Chapter 24 Corporations and Firm Structure

Shareholders

ndividuals who have purchased ownership stakes in a company, C-corporations, shareholders receive dividends and capital gains

Agency Problem

A misalignment of the interests of the owners (shareholders) and the managers of a firm. This arises from the separation of ownership and control.

Economic Profits

The difference between a firm’s revenues and its economic opportunity costs of production

Accounting Profits

The difference between a firm’s revenues and its reported costs of production.

Revenues

What the firm earns selling to the market.

Expenses

Cash flow costs of doing business, interest payments, and depreciation allowances.

Depreciation

The rate at which capital investments lose their value over time.

Debt Finance

Raising funds by borrowing from lenders, such as banks, or by selling bonds.

Equity Finance

Raising funds through sales of ownership shares in a firm.

Bonds

Promises by a corporation to make periodic interest payments, as well as ultimate repayment of principal, to the bondholders (the lenders).

Dividends

Periodic payments out of profits that investors receive from a company, per share owned.

Capital Gains (Corporate Finance)

Increases in the prices of shares since their purchase.

Retained Earnings

Net profits that are kept by the company rather than paid out to debt or equity holders. (One reason for the corporate tax is that if earnings were not taxed, owners could avoid taxes by retaining them).

Debt vs. Equity Conflict (Why Not All Debt?)

Although debt is tax-advantaged (interest payments are an expense ), firms still use equity because debt increases the risk of bankruptcy. If a firm fails to make interest payments, it defaults; with equity, a firm can simply not pay a dividend.

The Dividend Paradox

• The puzzle of why firms pay dividends (which are taxed at a high rate) rather than retaining earnings (which leads to lower-taxed capital gains ).

• two reasons: agency problems (investors want money out of managers' hands) and signaling (dividends signal good performance).

Corporate Tax Rate

the U.S. statutory corporate tax rate was reduced from 35% to 21% by the 2017 Tax Cuts and Jobs Act.

Effective Corporate Tax Rate (ETR)

The percentage increase in the rate of pre-tax return to capital that is necessitated by taxation.

Tax Credits

uses the Investment Tax Credit (ITC) as its primary example. A credit that reduces a firm's tax bill. The PDF notes that "sufficiently large deductions or credits can encourage investment above the pre-tax level".

Corporate Tax Incidence

The question of who bears the burden of the corporate tax. The PDF states the burden is shared by consumers, workers, corporate investors, and noncorporate investors. It also cites recent papers suggesting a large effect on wages.

Multinational Firms

Firms that operate in multiple countries.

Subsidiaries

It refers to the (often foreign) branches of a multinational firm. For example, it discusses transfer prices as reimbursements between subsidiaries.

Global Taxation

A tax system where firms are taxed on their profits regardless of which nation the profits are earned in. (This was the U.S. system before 2017 ).

Territorial Taxation

A tax system whereby firms are taxed only on profits earned in that country (e.g., in the United States). The U.S. moved to this system in 2017.

Transfer Prices

The amount that one subsidiary of a corporation reimburses another subsidiary of the same corporation for goods transferred between the two. Firms can use these to shift profits to low-tax countries.

Repatriation

It refers to multinational firms bringing profits that were held abroad back to their home country (e.g., back to the United States).