Chapter 15

Corporations

McGraw-Hill/Irwin Copyright © 2011 by The McGraw-Hill Companies, Inc. All rights reserved.
Formation

 A corporation has the most formal filing and

reporting requirements.

 Document must state the corporation’s name,

purpose, number of shares issued, and address of
the corporation’s headquarters.

 This document is known as the articles of

Incorporation.

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Liability

 Shareholders, directors, and officers of a

corporation are insulated from personal
liability in case the corporation runs up large
debts or suffers some liability.

 This liability protection is often referred to as

the corporate veil

 “Piercing corporate veil”

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Debt

 Corporations often borrow money from

commercial lenders (such as banks) to fund
day-to-day operations.

 For larger projects, corporations may also

use more sophisticated forms of debt such as
issuing bonds or debentures.

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Equity

 Corporations also sell equity to capitalize

their operations.

 For modest amounts of funding, corporations

may turn to private investors or groups of
investors.

 Corporation will hire a registered broker-

dealer to handle larger scale IPOs.

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Public Offerings

 A very complex and time-consuming process

of converting the corporation from privately
held to publicly held by engaging in an initial
public offering (IPO).

 At that point, the corporation may raise equity

by selling its shares to the general public and
to financial institutions.

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Taxation

 “C” corporations are considered a separate

legal, taxable entity from the owners for
income tax purposes. Therefore, corporations
pay tax on their earnings and then tax is paid
again if corporate earnings are distributed to
shareholders in the form of dividends (known
as double taxation).

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Taxation

 Subchapter S:

 Avoids double taxation.

 No more than 100 shareholders.

 Single class of stock.

 No non-resident alien shareholders.

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Shareholders

 Power to elect and remove directors.

 Power to veto fundamental changes to corporation,

e.g. sale of all assets, mergers, issuing more capital
stock, and issuing bonds.

 Shareholders also must approve any changes in the

structure of the corporation through amending the
articles of incorporation or bylaws.

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Board of Directors

 Sets strategy and policies of the corporation,

including payment of dividends.

 Also has important oversight functions.

 Most planning initiatives that result in a change to

the corporation, such as an acquisition of another
corporation’s assets or stock, are overseen by the
board prior to submitting the plan to shareholders for
approval.

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Officers

 The corporation’s officers are appointed by,

and may be removed by, the board of
directors. The officers carry out the day-to-
day operations of the corporation and
execute the strategy and mandates set out by
the board of directors.

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Fiduciary Duties of Officers and
Directors
 Duty of care and the duty of loyalty

 Breaching these duties may result in personal

liability for the officer or director.

 This may be referred to as the business

judgment rule.

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learning outcomes checklist

 15 - 1 Identify the sources and level of law

governing formation and internal corporate matters.

 15 - 2 Articulate the concept of the corporation as a

legally independent person.

 15 - 3 Recognize the liability associated with

improper formation by a promoter.

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learning outcomes checklist

 15 - 4 Understand the concept of a corporate veil

and identify circumstances under which a court will
pierce the veil and the impact on the principals.

 15 - 5 Explain the primary methods for capitalizing a

corporation.

 15 - 6 Categorize corporate entities on the basis of

how the income is taxed and understand the
concept of flow-through taxation.

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learning outcomes checklist

 15 - 7 Describe the fundamental structure and roles for officers,

directors and shareholders. The corporate form of entity and
understand the functions of each role and how it’s governed.

 15 - 8 Identify the major fiduciary duties owed by insiders of a

corporation to its shareholders and give examples of each duty.

 15 - 9 Apply the business judgment rule to an alleged breach of

fiduciary duty by an insider.

 15- 10 Distinguish between a shareholder derivative suit and a

direct action suit.

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