What is a business firm?

Legal entity that allows to engage in the

production of economic goods
Predominantly economic aims and traits
Numerous interests converge, but these
i t
interests
t do
d nott necessarily
il come together
t th
spontaneously or congruously
It is a complex reality

1
 Alitalia:
an example of complexity
In 2006, after a period of losses and state support, the Ministry of the
Economy, the main shareholder, decided to sell its share (approx. 50%) by
public auction
Large private equity funds and Alitalia's competitors (e.g. Aeroflot, Air
France) took part in the auction, but none of the offers met the seller
requirements
The Ministry of the Economy and the Ministry of Public Transport began
private negotiations to sell a stake to Air France. The sale was nearly
concluded
l d d but
b it i suddenly
dd l collapsed
ll d
Trade unions refused to accept Air France's proposal on labour issues
The centre-right winning coalition in 2008 considered a foreign acquisition not in
line with Italy's economic strategy
Eventually, a solution was found
Deal among government, commissioner (as the administrator is termed in
extraordinary administration proceedings), and CAI, a new Italian company used to
acquire Alitalia's assets 2
 Institutional structure

Organizations are groups of actors who

provide contributions and obtain rewards or
secure benefits
These groups of actors can be called stakeholders

The institutional structure identifies the main

actors and the basic rules of the game of the
business firm

3
Identifying stakeholders

4
Identifying stakeholders (contd.)
(contd )

5
Problems

6
 Partnerships
The base is a good relationship within the partners based on
trust
Eachh partner owns an equall interest
i in
i the
h partnership
hi
Equally entitled to participate in operating and managing
the
h bbusiness
i andd is
i entitled
i l d to an equall share
h off profits
fi
Share equally in paying taxes on those profits
Exposed to unlimited personal liability (also liable for the
actions of the other partners)
Liable for the bad conduct of the other partner in connection
with the partnerships business
Iff a partner ddecides
id to quiti or dies,
di the
h partnership
hi endsd
7
 Corporations
Separate legal entity
Draws resources from a variety of groups and establishes
andd maintains
i i itsi own identity
id i
Allows different parties to contribute capital, expertise,
l b for
labor, f the
h maximum
i benefit
b fi off all
ll off them
h
Lives on as long as it has capital
Investors get the chance to participate in the profits of the
enterprise without taking responsibility for the operations
The management gets the chance to run the company
without taking the responsibility of personally providing the
f nds
funds
8
 Ownership (contd
(contd.))
To raise capital, corporations may sell stocks, i.e. an
ownership share
A share
h hhas a certaini declared
d l d facef value,
l commonly l known
k as
the par value of a share (more on this in the accounting sessions)
The
Th owner off a share
h off stock k will
ill not have
h direct
di controll over
a corporation, but he is entitled to a proportionate distribution
of profits
The more shares a person owns, the larger his ownership stake
in the company and the greater his risk/rewards
Shareholders make money by receiving dividends and by
selling the stock at a higher price than they paid for it
9
 Ownership (contd
(contd.))
Two types of stock: common and preferred
Common stock carries a voting right. However, common
stockholders
t kh ld are the th last
l t to
t receive
i paymentt in i liquidation
li id ti
Preferred stock has no voting right but it does come with a
constant dividend: the company must pay its preferred stock
dividend obligations before paying dividend to common stock
shareholders

10
 Governance
A companys overall direction is decided by the directors,
while day-to-day operations are decided by managers
The owners (shareholders) of a corporation elect/fire a
Board of Directors, which then elects the officers (other
than
h theh election
l i off directors,
di shareholders
h h ld do d not
participate in the operations of the corporation)
The
Th Board
B d off Directors
Di is
i responsible
ibl for
f supervising
ii
managers and exercising the rights and responsibilities of
the corporation
The Board contributes to firms strategies and policies,
and
d elects/fires
l t /fi officers
ffi (e.g.
( CEO) whoh manage the
th
corporation 11
 Corporations vs.
vs partnerships
Limited liability of shareholders
Low risk (but limited authority)
Easy transferability of holdings
Low risk and costs of exit (flexibility)
( y)
Legal personality
Resilience
Centralized management (separation of ownership
and management)
Efficiency (but risk of conflicts)

12
Basic institutional structure

Stakeholders

Rewards Contributions

13
Dynamic integration of contributions
Imagine an ideal firm spontaneously based on
trust and cooperation
Control and coordination costs are minimized
Free exchange
g of ideas
No opportunistic behavior
High
g commitment to generate
g firm value
Social needs of everybody are satisfied (well-
being)

14
Challenges in real organizations
Contributions of many different actors, often
with different objectives even though
contributions
t ib ti are complementary
l t A plan
l iis
needed to ensure consistency
Expectation of rewards subject to limited
resources
Opportunistic behavior,
behavior e.g.
e g due to information
asymmetries
Organizational rent
Residual income (risk of conflicts)

15
 How to achieve integration
Assign the right/duty of governance to a set of
actors who take on this role either directly or via
representatives
Assign the right/duty to receive the residual
income
Planning and implementing the organizational
structure to provide guidelines for the behavior
of each member (e.g.
(e g define and share strategies,
strategies
implement reward schemes)
Choosing and implementing integration
mechanisms
h i with
ith actors
t external
t l to
t organizations
i ti
(e.g. suppliers contracts, control systems,
partnership
p p with competitors)
p )
16
 Core stakeholders
exercise the prerogative of economic
governance
Decide objectives, strategies and policies
Select the people who contribute to the economic
y of organizations
activity g
Design and implement governance and control
structures
Monitor the economic viability of organizations
The ultimate ggoal is to pproduce rewards for core
stakeholders
What about profit maximization? More on this in the next
sessions..
sessions
17