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Subject 1. Organizational Forms of Businesses PDF Download

There are three types of firms. The structure chosen determines how the owners share the risks and liabilities of the firm and how they participate in the making of decisions.

Proprietorship

  • It is a business firm owned by an individual who possesses the ownership right to the firm's profits and is personally liable for the firm's debts.
  • The proprietor often works directly for the firm, providing managerial and other labor services.
  • The business is constrained by the owner's ability to access capital and assume risk.
  • Examples: neighborhood grocery stores, barbershops, farms.
  • Corporate governance perspective: Since the manager and the owner are the same, this form presents fewer risks than the corporation.

    • The owner has the type and quality of information needed to evaluate various risks of the firm.
    • The owner can also easily monitor the condition and the risks of the business, and control the business' risk exposure.

Partnership

  • It is a business firm owned by two or more individuals who possess ownership rights to the firm's profits and are personally liable for the debts of the firm.
  • In terms of owner liability there is no difference between a proprietorship and a partnership.
  • Partners contribute capital and expertise, share all risk, business liability, and return.
  • In a limited partnership, at least one general partner operates the business and assumes unlimited liability. Limited partners have limited liability but lack control over business operations.
  • Examples: law, medical and accounting firms.
  • Corporate governance perspective: Partners typically overcome conflicts of interest internally by engaging in partnership contracts specifying the rights and responsibilities of each partner.

Corporation

  • It is a business firm owned by shareholders who possess ownership rights to the firm's profits, but whose liability is limited to the amount of their investment in the firm.
  • This is an attractive corporate structure since:

    • Stockholders' liability is limited to the extent of their explicit investment.
    • Ownership can easily be transferred.

  • A key feature is the separation between owners (principal) and managers (agent).
  • Capital sources: ownership capital (equity) + borrowed capital (debt)
  • Taxation: possible double taxation in some countries.
  • Corporate governance perspective: It's difficult for shareholders to monitor management and the firm's operations.

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