Corporate Finance - 4th Global Edition
Jonathan Berk & Peter DeMarzo
Chapter 1: the Corporation
1.1 4 types of firms
1) Sole proprietorship: a business owned and run by 1 person. They are very small with
few, if any, employees.
• Straightforward to set up
• No separation between the firm and the owner
• The owner has unlimited personal liability for any of the firm’s debts (can lead
to personal bankruptcy)
• The life of a sole proprietorship is limited to the life of the owner
2) Partnership: identical to a sole proprietorship, except that it has more than 1 owner.
• All partners are liable for the firm’s debts
• The partnership ends on the death or withdrawal of any single partner
• Limited partnership: partnership with 2 kinds of owners: general partners and
limited partners. Limited partners have limited liability, the death/withdrawal
does not dissolve the partnership, and cannot legally be involved in the
managerial decision making for the business
3) Limited liability company (LLC): a limited partnership without a general partner
4) Corporation: it is a legally defined, artificial being (a judicial person or legal entity),
separate from its owners. It is solely responsible for its obligations (and not the
owners).
- Formation:
o corporations must be legally formed, thus the state must formally give
its consent to the incorporation by chartering it
- Ownership:
o There is no limit on the number of owners of a corporation. The entire
ownership stake is divided into shares known as stock. All outstanding
shares are the equity of the corporation. An owner of a share is a
shareholder/stockholder/equity holder and is entitled to divided
payments. There is no limitation on who can own the stock of the
corporation, which allows free trade in the shares
Tax implications for corporate entities
shareholders of a corporation pay taxes twice: the corporation pays tax on its profits, and then
the shareholder pays their own personal income tax on this income (which is the distribution
of the profit).
S corporations
An exemption from double taxation is allowed by the U.S. Internal Revenue Code, S
corporations are corporations that elect subchapter S tax treatment. There are strict limitation
from the government, thus most large corporations are C corporations, which are corporations
subject to corporate taxes
1.2 Ownership vs. control of corporations
In a corporation, direct control and ownership are often separate.
1
Jonathan Berk & Peter DeMarzo
Chapter 1: the Corporation
1.1 4 types of firms
1) Sole proprietorship: a business owned and run by 1 person. They are very small with
few, if any, employees.
• Straightforward to set up
• No separation between the firm and the owner
• The owner has unlimited personal liability for any of the firm’s debts (can lead
to personal bankruptcy)
• The life of a sole proprietorship is limited to the life of the owner
2) Partnership: identical to a sole proprietorship, except that it has more than 1 owner.
• All partners are liable for the firm’s debts
• The partnership ends on the death or withdrawal of any single partner
• Limited partnership: partnership with 2 kinds of owners: general partners and
limited partners. Limited partners have limited liability, the death/withdrawal
does not dissolve the partnership, and cannot legally be involved in the
managerial decision making for the business
3) Limited liability company (LLC): a limited partnership without a general partner
4) Corporation: it is a legally defined, artificial being (a judicial person or legal entity),
separate from its owners. It is solely responsible for its obligations (and not the
owners).
- Formation:
o corporations must be legally formed, thus the state must formally give
its consent to the incorporation by chartering it
- Ownership:
o There is no limit on the number of owners of a corporation. The entire
ownership stake is divided into shares known as stock. All outstanding
shares are the equity of the corporation. An owner of a share is a
shareholder/stockholder/equity holder and is entitled to divided
payments. There is no limitation on who can own the stock of the
corporation, which allows free trade in the shares
Tax implications for corporate entities
shareholders of a corporation pay taxes twice: the corporation pays tax on its profits, and then
the shareholder pays their own personal income tax on this income (which is the distribution
of the profit).
S corporations
An exemption from double taxation is allowed by the U.S. Internal Revenue Code, S
corporations are corporations that elect subchapter S tax treatment. There are strict limitation
from the government, thus most large corporations are C corporations, which are corporations
subject to corporate taxes
1.2 Ownership vs. control of corporations
In a corporation, direct control and ownership are often separate.
1
