What Exactly Are Corporations?
Corporations are a special type of organization wherein the people who have ownership can transfer their shares of ownership to other individuals without having to legally reorganize the company. This transferring of shares is possible because the corporation is considered a separate legal entity from its owners, which isn’t the case for other forms of companies.
This characteristic has a few significant implications that influence the financial operations and status of corporations compared to other forms of organizations:
Professional managers typically run corporations rather than the owners given the wide distribution of ownership by non-owners. This leads to questions about moral hazard — the conflict of interest that occurs when managers make decisions that benefit themselves rather than the owners of the organization they’re managing, called the agency problem.
Often, an individual who holds a very large proportion of a corporation’s stock will also be a manager or a director, but generally speaking, corporations have the resources to hire highly experienced professionals.
The corporation is taxed on its earnings separately from the owners. In most organizations, the profits are considered the owners’ income and they’re only taxed as such. In corporations, however, the company itself is taxed on any earnings it makes and the owners are taxed on any income they generate by possessing stock ownership (called capital gains). This double taxation of income is one of the pitfalls associated with a corporate structure.
Corporations have limited liability, meaning the owners can’t be sued for the actions of the company. Oddly enough, this characteristic also frequently protects managers, though to a lesser extent since the establishment of the Sarbanes-Oxley laws, which hold managers more accountable.
Corporations are required to disclose all their financial information in a regulated, systematic, and standardized manner. These records are public not only to the government and the shareholders but also to the public. Shareholders can also request specialized financial information.
The primary goal of corporations is to provide goods or services in exchange for money; their underlying goal is to generate a profit, as the law requires them to operate using the Shareholder Wealth Maximization model wherein corporate management is legally obligated to operate in a manner that increases profitability and corporate value and, as a result, increase the value of the shares of stock held by the shareholders as the owners of the corporation.
In most cases, profits are the income of a corporation. The one exception is the nonprofit corporation, which includes such organizations as The American Red Cross, many public universities, and other organizations that operate within the parameters of a tax-exempt status.
Although nonprofits can still be profitable, their profits are capped (meaning they can’t make more than a specific percentage in profit), so they use their resources to provide goods or services below cost. Many nonprofits choose not to generate any revenues, relying instead on donations.