Key features of corporate issuers

What makes a corporation different?

A corporate issuer is a corporation that raises money from investors in financial markets, with equity, debt or both. Five features set it apart from the other business forms, and the exam tests each one by name.

Corporate issuera corporation that raises money in financial markets

• Legal identity Use it separate person; contracts, borrows, sues, is sued
• Owner–manager separation Use it shareholders → board → executives
  • Shareholders Use it elect and can replace directors by voting
  • Board of directors Use it appoints the CEO and other executives
• Limited liability Memorize maximum loss is the price paid for the shares
• External financing Use it see financing tree
• Taxation Memorize company taxed, dividends often taxed again

It has its own legal identity

A corporation is formed by registering with a regulator, and from then on it is a legal identity in its own right. It can sign contracts, hire people, borrow, invest, own property, pay tax, sue and be sued. It must follow the rules of every place where it is incorporated, operates or raises money. Its owners are not the corporation.

Owners and managers are separate

Owner–manager separation means the people who own the corporation need not run it. Shareholder s elect a board of directors . The board appoints the chief executive and other executives, who make the investing, financing and operating decisions. Directors and managers must act in the shareholders’ interest and, indirectly, in the interest of other stakeholders.

Shareholders influence the company mainly through their voting rights : electing directors and voting on matters in the company charter. If the board or managers disappoint, shareholders can vote to replace directors, though this can take time. Separation lets the corporation draw in investors who want a return but have no wish to manage anything.

Shareholders have limited liability

Under limited liability , the most a shareholder can lose is what was invested: the shares can fall to zero but no further, and creditors cannot pursue shareholders’ personal assets. Ownership is divided into small units, so investors can buy or sell a little at a time; some issuers have more than a billion shares. Some corporations also issue several share classes with different rights and risks.

It can raise money from anyone

Because buying a share is the only step needed to become an owner, a corporation can reach a far larger pool of investors than a partnership. Both individuals and institutions (mutual funds, pension funds, banks, governments, charities and other companies) can supply the money. The corporation is costlier to set up and run, so it is most attractive when capital needs exceed what a few partners could provide.

External financingfrom individuals and institutions

• Equity Use it owners; paid dividends if the board declares them
  • Sell shares Use it new money from new owners
  • Retain profit Use it reinvest instead of paying dividends
• Debt Use it repaid on a set date with interest
  • Loans Use it private agreement with a lender
  • Bonds Use it tradeable debt securities
  • Leases Use it paying to use an asset

Equity financing means selling shares or retaining profit. Shareholders have a right to dividend s if the board declares them, but no right to be repaid. Debt financing (loans, bonds, leases) must be repaid on a set date with interest.

How does double taxation work?

Most countries tax corporations on their profit. Many also tax shareholders on the dividends they receive, so profit that is paid out is taxed twice. This is double taxation . The tax is not just the sum of the two rates, because the shareholder pays tax only on what remains after company tax.

$$T = t_c + (1 - t_c) \times b \times t_d$$

Here $t_c$ is the corporate tax rate, $t_d$ the tax rate on dividends and $b$ the share of after-tax profit paid out. With full payout $b = 1$, the formula collapses to $t_c + (1 - t_c)\,t_d$.

What if only part of the profit is paid out?

Only the distributed part meets the second tax. The retained part pays company tax and nothing more for now.

Why do companies still choose the corporate form?

The corporation has a tax disadvantage only on profit that is paid out. A sole proprietor or partner is taxed on all profit, paid out or not. So the corporate form suits a business that expects to reinvest. Where the corporate rate is below the personal rate, it can even pay to keep profit inside the company. Some countries also reduce or remove the second layer with credits or exemptions on dividends, and a few do not tax companies at all.

Compare with the GBP 50 million example. If the business were a pass-through taxed at 40% personally, tax would be $0.40 \times 50 =$ GBP 20 million whether or not any cash was paid out, against GBP 25.625 million for a fully distributing corporation. If the corporation retained everything, it would owe only GBP 12.5 million for now.

Exam tip Double taxation bites only on what is paid out. Reinvested profit meets the company tax once.

Go deeper Net income versus economic profit

Net income is what is left after all fixed claims are met: suppliers, employees, lenders and tax. Owners also expect a return on the equity they have put in, so a firm earns economic profit only when net income exceeds the required return on equity. For example, net income of USD 18 million on equity of USD 150 million with a required return of 10% gives economic profit of $18 - 0.10 \times 150 =$ USD 3 million. A firm can report positive net income and still earn no economic profit.

Go deeper Taxable profit is not accounting profit

Tax codes and accounting standards define profit differently, so the profit a company reports to shareholders is rarely the profit it is taxed on. The financial statement analysis topic covers the differences under income taxes. For this lesson, treat the pre-tax profit as the amount that is taxed.

Go deeper Relief from double taxation

Some countries give shareholders a credit for the tax the company already paid, or exempt dividends that come from taxed profit. Others tax companies at different rates in different regimes, or not at all. When a question gives you a rate for dividends, use it as given. Relief changes the inputs, not the formula.