Business Law(BL2) Questions With Correct Rejoinders.
What is a Corporation? - accurate answers-In legal terms...
A fictional person created by or under the authority of the laws of a state,
distinct and separate from the people who own it - the shareholders
An entity capable to act - entering contracts, owning property, delegating
authority, suing and being sued
In economic terms...
A pool of (disparate) assets as necessary to carry out the firm's business and
to generate streams of revenues
In financial terms...
An investment device to shift away a substantial part of the risks against a
potentially unlimited upside
Core Attributes of a Corporation - accurate answers-1. Legal personality →
"entity shielding" effect
2. Limited liability → "owner shielding" effect
3. Transferable shares
4. Centralized management
5. Investor ownership
Agency Relationships in Economic Terms - accurate answers-Any relationship
in which one party (the "agent") promises to perform some service on behalf
of another (the "principal"). Some decision-making authority must then be
delegated to the agent. With that comes the risk of "moral hazard".
Agency Relationships in Legal Terms - accurate answers-A consensual
relationship created by contract or by law where one party, the principal,
grants authority for another party, the agent, to act on behalf of and under the
control of the principal to deal with a third party. An agency relationship is
fiduciary in nature, and the actions and words of an agent exchanged with a
third party bind the principal.
,Three dimensions of the Corporate Agency Problem - accurate answers-Three
relevant dimensions:
1. Shareholders vs. Managers
2. Controlling vs. Non-Controlling Shareholders
3. Shareholders vs. Creditors and/or Other Stakeholders (employees,
customers, etc.)
Managerial agency cost categories - accurate answers-1. Direct transfers of
value: Self-dealing transactions; Senior management remuneration; Business
opportunities
2. Indirect agency costs: Shirking and incompetence; Perquisites / benefits
and bonus in addition to salary; Waste, such as 'empire building'
Monitoring Shareholders (pros and cons) - accurate answers-• Pros - As the
residual claimants, shareholders have the most incentives to monitor.
• Cons - Shareholders suffer a number of "collective action problems", such as:
- Rational apathy
- Coordination (and information) costs
SHs' monitoring in companies with too dispersed share ownership may thus
be hard.
(However, the BOD also has a monitoring function, and Institutional
ownership can help in monitoring)
Private benefits of control - accurate answers-Advantages a controlling
shareholder can gain at the expense of minority shareholders, such as
extracting excess profits or using the company's assets for personal gain.
Examples include
• Tunneling / diversion of funds
• Transfer pricing
• Related party transactions in general
• Nepotism
• Infighting
,Legal Personality - accurate answers-Corporate entities have a separate legal
identity, distinct from the individuals who own or manage them.
Legal Personality → Entity Shielding Effect
Entity Shielding Effect - accurate answers-The firm's assets are protected
from shareholders and their personal creditors via two rules:
• Priority rule: business creditors have priority access to corporate assets.
• Liquidation protection: shareholders cannot arbitrarily withdraw corporate
assets.
Limited Liability - accurate answers-Shareholders have liability limited to
their investment in the corporation. Limited liability significantly enhances
shareholder diversification by capping risk exposure.
Limited Liability → Owner Shielding effect
Asset Shielding - accurate answers-Owner shielding, combined with entity
shielding, creates asset shielding (or "asset partitioning") clearly dividing
individual shareholders' from corporate assets, and ensuring that business
assets are pledged as security to business creditors.
Transferable Shares - accurate answers-Corporate shares are generally freely
transferable. This characteristic supports liquidity, continuity in the
company's operations, and the diversification of shareholders.(Note:
transferability refers to the legal ability to transfer ownership, not free
tradability in public markets).
Delegated Management with a Board Structure - accurate answers-Corporate
law universally delegates authority to manage the corporation to an elected
board of directors, which in turn delegate the day-to-day running of the firm
to its officers/ management.
The Board is:
1. separate from the operational managers of the corporation
2. elected by the shareholders
, 3. formally separated from shareholders
4. has multiple members
Investor Ownership - accurate answers-Corporate law is principally
structured to facilitate investor-owned firms, where both core elements of
ownership— control rights and residual earnings rights—are tied to the
contribution of equity capital.
Default vs. mandatory rules: - accurate answers-Default rules apply only if
parties don't explicitly specify otherwise, thus reducing transaction costs.
Mandatory rules cannot be altered by agreement and are designed to address
contracting failures, promote standardization, and protect the interests of
third parties.
Forces Shaping Corporate Law - accurate answers-• Efficiency effects: laws
evolve according to economic functionality, responding to corporate
ownership
structures, industry needs, and institutional arrangements.
• Political effects: interest groups, populist reforms following crises, historical
legacies, and jurisdictional
regulatory competition all influence lawmaking.
Contractarian theory - accurate answers-Corporation as a "nexus of contracts"
• Market participants are generally rational and that they can bargain over the
terms of their relationships.
• Corporate law's proper role is to supply default rules
• Mandatory rules are seen as unjustified intrusions into the private ordering
of business relationships, unless strong externalities or market failures are
present.
• States compete to attract incorporations by offering attractive default rules.
The resulting "race to the top"
What is a Corporation? - accurate answers-In legal terms...
A fictional person created by or under the authority of the laws of a state,
distinct and separate from the people who own it - the shareholders
An entity capable to act - entering contracts, owning property, delegating
authority, suing and being sued
In economic terms...
A pool of (disparate) assets as necessary to carry out the firm's business and
to generate streams of revenues
In financial terms...
An investment device to shift away a substantial part of the risks against a
potentially unlimited upside
Core Attributes of a Corporation - accurate answers-1. Legal personality →
"entity shielding" effect
2. Limited liability → "owner shielding" effect
3. Transferable shares
4. Centralized management
5. Investor ownership
Agency Relationships in Economic Terms - accurate answers-Any relationship
in which one party (the "agent") promises to perform some service on behalf
of another (the "principal"). Some decision-making authority must then be
delegated to the agent. With that comes the risk of "moral hazard".
Agency Relationships in Legal Terms - accurate answers-A consensual
relationship created by contract or by law where one party, the principal,
grants authority for another party, the agent, to act on behalf of and under the
control of the principal to deal with a third party. An agency relationship is
fiduciary in nature, and the actions and words of an agent exchanged with a
third party bind the principal.
,Three dimensions of the Corporate Agency Problem - accurate answers-Three
relevant dimensions:
1. Shareholders vs. Managers
2. Controlling vs. Non-Controlling Shareholders
3. Shareholders vs. Creditors and/or Other Stakeholders (employees,
customers, etc.)
Managerial agency cost categories - accurate answers-1. Direct transfers of
value: Self-dealing transactions; Senior management remuneration; Business
opportunities
2. Indirect agency costs: Shirking and incompetence; Perquisites / benefits
and bonus in addition to salary; Waste, such as 'empire building'
Monitoring Shareholders (pros and cons) - accurate answers-• Pros - As the
residual claimants, shareholders have the most incentives to monitor.
• Cons - Shareholders suffer a number of "collective action problems", such as:
- Rational apathy
- Coordination (and information) costs
SHs' monitoring in companies with too dispersed share ownership may thus
be hard.
(However, the BOD also has a monitoring function, and Institutional
ownership can help in monitoring)
Private benefits of control - accurate answers-Advantages a controlling
shareholder can gain at the expense of minority shareholders, such as
extracting excess profits or using the company's assets for personal gain.
Examples include
• Tunneling / diversion of funds
• Transfer pricing
• Related party transactions in general
• Nepotism
• Infighting
,Legal Personality - accurate answers-Corporate entities have a separate legal
identity, distinct from the individuals who own or manage them.
Legal Personality → Entity Shielding Effect
Entity Shielding Effect - accurate answers-The firm's assets are protected
from shareholders and their personal creditors via two rules:
• Priority rule: business creditors have priority access to corporate assets.
• Liquidation protection: shareholders cannot arbitrarily withdraw corporate
assets.
Limited Liability - accurate answers-Shareholders have liability limited to
their investment in the corporation. Limited liability significantly enhances
shareholder diversification by capping risk exposure.
Limited Liability → Owner Shielding effect
Asset Shielding - accurate answers-Owner shielding, combined with entity
shielding, creates asset shielding (or "asset partitioning") clearly dividing
individual shareholders' from corporate assets, and ensuring that business
assets are pledged as security to business creditors.
Transferable Shares - accurate answers-Corporate shares are generally freely
transferable. This characteristic supports liquidity, continuity in the
company's operations, and the diversification of shareholders.(Note:
transferability refers to the legal ability to transfer ownership, not free
tradability in public markets).
Delegated Management with a Board Structure - accurate answers-Corporate
law universally delegates authority to manage the corporation to an elected
board of directors, which in turn delegate the day-to-day running of the firm
to its officers/ management.
The Board is:
1. separate from the operational managers of the corporation
2. elected by the shareholders
, 3. formally separated from shareholders
4. has multiple members
Investor Ownership - accurate answers-Corporate law is principally
structured to facilitate investor-owned firms, where both core elements of
ownership— control rights and residual earnings rights—are tied to the
contribution of equity capital.
Default vs. mandatory rules: - accurate answers-Default rules apply only if
parties don't explicitly specify otherwise, thus reducing transaction costs.
Mandatory rules cannot be altered by agreement and are designed to address
contracting failures, promote standardization, and protect the interests of
third parties.
Forces Shaping Corporate Law - accurate answers-• Efficiency effects: laws
evolve according to economic functionality, responding to corporate
ownership
structures, industry needs, and institutional arrangements.
• Political effects: interest groups, populist reforms following crises, historical
legacies, and jurisdictional
regulatory competition all influence lawmaking.
Contractarian theory - accurate answers-Corporation as a "nexus of contracts"
• Market participants are generally rational and that they can bargain over the
terms of their relationships.
• Corporate law's proper role is to supply default rules
• Mandatory rules are seen as unjustified intrusions into the private ordering
of business relationships, unless strong externalities or market failures are
present.
• States compete to attract incorporations by offering attractive default rules.
The resulting "race to the top"
