Description
Advantage/Disadvantage of Private Limited & Public Limited Companies, Advantages of Partnership over Private Limited, Disadvantages of Partnership over Private Limited, Advantages of Partnership over Proprietary Firm, Disadvantages of Partnership over Proprietary Firm, Comparative Evaluation of Forms of Organization. It also includes What causes Agency Costs? What are the main implications of separation of ownership & management?
Corporate Finance
ASSIGNMENT 1
Organizations are mainly classified on the basis of ownership and management. The major forms of organization include – ? Proprietorship ? Partnership ? Hindu Undivided Family business ? Cooperative society ? Company (corporation) Types of Corporations: A company or a corporation can be either a private limited or a public limited company. Q 1.1 Advantage/Disadvantage of Private Limited & Public Limited Companies Comparative Glance at a Public Limited Company and Private Limited Company Basis Members Minimum number of directors Minimum paid up capital Index of members Transfer of shares Invitation to public to subscribe to shares Public Limited Company Minimum – 7 Maximum – unlimited Three Rs. 5 lakhs Compulsory No restriction Can invite the public to subscribe to its shares or debentures Private Limited Company Minimum – 2 Maximum – 50 Two Rs. 1 lakh Not compulsory Restriction on transfer Cannot invite the public to subscribe to its shares or debentures
Advantages of a Private Limited Company over a Public Limited Company: (i) A private company can be formed by only two members whereas seven people are needed to form a public company. (ii) There is no need to issue a prospectus as public is not invited to subscribe to the shares of a private company.
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(iii) Allotment of shares can be done without receiving the minimum subscription. (iv) A private company can start business as soon as it receives the certificate of incorporation. The public company, on the other hand, has to wait for the receipt of certificate of commencement before it can start a business. (v) A private company needs to have only two directors as against the minimum of three directors in the case of a public company. (vi) A private company is not required to keep an index of members while the same is necessary in the case of a public company. (vii) There is no restriction on the amount of loans to directors in a private company. Therefore, there is no need to take permission from the government for granting the same, as is required in the case of a public company. Q.1.2 Advantage / Disadvantage of Private Limited & Partnership
Advantages of Partnership over Private Limited
?
MODE OF CREATION - A company comes into existence only when it is
registered under the Companies Act. A partnership is created with the mutual agreement between the partners. Registration of a partnership is not compulsory under the Partnership Act.
?
MEMBERSHIP - The minimum numbers of members in a partnership is
two and the maximum is limited to 10 in case of banking and otherwise 20. The minimum number of members in case of a Private company is seven and the maximum number of members is 50.
?
AGENCY OF MEMBERS - A shareholder is not an agent of the company
and thus has no power to bind the company by his acts. In case of a partnership the partner is bound by all the acts of the other partners.
?
POWERS - The powers of a company are contained in the object clause
of the memorandum of association. A change can be affected in objects by following a rigid procedure as laid down in the act. In partnership the partners can do anything which they agree to.
?
DISSOLUTION - A company’s existence will come to an end only by the
order of the court. A partnership firm can be dissolved at any time by an agreement between the partners or in case of partnership at will, by the withdrawal of even one partner. Page 3 of 8
?
MANAGEMENT - Companies are managed by the directors who are
elected, appointed and reappointed by the shareholders in a general meeting. A partner on the other hand, unless otherwise provided in the partnership deed or agreement is allowed to participate in the management of the firm.
Disadvantages of Partnership over Private Limited:
?
LEGAL STATUS - A company has a separate distinct status whereas a
Partnership is not a separate distinct person.
?
LIABILITY OF MEMBERS -The liability of the members in case of a
company is limited to the value of shares held by him or up to the amount of guarantee given by him. In case of both Limited Liability and unlimited liability, the company is a distinct entity from its members. In case of a partnership however the liability of the partners is unlimited and they are severally or jointly responsible liable for the debts of the firm.
?
TRANSFER OF SHARES - The shares in case of a private company are
transferable, although with little ease whereas in case of a Partnership, no partner can transfer, sell his share without the consent of all the other partners.
?
PERPETUAL SUCCESSION - A company enjoys perpetual succession and
the existence of a company is not threatened by the death, of its members.
?
LEGAL OBLIGATIONS - A company is subject to the direct control by the
Act and it has to comply with the various legal provisions regarding the maintenance of statutory books, getting the accounts audited by the CA’s. There are no such legal obligations in case of a partnership. Q.1.3 Advantage / Disadvantage of Partnership firm & Proprietor Firm Advantages of Partnership over Proprietary Firm:
?
NUMBER OF MEMBERS - The minimum numbers of members in a
partnership is two and the maximum is limited to 10 in case of banking Page 4 of 8
and otherwise 20. A sole proprietorship business is started by an individual.
?
SHARE OF PROFIT/LOSS - In case of partnership the profits and loss are
shared between the partners in the agreed profit sharing ratio. In case of sole proprietorship the profit/ loss accrues to an individual. Disadvantages of Partnership over Proprietary Firm:
?
MODE OF CREATION - A partnership is created with the mutual
agreement between the partners. Registration of a partnership is not compulsory under the Partnership Act. A proprietary firm is a start up by a single person without being governed by any act. Thus there is greater freedom to operate in case of a proprietorship and in case of a partnership there is governance by rules.
Comparative Evaluation of Forms of Organization Basis of comparison Formation Sole Proprietorship Minimal legal formalities, easiest formation Partnership Registration is optional, easy formation Minimum – 2, Maximum – (Banking – 10, Others – 20) Limited but more than that can be Company Registration compulsory, lengthy and expensive formation process Minimum Private2, Public-7. Maximum Private50, PublicUnlimited Large financial resources Page 5 of 8
Members
Only owner
Capital contribution
Limited finance
Liability Control and management
Unlimited Owner takes all decisions, quick decision making Unstable, business and owner regarded as one
raised in case of sole proprietorship Unlimited and joint Partners take decisions, consent of all partners is needed
Limited Separation between ownership and management
Continuity
More stable but Stable because of affected by status separate legal of partners status
Q. 2: What causes Agency Costs? What are the main implications of separation of ownership & management? An agency cost is the cost incurred by an organization that is associated with problems such as divergent management-shareholder objectives and information asymmetry. It refers to the conflicts of interest that arise between all of these different groups. The information asymmetry that exists between shareholders and the Chief Executive Officer is generally considered to be a classic example of a principal-agent problem. The agent (the manager) is working on behalf of the principal (the shareholders), who does not observe the actions of the agent. This information asymmetry causes the agency problems of moral hazard and adverse selection. Causes of Agency Costs: 1.Difference in Information: • • • • Stock prices and returns Issue of shares and other securities Dividends Financing
2.Different Objectives: • Managers v/s. Stockholders:
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The interests of managers, stockholders, bondholders and society can diverge. What is good for one group may not necessarily be for another. Managers may have other interests (job security, perks, compensation) that they put over stockholder wealth maximization. Actions that make stockholders better off (increasing dividends, investing in risky projects) may make bondholders worse off. • Top management v/s. Operating management: The board of directors in the literature is typically viewed as aligned with either management or with stockholders, but recent theory suggests that they too have own objectives. A very easy non-executive director is valuable to the CEO who gets more leeway, but a very critical non-executive director may be just as valuable to the stockholders. Directors further don't want to be the only ones who are critical towards the CEO, because that increases their chances of being removed from the board. The behaviour of directors is not well known and the theory is largely scarce on this matter. Stockholders v/s. Banks & Other Lenders: Banks and other lenders typically value a risk-averse strategy since that will increase the chances of getting their investment back. Stockholders on the other hand are willing to take on very risky projects. If the risky projects succeed they will get all of the profits themselves, whereas if the projects fail the risk is shared with the lender. Lenders know this of course, so they will have costly and large ex-ante contracts in place prohibiting the management from taking on very risky projects should they arise, or they will simply raise the interest rate which in turn increases the cost of capital for the company.
•
Implications of separation of Ownership and Management:
1. Professional management: A company can afford to pay higher salaries to specialists and professionals. It can, therefore, employ people who are experts in their area of specializations. The scale of operations in a company leads to division of work. Each department deals with a particular activity and is headed by an expert. This leads to balanced decision making as well as greater efficiency in the company’s operations.
Page 7 of 8
2. Conflict in interests: There may be conflict of interest amongst various stakeholders of a company. The employees, for example, may be interested in higher salaries, consumers’ desire higher quality products at lower prices and the shareholders want higher returns in the form of dividends and increase in the intrinsic value of their shares. These demands pose problems in managing the company as it often becomes difficult to satisfy such diverse interests.
Page 8 of 8
doc_178206077.doc
Advantage/Disadvantage of Private Limited & Public Limited Companies, Advantages of Partnership over Private Limited, Disadvantages of Partnership over Private Limited, Advantages of Partnership over Proprietary Firm, Disadvantages of Partnership over Proprietary Firm, Comparative Evaluation of Forms of Organization. It also includes What causes Agency Costs? What are the main implications of separation of ownership & management?
Corporate Finance
ASSIGNMENT 1
Organizations are mainly classified on the basis of ownership and management. The major forms of organization include – ? Proprietorship ? Partnership ? Hindu Undivided Family business ? Cooperative society ? Company (corporation) Types of Corporations: A company or a corporation can be either a private limited or a public limited company. Q 1.1 Advantage/Disadvantage of Private Limited & Public Limited Companies Comparative Glance at a Public Limited Company and Private Limited Company Basis Members Minimum number of directors Minimum paid up capital Index of members Transfer of shares Invitation to public to subscribe to shares Public Limited Company Minimum – 7 Maximum – unlimited Three Rs. 5 lakhs Compulsory No restriction Can invite the public to subscribe to its shares or debentures Private Limited Company Minimum – 2 Maximum – 50 Two Rs. 1 lakh Not compulsory Restriction on transfer Cannot invite the public to subscribe to its shares or debentures
Advantages of a Private Limited Company over a Public Limited Company: (i) A private company can be formed by only two members whereas seven people are needed to form a public company. (ii) There is no need to issue a prospectus as public is not invited to subscribe to the shares of a private company.
Page 2 of 8
(iii) Allotment of shares can be done without receiving the minimum subscription. (iv) A private company can start business as soon as it receives the certificate of incorporation. The public company, on the other hand, has to wait for the receipt of certificate of commencement before it can start a business. (v) A private company needs to have only two directors as against the minimum of three directors in the case of a public company. (vi) A private company is not required to keep an index of members while the same is necessary in the case of a public company. (vii) There is no restriction on the amount of loans to directors in a private company. Therefore, there is no need to take permission from the government for granting the same, as is required in the case of a public company. Q.1.2 Advantage / Disadvantage of Private Limited & Partnership
Advantages of Partnership over Private Limited
?
MODE OF CREATION - A company comes into existence only when it is
registered under the Companies Act. A partnership is created with the mutual agreement between the partners. Registration of a partnership is not compulsory under the Partnership Act.
?
MEMBERSHIP - The minimum numbers of members in a partnership is
two and the maximum is limited to 10 in case of banking and otherwise 20. The minimum number of members in case of a Private company is seven and the maximum number of members is 50.
?
AGENCY OF MEMBERS - A shareholder is not an agent of the company
and thus has no power to bind the company by his acts. In case of a partnership the partner is bound by all the acts of the other partners.
?
POWERS - The powers of a company are contained in the object clause
of the memorandum of association. A change can be affected in objects by following a rigid procedure as laid down in the act. In partnership the partners can do anything which they agree to.
?
DISSOLUTION - A company’s existence will come to an end only by the
order of the court. A partnership firm can be dissolved at any time by an agreement between the partners or in case of partnership at will, by the withdrawal of even one partner. Page 3 of 8
?
MANAGEMENT - Companies are managed by the directors who are
elected, appointed and reappointed by the shareholders in a general meeting. A partner on the other hand, unless otherwise provided in the partnership deed or agreement is allowed to participate in the management of the firm.
Disadvantages of Partnership over Private Limited:
?
LEGAL STATUS - A company has a separate distinct status whereas a
Partnership is not a separate distinct person.
?
LIABILITY OF MEMBERS -The liability of the members in case of a
company is limited to the value of shares held by him or up to the amount of guarantee given by him. In case of both Limited Liability and unlimited liability, the company is a distinct entity from its members. In case of a partnership however the liability of the partners is unlimited and they are severally or jointly responsible liable for the debts of the firm.
?
TRANSFER OF SHARES - The shares in case of a private company are
transferable, although with little ease whereas in case of a Partnership, no partner can transfer, sell his share without the consent of all the other partners.
?
PERPETUAL SUCCESSION - A company enjoys perpetual succession and
the existence of a company is not threatened by the death, of its members.
?
LEGAL OBLIGATIONS - A company is subject to the direct control by the
Act and it has to comply with the various legal provisions regarding the maintenance of statutory books, getting the accounts audited by the CA’s. There are no such legal obligations in case of a partnership. Q.1.3 Advantage / Disadvantage of Partnership firm & Proprietor Firm Advantages of Partnership over Proprietary Firm:
?
NUMBER OF MEMBERS - The minimum numbers of members in a
partnership is two and the maximum is limited to 10 in case of banking Page 4 of 8
and otherwise 20. A sole proprietorship business is started by an individual.
?
SHARE OF PROFIT/LOSS - In case of partnership the profits and loss are
shared between the partners in the agreed profit sharing ratio. In case of sole proprietorship the profit/ loss accrues to an individual. Disadvantages of Partnership over Proprietary Firm:
?
MODE OF CREATION - A partnership is created with the mutual
agreement between the partners. Registration of a partnership is not compulsory under the Partnership Act. A proprietary firm is a start up by a single person without being governed by any act. Thus there is greater freedom to operate in case of a proprietorship and in case of a partnership there is governance by rules.
Comparative Evaluation of Forms of Organization Basis of comparison Formation Sole Proprietorship Minimal legal formalities, easiest formation Partnership Registration is optional, easy formation Minimum – 2, Maximum – (Banking – 10, Others – 20) Limited but more than that can be Company Registration compulsory, lengthy and expensive formation process Minimum Private2, Public-7. Maximum Private50, PublicUnlimited Large financial resources Page 5 of 8
Members
Only owner
Capital contribution
Limited finance
Liability Control and management
Unlimited Owner takes all decisions, quick decision making Unstable, business and owner regarded as one
raised in case of sole proprietorship Unlimited and joint Partners take decisions, consent of all partners is needed
Limited Separation between ownership and management
Continuity
More stable but Stable because of affected by status separate legal of partners status
Q. 2: What causes Agency Costs? What are the main implications of separation of ownership & management? An agency cost is the cost incurred by an organization that is associated with problems such as divergent management-shareholder objectives and information asymmetry. It refers to the conflicts of interest that arise between all of these different groups. The information asymmetry that exists between shareholders and the Chief Executive Officer is generally considered to be a classic example of a principal-agent problem. The agent (the manager) is working on behalf of the principal (the shareholders), who does not observe the actions of the agent. This information asymmetry causes the agency problems of moral hazard and adverse selection. Causes of Agency Costs: 1.Difference in Information: • • • • Stock prices and returns Issue of shares and other securities Dividends Financing
2.Different Objectives: • Managers v/s. Stockholders:
Page 6 of 8
The interests of managers, stockholders, bondholders and society can diverge. What is good for one group may not necessarily be for another. Managers may have other interests (job security, perks, compensation) that they put over stockholder wealth maximization. Actions that make stockholders better off (increasing dividends, investing in risky projects) may make bondholders worse off. • Top management v/s. Operating management: The board of directors in the literature is typically viewed as aligned with either management or with stockholders, but recent theory suggests that they too have own objectives. A very easy non-executive director is valuable to the CEO who gets more leeway, but a very critical non-executive director may be just as valuable to the stockholders. Directors further don't want to be the only ones who are critical towards the CEO, because that increases their chances of being removed from the board. The behaviour of directors is not well known and the theory is largely scarce on this matter. Stockholders v/s. Banks & Other Lenders: Banks and other lenders typically value a risk-averse strategy since that will increase the chances of getting their investment back. Stockholders on the other hand are willing to take on very risky projects. If the risky projects succeed they will get all of the profits themselves, whereas if the projects fail the risk is shared with the lender. Lenders know this of course, so they will have costly and large ex-ante contracts in place prohibiting the management from taking on very risky projects should they arise, or they will simply raise the interest rate which in turn increases the cost of capital for the company.
•
Implications of separation of Ownership and Management:
1. Professional management: A company can afford to pay higher salaries to specialists and professionals. It can, therefore, employ people who are experts in their area of specializations. The scale of operations in a company leads to division of work. Each department deals with a particular activity and is headed by an expert. This leads to balanced decision making as well as greater efficiency in the company’s operations.
Page 7 of 8
2. Conflict in interests: There may be conflict of interest amongst various stakeholders of a company. The employees, for example, may be interested in higher salaries, consumers’ desire higher quality products at lower prices and the shareholders want higher returns in the form of dividends and increase in the intrinsic value of their shares. These demands pose problems in managing the company as it often becomes difficult to satisfy such diverse interests.
Page 8 of 8
doc_178206077.doc