managers don’t really maximize shareholder value. This often-cited goal is an absolute ideal that is impossible to assess. As a practical matter, managers strive to outperform—or at least keep up with – competing corporations. A corporation’s stock can drop 5%, but managers are heroes so long as the market drops 10%. This relativist way of thinking is indefensible except for the fact that there are no good alternatives.

Cast on a relative sea and rudderless without strong board leadership, American corporations drifted. The wakeup call came in the 1980s, when Japanese corporations flooded US markets with high-quality goods at reasonable prices. The Japanese offered a unique opportunity to understand—in an absolute sense—how far US corporations had strayed from maximizing shareholder value.

One response was hostile takeovers. Financed with junk bonds, raiders would seize control of a firm, fire management, slash expenses, and then sell off a reorganized firm at a profit. That was the theory. In practice, the takeover market of the 1980s was marred by kickbacks and insider trading, but proponents justified the market in ways that resonated with the public. Michael Milken was the messiah. Bruck (1988) explained: Bruck (1988), 12.

Milken had long professed contempt for the corporate establishment, portraying many of its members as fat, poorly managed behemoths who squandered their excess capital and whose investment-grade bonds, as he loved to say, could move in only one direction – down.

Takeovers threatened the prerequisites of managers, and some started to act – slashing expenses and refocusing their firms. When management didn’t act, boards might. The boards of General Motors, IBM and American Express all fired underperforming CEOs. Delaware courts and the SEC clarified the responsibilities of boards. Institutional investors also acted, pressuring boards to fire underperforming CEOs or to reform themselves. These efforts coalesced into a corporate governance movement that promoted reforms such as

  • requiring that a majority of directors be independent;
  • separating the roles of CEO and chairman, or failing that, appointing a “lead” independent director to play a role similar to that of chairman;
  • requiring that keyboard committees be composed exclusively of independent directors.
  • elimination of poison pills, golden parachutes and other anti-takeover devices.

Following the corporate scandals of 2001-2002, some of the reforms promoted by the corporate governance movement were adopted in legislation or in stock exchange rules.

Special Purpose Vehicles

Today, corporations are widely employed as special purpose vehicles in structured finance. In this role, corporations may be little more than receptacles for property—perhaps leased property or collateral backing a securitization. As a special purpose vehicle, a corporation has little in common with the Roman corporations, not to mention the great trading corporations of the 1600s or the industrial corporations of the robber barons. Special purpose vehicles generally have no employees. In some cases, ownership is mostly concentrated in a single sponsoring corporation, in which case the concept of a group of people acting as one hardly applies. Special purpose vehicles don’t have to be implemented as corporations, but doing so is a convenient means of achieving limited liability.

Special purpose vehicles serve many valuable purposes, but they also offer an opportunity for abuse. This became starkly apparent in the Enron scandal, in which special purpose vehicles were widely used to hide that firm’s massive debts.

Types Of Corporations

Corporations can be private, nonprofit, municipal, or quasi-public. Private corporations are in business to make money, whereas nonprofit corporations generally are designed to benefit the general public. Municipal corporations are typically cities and towns that help the state function at the local level. Quasi-public corporations would be considered private, but their business serves the public’s needs, such as by offering utilities or telephone service.

There are two types of private corporations. One is the public corporation, which has a large number of investors, called shareholders. Corporations that trade their shares, or investment stakes, on securities exchanges or that regularly publish share prices are typical publicly held corporations.

The other type of private corporation is the closely held corporation. Closely held corporations have relatively few shareholders (usually 15 to 35 or fewer), often all in a single-family; no outside market exists for the sale of the shares; all or most of the shareholders help run the business, and the sale or transfer of shares is restricted. The vast majority of corporations are closely held.

Getting A Corporation Started

Many corporations get their start through the efforts of a person called a promoter, who goes about developing and organizing a business venture. A promoter’s efforts typically involve arranging the needed capital, or financing, using loans, money from investors, or the promoter’s own money; assembling the people and assets (such as land, buildings, and leases) necessary to run the corporation; and fulfilling the legal requirements for forming the corporation.

A corporation cannot be automatically liable for obligations a promoter incurred on its behalf. Technically, a corporation does not exist during a promoter’s pre-incorporation activities. A promoter, therefore, cannot serve as a legal agent, who could bind a corporation to a contract. After formation, a corporation must somehow assent before it can be bound by an obligation a promoter made on its behalf. Usually, if a corporation gets the benefits of a promoter’s contract, it will be treated as though it assented to and accepted the contract.

The first question faced by incorporators (those forming a corporation) is where to incorporate. The answer often depends on the type of corporation. Theoretically, both closely held and large public corporations may incorporate in any state. Small businesses operating in a single state usually incorporate in that state. Most large corporations select Delaware as their state of incorporation because of its sophistication in dealing with corporation law.

Incorporators then must follow the mechanics set forth in the state’s statutes. Corporation statutes vary from state to state, but most require basically the same essentials in forming a corporation. Every statute requires incorporators to file a document, usually called the articles of incorporation, and pay a filing fee to the secretary of state’s office, which reviews the filing. If the filing receives approval, the corporation is considered to have started existing on the date of the first filing.

The articles of incorporation typically must contain (1) the name of the corporation, which often must include Company, Corporation, or the like and may not resemble too closely the names of other corporations in the state; (2) the length of time the corporation will exist, which can be perpetual or renewable; (3) the corporation’s purpose, usually described as “any lawful business purpose”; (4) the number and types of shares the corporation may issue and the rights and preferences of those shares; (5) the address of the corporation’s registered office, which need not be the corporation’s business office, and the registered agent at that office who can accept legal service of process; (6) the number of directors and the names and addresses of the first directors; and (7) each incorporator’s name and address.

A corporation’s bylaws usually contain the rules for actually running the corporation. Bylaws normally are not filed with the secretary of state and are easier to amend than the articles of incorporation. The bylaws should be complete enough that corporate officers can rely on them to manage the corporation’s affairs. The bylaws regulate the conduct of directors, officers, and shareholders and set forth rules governing internal affairs. Bylaws can include definitions of management’s duties, and times, locations, and voting procedures for meetings affecting a corporation.

People Behind A Corporation: Rights And Responsibilities

The primary players in a corporation are the shareholders, directors, and officers. Shareholders are the investors in a corporation. They elect, and sometimes remove, the directors and occasionally must vote on specific corporate transactions or operations. The board of directors is the top governing body. Directors establish corporate policy and hire officers, to whom they usually delegate their obligations to administer and manage the corporation’s affairs. Officers run the day-to-day business affairs and carry out the policies the directors establish.

Shareholders

Shareholders are people who have an investment stake in a corporation, in the form of a share of stock. Their financial interest in the corporation is determined by the percentage of the total outstanding shares they own. Along with their financial stake, shareholders generally receive a number of rights, all designed to protect their investment.

Foremost among these rights is the power to vote. Shareholders vote to elect and remove directors, to change or add to the bylaws, to ratify (approve after the fact) directors’ actions where the bylaws require shareholder approval, and to accept or reject changes not part of the regular course of business, such as mergers or dissolution. This power to vote, though limited, does give the shareholders some role in running a corporation.

Shareholders typically exercise their voting rights at annual or special meetings. Most statutes provide for an annual meeting, with requirements for some advance notice, and any shareholder can get a court order to hold an annual meeting when one has not been held within a specified period of time. Although the main purpose of the annual meeting is to elect directors, the meeting may deal with any relevant matter, even one not specifically mentioned in the advance notice. Almost all states allow shareholders to conduct business by unanimous written consent, without a meeting.

Shareholders elect directors each year at the annual meeting. Most statutes provide that directors be elected by a majority of the voting shares present at the meeting. The same number of shares needed to elect a director normally is required to remove a director, usually without proof of cause, such as fraud or abuse of authority.

A special meeting is any meeting other than an annual meeting. The bylaws govern who may call a special meeting; typically, the directors, certain officers, or the holders of a specified percentage of outstanding shares may do so. The only subjects that a special meeting may address are those specifically listed in an advance notice.

Statutes require that a quorum exist at any corporation meeting. A quorum exists when a specified number of a corporation’s outstanding shares are represented. Statutes determine what level of representation constitutes a quorum; most require one-third. Once a quorum exists, most statutes require an affirmative vote of the majority of the shares present before a vote can bind a corporation. Generally, once a quorum is present, it continues, and the withdrawal of a faction of voters does not prevent the others from acting.

A corporation determines who may vote based on its records. Corporations issue share certificates in the name of a person, and that person becomes the record owner (owner according to company records) and is treated as the sole owner of the shares. The company records of these transactions are called stock transfer books or share registers. A shareholder who does not receive a new certificate is called the beneficial owner and cannot vote, but the beneficial owner is the real owner and can compel the record owner to act as the beneficial owner desires.

Those who hold shares by a specified date before a meeting, called the record date, may vote at the meeting. Before each meeting, a corporation must prepare a list of shareholders eligible to vote, and each shareholder has an unqualified right to inspect this voting list.

Shareholders typically have two ways of voting: straight or cumulative. Under straight voting, a shareholder may vote her or his shares once for each position on the board. For example, if a shareholder owns 50 shares and there are three director positions, the shareholder can only cast 50 votes for each position. Under cumulative voting, the same shareholder has the option of casting all 150 votes for a single candidate. Cumulative voting increases the participation of minority shareholders by boosting the power of their votes.

Shareholders also may vote as a group or block. A shareholder voting agreement is a contract among a group of shareholders to vote in a specified manner on certain issues; this is also called a pooling agreement. Such an agreement is designed to maintain control or maximize voting power. Another arrangement is a voting trust. This has the same objectives as a pooling agreement, but in a voting trust, shareholders assign their voting rights to a trustee who votes on behalf of all the shares in the trust.

Shareholders need not attend meetings to vote; they may authorize a person, called a proxy, to vote their shares. Proxy appointment often is solicited by parties interested in gaining control of the board of directors or in passing a particular proposal; their request is called a proxy solicitation. Proxy appointment must be in writing, usually may last no longer than a year, and can be revoked.

Federal law generates most proxy regulation, and the Securities and Exchange Commission (SEC) has comprehensive and detailed regulations. These rules define the form of proxy solicitation documents and require the distribution of substantial information about director candidates and other issues up for shareholder vote. Not all corporations are subject to federal proxy law; generally, the law covers only large corporations with many shareholders and with shares traded on a national securities exchange. These regulations aim to protect investors from promiscuous proxy solicitation by irresponsible outsiders seeking to gain control of a corporation and from unscrupulous officers seeking to retain control of management by hiding or distorting facts.

In addition to voting rights, shareholders also have a right to inspect a corporation’s books and records. A corporation almost always views the invocation of this right as hostile. Shareholders may only inspect records if they do so for a “proper purpose”; this is a purpose reasonably relevant to the shareholder’s financial interest, such as determining the worth of his or her holdings. Shareholders can be required to own a specified amount of shares or to have held the shares for a specified period of time before inspection is allowed. Shareholders generally may review all relevant records needed to gather information in which they have a legitimate interest. Shareholders also may examine a corporation’s record of shareholders, including names and addresses and classes of shares.

Directors

Statutes contemplate that a corporation’s business and affairs will be managed by the board of directors or under the board’s authority or direction. Directors often delegate to corporate officers their authority to formulate policy and manage the business. In closely held corporations, directors normally involve themselves more in management than do their counterparts in large corporations. Statutes empower directors to decide whether to declare dividends; to formulate proposed important corporate changes, such as mergers or amendments to the articles of incorporation; and to submit proposed changes to shareholders. Many boards appoint committees to handle technical matters, such as litigation, but the board itself must deal with important matters. Directors customarily are paid a salary and often receive incentive plans that can supplement that salary.

A corporation’s articles or bylaws typically control the number of directors, the terms of the directors’ service, and the directors’ ability to change their number and terms. The shareholders’ power of removal functions as a check on directors who may wish to act contrary to the majority shareholders’ wishes. The directors’ own fiduciary duties, or obligations to act for the benefit of the corporation, also serve as a check on directors.

The bylaws usually regulate the frequency of regular board meetings. Directors also may hold special board meetings, which are any meetings other than regular board meetings. Special meetings require some advance notice, but the agenda of special directors’ meetings is not limited to what is set forth in the notice, as it is with shareholders’ special meetings. In most states, directors may hold board meetings by phone and may act by unanimous written consent without a meeting.

A quorum for board meetings usually exists if a majority of the directors in office immediately before the meeting are present. The quorum number may be increased or decreased by amending the bylaws, though it may not be decreased below any statutory minimum. A quorum must be present for directors to act, except when the board is filling a vacancy. Most statutes allow either the board itself or shareholders to fill vacancies.

Directors’ fiduciary duties fall under three broad categories: the duty of care, the duty of loyalty, and duties imposed by statute. Generally, a fiduciary duty is the duty to act for the benefit of another—here, the corporation— while subordinating personal interests. A fiduciary occupies a position of trust for another and owes the other a high degree of fidelity and loyalty.

A director owes the corporation the duty to manage the corporation’s business with due care. Statutes typically define using due care as acting in good faith, using the care an ordinarily prudent person would use in a similar position and situation, and acting in a manner the director reasonably thinks is in the corporation’s best interests. Courts do not often second-guess directors, but they do usually find personal liability for corporate losses where there is self-dealing or negligence.

Self-dealing transactions raise questions about directors’ duty of loyalty. A self-dealing transaction occurs when a director is on both sides of the same transaction, representing both the corporation and another person or entity involved in the transaction. Self-dealing may endanger a corporation because the corporation may be treated unfairly. If a transaction is questioned, the director bears the burden of proving it was in fact satisfactory.

Self-dealing usually occurs in one of four types of situations: transactions between a director and the corporation; transactions between corporations where the same director serves on both corporations’ boards; by a director who takes advantage of an opportunity for business that arguably may belong to the corporation; and by a director who competes with the corporation.

The taking of a corporate opportunity poses the most significant challenge to a director’s duty of loyalty. A director cannot exploit the position of director by taking for herself or himself a business opportunity that rightly belongs to the corporation. Most courts facing this question compare how closely related the opportunity is to the corporation’s current or potential business. A part of this analysis involves assessing the fairness of taking the opportunity. Simply taking a corporation’s opportunity does not automatically violate the duty of loyalty. A corporation may relinquish the opportunity, or the corporation may be incapable of taking the opportunity for itself.

Directors charged with violating their duty of care usually are protected by what courts call the business judgment rule. Basically, the rule states that even if the directors’ decisions turn out badly for the corporation, the directors will not be personally liable for losses if those decisions were based on reasonable information and if the directors acted rationally. Unless the directors commit fraud, a breach of good faith, or an illegal act, courts presume their judgment was formed to promote the best interests of the corporation. In other words, courts focus on the process of reaching a decision, not on the decision itself, and require directors to make informed decisions, not passive decisions.

State statutes often impose additional duties and liabilities on directors as fiduciaries to a corporation. These laws may govern conduct such as paying dividends when a statute or the articles prohibit doing so; buying shares when a statute or the articles prohibit doing so; giving assets to shareholders during liquidation without resolving a corporation’s debts, liabilities, or obligations; and making a prohibited loan to another director, an officer, or a shareholder.

If a court finds a director has violated a duty, the director still may not face personal liability. Some statutes require or permit corporations to indemnify a director who violated a duty but acted in good faith, received no improper personal benefit, and reasonably thought the action was lawful and in the corporation’s best interests. Indemnification means that the corporation reimburses the director for expenses incurred defending himself or herself and for amounts he or she paid after losing or settling a claim.

Officers

The duties and powers of corporate officers can be found in statutes, articles of incorporation, bylaws, or corporate resolutions. Some statutes require a corporation to have specific officers; others merely require that the bylaws contain a description of the officers. Officers usually serve at the will of whoever appointed them, and they can generally be fired with or without cause, although some officers sign employment contracts.

Typically, corporations have as officers a president, one or more vice presidents, a secretary, and a treasurer. The president is the primary officer and supervises the corporation’s business affairs. This officer sometimes is referred to as the chief executive officer, but the ultimate authority lies with the directors. The vice president fills in for the president when she or he cannot or will not act. The secretary keeps minutes of meetings, oversees notices, and manages the corporation’s records. The treasurer manages and is responsible for the corporation’s finances.

Officers act as a corporation’s agents and can bind the corporation to contracts and agreements. Many parties dealing with corporations require that the board pass a resolution approving any contract negotiated by an officer, as a sure way to bind the corporation to the contract. In the absence of a specific resolution, the corporation still may be bound if it ratified the contract by accepting its benefits or if the officer appeared to have authority to bind the corporation. Courts treat corporations as having knowledge of information if a corporate officer or employee has that knowledge.

Like directors, officers owe fiduciary duties to the corporation: good faith, diligence, and a high degree of honesty. But most litigation about fiduciary duties involves directors, not officers.

An officer does not face personal liability for a transaction if the officer merely acts as the corporation’s agent. Nevertheless, the officer may be personally liable for a transaction where the officer intends to be bound personally or creates the impression he or she will be; where the officer exceeds his or her authority; and where a statute imposes liability on the officer, such as for failure to pay taxes.

Finances

Shares

A corporation divides its ownership units into shares, and can issue more than one type or class of shares. The articles of incorporation must state the type or types and the number of shares that can be issued. A corporation may offer additional shares once it has begun operating, sometimes subject to current shareholders’ preemptive rights to buy new shares in proportion to their current ownership.

Directors usually determine the price of shares. Some states require corporations to assign a nominal or minimum value to shares, called a par value, although many states are eliminating this practice. Many states allow some types of noncash property to be exchanged for shares. Corporations also raise money through debt financing—also called debt securities—which gives the creditor an interest in the corporation that ultimately must be paid back, much like a loan.

If a corporation issues only one type of share, its shares are called common stock or common shares. Holders of common stock typically have the power to vote and a right to their share of the corporation’s net assets. Statutes allow corporations to create different classes of common stock, with varying voting power and dividend rights.

A corporation also may issue preferred shares. These are typically nonvoting shares, and their holders receive a preference over holders of common shares for payment of dividends or liquidations. Some preferred dividends may be carried over into another year, either in whole or in part.

Dividends

A dividend is a payment to shareholders, in proportion to their holdings, of current or past earnings or profits, usually on a regular and periodic basis. Directors determine whether to issue dividends. A dividend can take the form of cash, property, or additional shares. Shareholders have the right to force payment of a dividend, but they usually succeed only if the directors abused their discretion.

Restrictions on the distribution of dividends can be found in the articles of incorporation and in statutes, which seek to ensure that the dividends come out of current and past earnings. Directors who vote for illegal dividends can be held personally liable to the corporation. In addition, a corporation’s creditors often will contractually restrict the corporation’s power to make distributions.

Changes And Challenges Faced By Corporations

Amendments

The most straightforward and common changes faced by corporations are amendments to their bylaws and articles. The directors or incorporators initially adopt the bylaws. After that, the shareholders or directors, or both, hold the power to repeal or amend the bylaws, usually at shareholders’ meetings and subject to a corporation’s voting regulations. Those with this power can adopt or change quorum requirements; prescribe procedures for the removal or replacement of directors; or fix the qualifications, terms, and numbers of directors. Most modern statutes limit the authority to amend articles only by requiring that an amendment would have been legal to include in the original articles. Some statutes shield minority shareholders from harmful majority-approved amendments.

Mergers And Acquisitions

A merger or acquisition generally is a transaction or device that allows one corporation to merge into or take over another corporation. Mergers and acquisitions are complicated processes that require the involvement and approval of both the directors and the shareholders.

In a merger or consolidation, two corporations become one by either maintaining one of the original corporations or creating a new corporation consisting of the prior corporations. Where statutes authorize these combinations, these changes are called statutory mergers. The statutes allow the surviving or new corporation to automatically assume ownership of the assets and liabilities of the disappearing corporation or corporations.

Statutes protect shareholder interests during mergers, and state courts assess these combinations using the fiduciary principles applied in self-dealing transactions. Most statutes require a majority of the shareholders to approve a merger; some require two-thirds. Statutes also allow shareholders to dissent from such transactions, have a court appraise the value of their stake, and force payment at a judicially determined price.

Mergers can involve sophisticated transactions designed to simply combine corporations or to create a new corporation or to eliminate minority shareholder interests. In some mergers, an acquiring corporation creates a subsidiary as the form for the merged or acquired entity. A subsidiary is a corporation that is majority-owned or wholly owned by another corporation. Creating a subsidiary allows an acquiring corporation to avoid responsibility for an acquired corporation’s liabilities, while providing shareholders in the acquired corporation an interest in the acquiring corporation.

Mergers also can involve parent corporations and their subsidiaries. A similar though distinct transaction is the sale, lease, or exchange of all or practically all of a corporation’s property and assets. The purchaser in such a transaction typically continues operating the business, though its scope may be narrowed or broadened. In most states, shareholders have a statutory right of dissent and appraisal in these transactions, unless the sale is part of ordinary business dealings, such as issuing a mortgage or deed of trust covering all of a corporation’s assets.

Not all business combinations are consensual. Often an aggressor corporation will use takeover techniques to acquire a target corporation. Aggressor corporations primarily use the cash tender offer in a takeover: the aggressor attempts to get the target corporation’s shareholders to sell, or tender, their shares at a price the aggressor will pay in cash. The aggressor sets the purchase price above the current market price, usually 25 to 50 per cent higher, to make the offer attractive. This practice often requires the aggressor to assume significant debts in the takeover, and these debts often are paid for by selling off parts of the target corporation’s business.

Restraints and protections do exist in these situations. In takeovers of registered or large, publicly held corporations, federal law requires the disclosure of certain information, such as the source of the money in the tender offer. In smaller corporations, a controlling shareholder, who holds a majority of a corporation’s shares, cannot transfer control to someone outside the corporation without a reasonable investigation of the potential buyer. A controlling shareholder also cannot transfer control where there is a suspicion the buyer will use the corporation’s assets to pay the purchase price or will otherwise wrongfully take the corporation’s assets.

Corporations can employ defensive tactics to fend off a takeover. They can find a more compatible buyer (a “white knight”); issue additional shares to make the takeover less attractive (a “lockup”); create new classes of stock whose rights increase if any person obtains more than a prescribed percentage (a “poison pill”); or boost share prices to make the takeover price less appealing.

Dissolution

A corporation can terminate its legal existence by engaging in the dissolution process. Most statutes allow corporations to dissolve before they begin to operate as well as after they get started. The normal process requires the directors to adopt a resolution for dissolution and the shareholders to approve it, by either a simple majority or, in some states, a two-thirds majority. After approval, the corporation engages in a “winding-up” period, during which it fulfils its obligations for taxes and debts, before making final, liquidation distributions to shareholders.

Derivative Suits

Shareholders can bring suit on behalf of a corporation to enforce a right or remedy a wrong done to the corporation. Shareholders “derive” their right to bring suit from a corporation’s right. A common claim in a derivative suit would allege misappropriation of corporate assets or other breaches of duty by the directors or officers. Shareholders most often bring derivative suits in federal courts.

Shareholders must manoeuvre through several procedural hoops before actually filing suit. Many statutes require them to put up security, often in the form of a bond, for the corporation’s expenses and attorneys’ fees from the suit, to be paid if the suit fails; this requirement often kills a suit before it begins. The shareholders must have held stock at the time of the contested action and owned it continuously since. The shareholders must first demand that the directors enforce the right or remedy the wrong; if they fail to make a demand, they must offer sufficient proof of the futility of such a demand. Normally, a committee formed by the directors handles—and dismisses—the demand, and informed decisions are protected by the business judgment rule.

Proxy Contests

A proxy contest is a struggle for control of a public corporation. In a typical proxy contest, a nonmanagement group vies with management to gain enough proxies to elect a majority of the board and gain control of the corporation. A proxy contest may be a part of a takeover attempt.

Management holds most of the cards in such disputes: it has the current list of shareholders; shareholders normally are biased in its favour, and the nonmanagement group must finance its part of the proxy contest, but if management acts in good faith, it can use corporate money for its solicitation of proxy votes. In proxy contests in large, publicly held corporations, federal regulations prohibit, among other things, false or misleading statements in solicitations for proxy votes.

Insider Trading

Federal, and often state, laws prohibit a corporate insider from using nonpublic information to buy or sell stock. Most cases involving violations of these laws are brought before federal courts because the federal law governing this conduct is extensive. The federal law, which is essentially an antifraud statute, states that anyone who knowingly or recklessly misrepresents, omits, or fails to correct a material or important fact that causes reliance in a sale or purchase, is liable to the buyer or seller. Those with inside information must either disclose the information or abstain from buying or selling.

Permutations

Corporations do not represent the only, or necessarily the best, type of business. Several other forms of business offer varying degrees of organizational, financial, and tax benefits and drawbacks. The selection of a particular form depends on the investors’ or owners’ objectives and preferences, and on the type of business to be conducted.

A partnership is the simplest business organization involving more than one person. It is an association of two or more people to carry on business as co-owners, with shared rights to manage and gain profits and with shared personal liability for business debts. A proprietorship is more or less a one-person partnership. It is a business owned by one person, who alone manages its operation and takes its profits and is personally liable for all its debts. A limited partnership is a partnership with two or more general partners, who manage the business and have personal and unlimited liability for its debts, and one or more limited partners, who have almost no management powers and whose liability is limited to the amount of their investment. In a limited liability company, the limited liability of a limited partnership is combined with the tax treatment of a partnership, and all partners have limited liability and the authority to manage; this is a relatively new business form.

A corporation thus provides limited liability for shareholders, unlike a partnership, a proprietorship, or a limited partnership, all of which expose owners to unlimited liability. A corporation is taxed like a separate entity on earnings, out of which the corporation pays dividends, which are then taxed to the shareholders; this is considered double taxation. Partnerships and limited partnerships are not taxed as separate entities, and income or losses are allocated to the partners, who are directly taxed; this “flow-through” taxation allocates income or losses only once. Corporations centralize management in the directors and officers, whereas partnerships divide management among all partners or general partners. Corporations can continue indefinitely despite the death or withdrawal of a shareholder; partnerships and limited partnerships end with the death or withdrawal of a partner. Shareholders in a corporation generally can sell or transfer their stock without limitation; holders of interest in a partnership or limited partnership can convey their interest only if the other partners approve. Corporations must abide by significant formalities and cope with a great volume of paperwork; partnerships and limited partnerships face few formalities and few limitations in operating their business.


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Definition Sources


Definitions for Corporation are sourced/syndicated and enhanced from:

  • A Dictionary of Economics (Oxford Quick Reference)
  • Oxford Dictionary Of Accounting
  • Oxford Dictionary Of Business & Management

This glossary post was last updated: 27th April, 2020 | 5 Views.