Corporation

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A corporation is a business or non-profit organization with a legal existence distinct from its owners, founders or managers.

Contents

Business Corporation Structure and Classification

A typical business corporation is formed by an individual incorporator filing articles of incorporation (a short legal document) with the Secretary of State in the state of incorporation, and issuing shares of stock in exchange for property and/or services to shareholders. The shareholders then elect a board of directors who in turn appoint one or more officers of the corporation to manage its day to day business. Typically, the most senior officer, to whom all other officers report on a day to day basis, is called the President or CEO of the corporation. Officers of a corporation, in turn may hire other employees and agents to act on behalf of the corporation in the corporation's name. With the exception of owners of large percentages of shares (usually 5%+) of "publicly held corporations", the names of the people who own shares in a business corporation are normally not a matter of public record, but the members of the board of directors and officers identities are generally a matter of public record.

Most corporations have just one type of stock and one type of shareholder, but some corporations have multiple types of stock with different rights. For example, it is not uncommon to have "preferred stock" which pays a fixed return to the extent that funds are available to make payments and only votes when dividends in the preferred amount are not currently being paid, and "common stock" which is voting stock that is entitled to receive dividend payments only if the preferred stock has been paid in full.

One of the main distinctions between different kinds of corporations is between a "privately held corporation" in which shares are owned by a small number of individuals and not traded on a stock exchange, and a "publicly held corporation", in which stock is sold to the general public, shares are traded on a stock exchange, or there are more than 500 shareholders (under U.S. securities laws, different defintions are applied in different contexts). In fact, the vast majority of privately held corporations have ten or fewer shareholders, and a majority have just one or two shareholders. An "S corporation" is a privately held corporation which has elected to be treated in a manner similar to a partnership for tax purposes.

Privately held corporations are regulated primarily under state law, and a corporation incorporated in any state may operate in any other state with a minimum of formalities, regardless of its ties to the state of incorporation. This has produced a "race to the bottom" which has made significant state regulations of corporate affairs largely futile. Publicly held corporations are regulated under both state law and federal "securities laws" which are much more strict about requiring public disclosure of information relating to the business of the corporation.

There are several million corporations incorporated and active in the United States and about 15,000 publicly held corporations incorporated in the United States. There are several thousand publicly held corporations whose shares are traded regularly on the major stock exchanges.

The Separation of Ownership and Control

In privately held corporations, the small number of owners, many of whom are also employees and officers of the corporation, typically govern the corporation in an informal manner. Ownership and control of the corporation in these cases is typically closely aligned.

This is not true in publicly held corporations. In a publicly held corporation, the Board of Directors is typically hand picked by the CEO and typically includes many members of the senior executive team. Even so called "independent directors" often feel a strong sense of loyalty to the CEO. The Board of Directors in such corporations typically ratifies all important decisions of the CEO and exists primarily to set the CEOs salary (typically at the highest level that outside consultants are willing to recommend) and to replace the CEO when he dies or becomes incompetent for some reason. While in theory, the Board of Directors is elected by the shareholders, in practice, publicly held companies do not have competitive elections for the Board of Directors. Instead, shareholders are given a single slate of directors nominated by the existing Board of Directors (often with input from the CEO) who must be given an up or down vote by the shareholders, and shareholders almost invariably vote in favor of that slate.

Occassionally, dissenting shareholders proposed an alternative slate of directors. This is called a "proxy fight" (since most votes in corporate board elections are cast by proxy). Proxy fights are rare and almost never prevail outside the context of a "corporate takeover" in which a small group of investors or another corporation buys a large block of the target corporation's stock for the purpose of gaining control of the corporation.

Rather than trying to control corporate behavior through the formal process of voting for the board of directors, most investors apply the "Wall Street Rule" of selling stock in corporations with management teams they do not have confidence in, and buying stock in corporations with management teams that they do have confidence in.

In short, outside of corporate takeovers, most public corporations are effectively controlled by a small, self-perpetuating management teams that owns only a small percentage of the corporation's total stock.

Powers and Responsibilities of a Corporation

When an officer or a subordinate employee of an officer hired by the officer in the name of the corporation acts in furtherance of corporation business, contracts can be entered into in the name of the corporation and property can be owned in the name of the corporation. Officers acting in the name of the corporation can also bring lawsuits and defend against lawsuits in which the corporation is named as a defendant. Corporations are responsible for "torts" (i.e. civil wrongs such as accidents caused by negligence) which arise from acts of employees and agents of the corporation committed in furtherance of the business of the corporation. Corporations can also be charged with crimes although the punishment is generally limited to fines and dissolution of the corporation's existence.

When a corporation is successfully sued or convicted of a crime, any punishment or recovery against it is limited to the property of the corporation (and any other rights it may have, such as contract rights). The worst thing that can happen to shareholders in the corporation as a result of a successful lawsuit or criminal conviction is that their shares of stock become worthless. The shareholders of a corporation are not personally liable for the debts or obligations of a corporation. If a corporation goes bankrupt, its shares are made worthless and new shares will be issued (if the corporation does not liquidate all of its assets) to new individuals who contribute "new value" to the corporation, or to creditors. In rare cases, there are exceptions to the general rule of "limited liability" for shareholders of a corporation. This is known as "piercing the corporate veil."

Officers, employees and agents of a corporation are not responsible for the contractual obligations of a corporation (i.e. its promises) unless they personally guarantee that obligation in writing. Officers, employees and agents of a corporation are generally not responsible for a corporation's torts or crimes or other violations of the law, unless they are shown to have personally taken intentional, reckless or negligent acts that contributed to the harm. They are generally not responsible for the acts of their subordinate officers, employees and agents of the corporation.

A corporation which is solvent is permitted to distribute dividends out of its profits to shareholders, which are payments of money or property to shareholders made because the shareholders own shares in the company. Dividends are only paid when declared by the Board of Directors and cannot be demanded by any individual shareholder. Many corporations, which are in a growth phase, make a policy decision not to pay dividends and instead to reinvest all profits into the corporation's business. A solvent corporation may also, at any time, liquidate and distribute the assets it has after payment of its outstanding liabilities (including tax liabilties) to its shareholders.

Corporations are not permitted to vote, and in the United States are not permitted to make campaign contributions except through political action committees. But, the collection of rights which a corporation does have, which includes the constitutional right to free speech, is sometimes called "corporate personhood".

Non-Profit Corporations

A non-profit corporation is generally similar to a business corporation, but cannot pay dividends, must distribute any assets remaining upon a liquidation to another non-profit, and has either a self-perpetuating board of directors, or a group of "members" who select of a board whose membership is typically not based on stock ownership.

History

Prior to the 19th century, business was generally carried out by individual or partnerships with unlimited liability, with the handful of corporations in existence specifically authorized by legislative act. Corporations could be incorporated as a matter of right without legislative action starting in the 19th century. This roughly coincided with the development of the industrial age of the economy.

Related Entity Types

Different countries have different names and different rules regarding corporations. Within the United States two other common types of business entities are limited liability partnerships and limited liability companies. These entities are similar to corporations in many way, but are treated for tax purposes as partnerships in most cases.

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