A corporation is a legal entity. In the view of the law, it is a legal person that is owned by its shareholders. As a legal person, the corporation can make contracts, carry on a business, borrow or lend money, and sue or be sued. One corporation can make a takeover bid for another and then merge the two businesses. Corporations pay taxes—but cannot vote!
In the U.S., corporations are formed under state law, based on articles of incorporation that set out the purpose of the business and how it is to be governed and operated. For example, the articles of incorporation specify the composition and role of the board of directors.
A corporation’s directors choose and advise top management and are required to sign off on some corporate actions, such as mergers and the payment of dividends to shareholders.
A corporation is owned by its shareholders but is legally distinct from them. Therefore the shareholders have limited liability, which means that shareholders cannot be held personally responsible for the corporation’s debts.
When the U.S. financial corporation Lehman Brothers failed in 2008, no one demanded that its stockholders put up more money to cover Lehman’s massive debts. Shareholders can lose their entire investment in a corporation, but no more.
Corporations do not have to be prominent, multinational businesses. You can organize a local plumbing contractor or barber shop as a corporation if you want to take the trouble. But usually corporations are larger businesses or businesses that aspire to grow.
When a corporation is first established, its shares may be privately held by a small group of investors, perhaps the company’s managers and a few backers. In this case the shares are not publicly traded and the company is closely held.
Eventually, when the firm grows and new shares are issued to raise additional capital, its shares are traded in public markets such as the New York Stock Exchange. Such corporations are known as public companies.
Most well-known corporations in the U.S. are public companies with widely dispersed shareholdings. In other countries, it is more common for large corporations to remain in private hands, and many public companies may be controlled by just a handful of investors.
The latter category includes such well-known names as Fiat, Porsche, Benetton, Bosch, IKEA, and the Swatch Group.
A large public corporation may have hundreds of thousands of shareholders, who own the business but cannot possibly manage or control it directly. This separation of ownership and control gives corporations permanence.
Even if managers quit or are dismissed and replaced, the corporation survives. Today’s stockholders can sell all their shares to new investors without disrupting the operations of the business. Corporations can, in principle, live forever, and in practice they may survive many human lifetimes.
One of the oldest corporations is the Hudson’s Bay Company, which was formed in 1670 to profit from the fur trade between northern Canada and England. The company still operates as one of Canada’s leading retail chains.
The separation of ownership and control can also have a downside, for it can open the door for managers and directors to act in their own interests rather than in the stockholders’ interest.
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