Lecture 9
BUSINESS ORGANIZATION

1. What is a firm?

An institution that hires factors of production and organizes those factors to produce and sell goods and services

2. Why firms?

• Lower transaction costs
• Economies of scale
• Economies of team production: Each team specializes (accounting, production etc.)

3. How are businesses organized?

• Proprietorships
• Partnerships
• Corporations
  • C-Corporations: Standard corporation
  • S-Corporations: Enjoy special tax status; No more than 100 shareholders

3.1 Proprietorships

Pros:
• Easy to set up
• Owner makes all decisions
• Profits taxed once
Cons:
• Unlimited liability
• Limited capital
• Firm dies with owner

Pros:
• Easy to set up
• Diversified decision making
• Profits taxed once
Cons:
• Achieving consensus may be slow
• Unlimited liability
• Limited capital
• Withdrawal of a partner could create problems

3.3 Corporations

Pros:
• Limited liabilities for owners
• Greater access to capital
  • Issue of stocks and bonds
  • But for S-Corporations, small number of shareholders limits ability to raise capital
• Professional management
• Perpetual life
Cons:
• Taxation
  • Double taxation for C-Corporations
  • S-Corporations are pass-through entities: No income tax at corporate level. Profits/losses reported on owners' personal tax returns.
• Complex management structure can make decisions slow and expensive
• Conflicting goals for owners and managers:
  • The Principal-Agent Problem
  • What steps do shareholders take to resolve the problem?

4. The Profit Motive

Question: In a capitalist economy, firms seek to maximize profits. Is this a reasonable postulate? Regardless of the type of business?

Summary

Source: sba.gov