Take Home Test for Corporate Governance

(For Batch 18 – Insurance & Banking major)

Due on or before 4 P M February 07, 2011

Your answers for each question may be limited to around 350 words

1. Discuss the advantages and disadvantages of the corporate form of business entity

1. Corporations act as separate legal entities from the owners of the business. Corporations
may initiate or be subject to legal process, accumulate debts and assets, as well as enter
into contractual agreements, as stated on the All Business website. Investors may look upon
the corporate structure in a more favorable light, as it appears more credible when compared
to a sole proprietorship.

Liability
2. Personal asset protection is one of the main benefits of a corporation. Shareholders of a
corporation enjoy limited liability from business losses, debts and obligations. According to
AllBusiness, the personal assets of shareholders may not be used to satisfy debts and
obligations of a corporation. In addition, a shareholder's personal creditors may not pursue
corporate assets in an effort to recover personal debts or obligations.

Transferring Shares
3. Shareholders of a corporation may buy and sell shares freely. As explained on AllBusiness,
shares of a corporation are transferable and aren't contingent on who the owners or
investors of the corporation may be at a given time. For this reason, it may be easier to
transfer ownership in a corporation when compared to other business entities.

Unlimited Life
4. A corporation will continue to exist even after shareholders die or sell their interest in the
corporation. Corporations have unlimited life, which allows a business to exist until it formally
dissolves or merges with another business.

Raising Capital
5. Corporations can raise capital easier than other business entities. Corporations have the
ability to issue stock to raise funds for expansion and other corporate activities. As a matter
of fact, a corporation appears as the only business entity capable of issuing stock.
Furthermore, corporations may be able to attract key employees by offering stock in the
company, as indicated on the AllBusiness website.
 Business owners often are advised to incorporate, and a number of legal filing services have
popularized the process through a flurry of radio and television advertisements. Aside from the marketing,
there are real and significant benefits businesses can receive by incorporating.
Taxes
 Corporations enjoy a number of tax benefits unavailable to individuals. Because a corporation pays
taxes only on its profits rather than income, according to the nonprofit lobbying organization Americans for
Tax Reform, high expenses can significantly reduce the corporation's tax bill. According to the business
reference website BizFilings.com, businesses often incorporate to gain tax advantages on expenses like
health care, insurance and self-employment taxes.
Liability
 Aside from tax benefits, liability remains the primary reason many businesses incorporate. When
operating a business as a proprietorship or a partnership, business principals and owners assume some
personal liability for the organization's expenses, debts and actions. Once a business incorporates,
according to the business law section of FreeAdvice.com, the corporation becomes an independent legal
entity. This legal status helps protect the personal assets of employees, officers and stakeholders, as the
corporation assumes liability for its own debts and actions.
Perpetual Life
 In an unincorporated business entity like a sole proprietorship, the business often suffers a significant
loss when the owner retires, dies or becomes unable to work. As an independent entity, according to
Incorporate.com, a corporation continues to operate even when its founders or principals remove
themselves. Some large corporations have persisted for well over 100 years, and many corporations
withstand numerous changes in leadership and senior management.
Stock Issuance
 Once a business incorporates, it becomes its own legal entity rather than a collection of officers or
business principals. Because the organization exists as a single entity, it may issue shares of partial
ownership as a means of raising capital. Each time an investor purchases a share, that investor takes a
small ownership interest in the corporation, though this ownership may come with some restrictions.
According to the 2009 Florida Statutes, the corporation's board of directors may set the terms and rights
that investors receive when they purchase shares.
Credibility
 Becoming incorporated, according to Florida's Department of Corporations, requires a considerable
amount of forethought and planning. In addition to naming principals of the company and reporting
assets, corporations must periodically provide reports that describe the entity's general well-being.
While incorporation does not guarantee that the organization will act in an ethical manner, the work
involved in setting up a corporation and the requisite state registration filings lend a measure of
credibility to the organization.

Overview
If you’re trying to decide whether to incorporate your business, you may be weighing the pros and cons of running a
corporation. Similar to other forms of business, a corporation has its advantages and disadvantages. Evaluate the
elements of a corporate form of business to determine if it is the right choice for your company.

Limits Liability
The primary advantage of a corporate form of business is that a corporation is a stand-alone entity, which means you
are not personally liable for the assets and debts of the business. Incorporating protects your personal assets from
lawsuits, debt collection and other business issues that can arise.

Tax Treatment
The stand-alone entity also separates tax liabilities, which is another advantage. This means that the corporation’s
taxes are separate from your personal tax liabilities. As a business owner, you are responsible for paying taxes only
on the money the corporation pays you in the form of a salary, commission or dividends--this is on your personal tax
return. The corporation is responsible for paying corporate taxes (at the corporate tax rate) on any profit the company
makes.

Everlasting
Another advantage of a corporate form of business is it does not die when its owners do. Because a corporation is its
own entity, it lives on, even after shareholders (owners) decide to move on or dissolve the corporation or if the
corporation merges with another company. It is easier to sell or merge a corporation because it is a matter of
changing shareholders rather than having to establish an entirely new business.

Costs
One of the primary disadvantages of a corporation is the costs for running a corporate form of business. It costs
money to incorporate with the state where the business operates. You can choose to hire an attorney or accountant
to help you complete the incorporation paperwork, but it is not a requirement. If you incorporate directly with the
Secretary of State, as of 2010, the fee ranges from $99 to $150. Beyond the initial incorporation fees, the corporate
form of business also has ongoing fees associated with it. An annual report fee can range up to $150 a year for each
year the corporation exists after the initial incorporation filing.

Double Taxation
For C corporations, the corporation ends up paying taxes twice. First, when the C corporation turns a profit, it pays a
corporate tax rate on the profit amount. The second time the C corporation pays taxes is when it pays dividends to
shareholders. Many businesses that incorporate choose to incorporate as an S corporation instead in order to avoid
paying taxes twice. The only difference between a C corporation and an S corporation is a tax designation filed with
the IRS using Form 2553. According to the IRS, an S corporation can choose to pass the income, losses, deductions
and credit for the corporation through to the shareholders of the corporation for federal tax purposes. This avoids the
double taxation possibility a C corporation is subject to.

Documentation
Corporations need to maintain more records than other business entities. Corporations must file annual reports and
tax returns and maintain business bank accounts and records that are separate from personal accounts. Shareholder
meeting records, board of director meeting records, licenses and other corporate records also are necessary.

A corporation is defined as a legal entity or structure created under the authority of a state's laws,
consisting of a person or group of persons who become shareholders. The entity's existence is
considered separate and distinct from that of its members. Like a real person, a corporation can enter into
contracts, sue and be sued, pay taxes separately from its owners, and do the other things necessary to
conduct business.
Incorporation can be a complicated process. You may choose to hire an attorney to guide you through the
process (read Do I Need an Attorney to Form a Corporation? for more information).

Regardless of the tack you take, take into consideration the advantages and disadvantages listed below
before you embark on incorporating your company. And when you're ready to incorporate, make sure to
read Once You've Decided to Incorporate.

Advantages

• Limited liability. One of the key reasons for forming a corporation is the limited liability
protection provided to its owners. Because a corporation is considered a separate legal entity, the
shareholders have limited liability for the corporation's debts. The personal assets of shareholders
are not at risk for satisfying corporate debts or liabilities.
• Corporate tax treatment. Since a corporation is a separate legal entity, it pays taxes separate
and apart from its owners (at least in the typical C corporation). Owners of a corporation only pay
taxes on corporate profits paid to them in the form of salaries, bonuses, and dividends. The
corporation pays taxes, at the corporate rate, on any profits.
• Attractive investment. The built-in stock structure of a corporation makes it attractive to
investors.
• Capital incentive. The stock structure also allows corporations to attract key and talented
employees by offering them an ownership interest in the form of stock options or stock.
• Owner/employee. A business owner who works in his or her own business may become an
employee and thus be eligible for reimbursement or deduction of many types of expenses, including
health and life insurance.
• Operational structure. Corporations have a set management structure. The owners of a
corporation are shareholders, who elect a Board of Directors, which then elects the officers. Other
than the election of directors, shareholders do not participate in the operations of the corporation.
The Board of Directors is responsible for managing and exercising the rights and responsibilities of
the corporation. The Board sets corporate policy and the strategy for the corporation, and elects
officers — usually a CEO, vice president, treasurer, and secretary — to follow the policies set by the
Board, and manage the corporation on a day-to-day basis. In a small corporation, the lines between
the shareholders, Board of Directors, and officers tends to blur because the same people may be
serving in all capacities.
• Perpetual existence. A corporation continues to exist until the shareholders decide to dissolve
it or merge with another business.
• Freely transferable shares. Shares of corporations are freely transferable, because as a
separate entity, the existence of a corporation is not dependent upon who the owners or investors
are at any one time. A corporation continues to exist as a separate entity, and is not terminated or
dissolved even when shareholders die or sell their shares. Shares of corporations are freely
transferable unless shareholders have "buy-sell" agreements limiting when and to whom shares may
be sold or transferred. Also, securities laws may restrict the transferability of shares.
Disadvantages

• Fees. It costs money to incorporate. There are four types of fees: a fee to file the Articles of
Incorporation with the Secretary of State, a first-year franchise tax prepayment, fees for various
governmental filings, and attorneys' fees. But every year, tens of thousands of businesses choose to
incorporate online without the use of an attorney. For example, basic incorporation before filing fees
at a site like LegalZoom.com costs just $99.
• Formalities. The proper corporate formalities of organizing and running a corporation must be
followed, to receive the benefits of being a corporation.
• Paperwork. Paperwork is a huge component of the corporate formalities that must followed.
Reports and tax returns must be compiled and filed in a timely fashion; business bank accounts and
records must be maintained and kept separate from personal accounts and assets; records must be
kept of corporate actions, including meetings of shareholders and Board of Directors; and licenses
must be maintained.
• Disclosure of names of corporate officers and directors. Most states do not require that
names of shareholders be a matter of public record; however, many states require that the names
and addresses of corporate officers and directors be listed on one or more documents filed with the
Secretary of State.
• Dissolution. Since corporations have a perpetual existence, states provide a mechanism for
dissolving a corporation and liquidating its assets. Dissolution does not happen automatically. A
corporation can be dissolved voluntarily or involuntarily. A corporation's officers and directors are
charged with responsibility for dissolving the corporation, including gathering corporate assets,
paying creditors and outstanding claims, and distributing the remaining assets to shareholders.
• Tax consequences. C corporations have potential double-tax consequences — once when the
company makes its profit, and a second time when dividends are paid to shareholders. S
corporations can mitigate this tax issue.

2. Explain all the important rights and privileges of a shareholder.

A shareholder or stockholder is an individual or institution (including a corporation) that legally owns

one or more shares of stock in a public or private corporation. Shareholders own the stock, but not the
corporation itself (Fama 1980).

Stockholders are granted special privileges depending on the class of stock. These rights may include:

 The right to sell their shares, provided there is a buyer.

 The right to vote on the directors nominated by the board.
 The right to nominate directors (although this is very difficult in practice because of minority
protections) and propose shareholder resolutions.
  The right to dividends if they are declared.
 The right to purchase new shares issued by the company.
 The right to what assets remain after a liquidation.

Stockholders or shareholders are considered by some to be a subset of stakeholders, which may include
anyone who has a direct or indirect interest in the business entity. For example, labor, suppliers,
customers, the community, etc. are typically considered stakeholders because they contribute value
and/or are impacted by the corporation.

Shareholders in the primary market who buy IPOs provide capital to corporations; however, the vast
majority of shareholders are in the secondary market and provide no capital directly to the corporation.
Contrary to popular opinion, shareholders of American public corporations are the (1) owners of the
corporation, (2) the claimants of the profit, or (3) investors, as in the contributors of capital.[1] [2]

Shareholder Rights

Background

In practice, the strict rights and entitlements that come with the ownership of shares in a
Limited Company are seldom fully exploited or utilised by shareholders. This is largely
because shareholders are generally unaware of the rights that they have simply by virtue of
being a shareholder. Similarly, most Company Directors would be alarmed at the strict
obligations that they have as regards the Company’s shareholders, which include
maintaining a Register of Directors/Secretaries, a Register of Shareholders, a Register of
Director’s Interest in Shares, a Register of Charges and Minute Books. These must be kept
open to inspection by shareholders.

More shares, more power

It may seem an obvious statement but the greater the shareholding of an individual, the
greater are his/her rights and the greater is his/her power within the Company. This is so
not only because the larger the shareholding the more likely it is to represent a controlling
interest, but also because the Companies Act affords greater rights and power to an
individual as the size of his/her shareholding increases. For example, a shareholder owning
5% of a company has the right to have an item placed on the Agenda for discussion at a
General Meeting and, once the shareholder’s ownership reaches 10% of the company,
he/she has greater rights including the right to force a formal audit of the annual accounts.
Controlling Interest

In the great majority of Limited Companies, a shareholding in excess of 50% of the issued
share capital will be enough to control the company, dictate the makeup of the Board of
Directors and to be able to do most of the acts necessary to run the company in its
everyday business.

It is possible for those owning less than 50% of a company to protect themselves from
being at the mercy of those holding over 50% of the shares in the company and this is one
reason why shareholders should give serious consideration to agreeing a shareholders
agreement or adopting professionally drafted Articles of Association.