Ownership of Firms - Summary
Ownership of Firms
Firms
- A firm is a production unit that decides on employing factors of production and producing goods/services.
- Can exist virtually (e.g., online store).
- Owned by the government (public enterprise) or private individuals (private enterprise).
Public Enterprise
- Wholly owned by the government or its agencies.
- Aims to provide services to the public at a lower price or stable supply, rather than profit maximization.
- Examples in Hong Kong: Government Departments, Public Corporations.
Features of Public Enterprise
- More sufficient capital through government support.
- Better access to public information from the government.
- Better control/lower prices of goods and services.
- Less efficient management due to the lack of profit maximization goal.
- Lower quality of goods and services due to reduced incentives for improvement.
Private Enterprise
- Owned by private individuals, aiming at profit maximization.
- Classified into sole proprietorship, partnership, private limited company, and public limited company.
Sole Proprietorship and Partnership
- Not independent legal entities.
- Sole Proprietorship: One owner.
- Partnership: At least two owners.
Common Features
- Not independent legal entity: cannot have separate legal rights/responsibilities from owners.
- Owner(s) bear unlimited liability: personal assets at risk for business debts and fines.
- Lack of continuity: dissolves upon death, retirement, or bankruptcy of an owner.
- Lower profits tax rate than limited companies.
- Simpler and less costly set-up procedure.
- Public disclosure of financial information is not required.
Advantages of Sole Proprietorship vs. Partnership
- Prompter decision-making.
- Not legally bound by other owners' decisions.
- Easy to transfer or close the business.
- No need to share profits.
Advantages of Partnership vs. Sole Proprietorship
- Wider source of capital.
- Risk can be shared among partners.
- Specialization in management is possible.
Limited Companies: Private and Public
- An independent legal entity where owners (shareholders) have limited liability.
- Classified into private limited company and public limited company.
Common Features
- A legal entity: Can own property and enter into contracts.
- Owners enjoy limited liability: personal assets are protected from business debts.
- Lasting continuity: Unaffected by changes in shareholders.
- Higher profits tax rate than sole proprietorships and partnerships.
- More complicated set-up procedure.
- Separation of ownership and management is possible.
- Right to issue shares and bonds.
Differences between Private and Public Limited Companies
| Feature | Private Limited Company | Public Limited Company |
|---|
| Number of Shareholders | cannot exceed 50 | no upper limit |
| Sources of Capital | Private channels only | Issue shares and bonds to the public, stock exchange listing |
| Transfer of Ownership | Consent from other shareholders needed | Shares can be freely transferred |
| Disclosure of Information | Not required to disclose to the public | Required to disclose to the public |
Shares and Bonds
- Ways for limited companies to raise capital: shares (equity financing) and bonds (debt financing).
Key Differences
| Feature | Shares | Bonds |
|---|
| Nature | Certificates of ownership | Debt securities |
| Status of Holders | Owners with voting rights | Creditors with no voting rights |
| Repayment Priority | Lower priority in liquidation | Higher priority in liquidation |
| Return | Dividends (not guaranteed) | Interest (generally guaranteed) |
| Capital Gain/Loss | Possible due to price fluctuations | Possible due to price fluctuations |
Issuing Shares vs. Bonds (from the Firm's Perspective)
| Issuing Shares (over bonds) | Issuing Bonds (over shares) |
|---|
| Advantages | - no interest burden - not diluting existing shareholder’s power of control - no redemption obligation - no risk of being taken over | - diluting existing shareholders’ power of control - has interest burden - higher risk of being taken over - has redemption obligation |
| Disadvantages | diluting existing shareholders’ power of control | has interest burden has redemption obligation |
Buying Shares vs. Bonds (from Small Investors’ Perspective)
| Buying Shares (over bonds) | Buying Bonds (over shares) |
|---|
| Advantages | - has voting rights - possible to have higher return | - higher priority of getting paid - stable return |
| Disadvantages | - lower priority of getting paid - unstable return | - no voting rights - not possible to earn higher return |