Tag Archives: types of firms in economics

The Business Sector

7 Jul

Business sector

   A firm can be organized in several ways. We should distinguish three types: a plant, a firm and an industry.

  • A plant is a physical establishment (a factory, a mine, a store or a farm) that may perform one or more functions in producing, fabricating and distributing of goods and services.
  • A firm is an organization that employs resources to produce goods and services. Firms may own and operate one or more plants.
  • An industry is a group of firms that produce the same or similar products.

   The organizational structure of firms is diverse and very complex. Multi-plant firms may be organized horizontally, most of them performing the same function or they may be vertically integrated, meaning that each plant is performing different actions in the various stage of production process. Other firms may be conglomerates, which mean that their plants produce products in different industries.

Forms of Business
   There are three major legal forms of business:

  • Sole Proprietorship- is a business that is owned and operated by a single person. The owner (proprietor) is the person who supervises the whole operation of production.
  • Partnership- this form of business represent an organization that is owned and operated by two or more individuals (partners).All of them usually invest their money in this business and all of them share the risk of having losses.
  • A corporation- is a legal business unit chartered by federal or provincial governments that operates as a distinct unit from the stockholders who own it. This type of business is run by managers.

   Characteristics
   Each form of business has its advantages and disadvantages.
Sole Proprietorships are numerous because they are easy to create and organize. The proprietor is the person who makes decisions of further development of this type of business. Proprietor’s revenue depends on success and logic of his actions, so owner has a strong incentive to manage this economic unit efficiently.
   One of the main disadvantages is that financial resources are limited to what owner has in bank or can borrow. Because this type of business often fails banks aren’t eager to offer them credit. The proprietor carries all management functions: takes decision what to produce, how much to produce, whom to hire and where to sell the goods. This type of firm doesn’t get the benefits of specialization since it’s very small and quantity produced is very low. One of the most important characteristic is unlimited liability. Individuals can lose not only firm’s assets, but also personal assets, if firm’s assets aren’t sufficient to pay the bills.
  Partnership, like sole proprietorship, is easy to organize. Greater specialization of management is possible because more people run this economic unit and also financial resources of proprietorship are greater than that of sole proprietorship. Banks are more likely to offer financial resources to this type of business than to sole proprietorships.
    When more people participate in managing of a firm, there may be some disagreements on some basic policies, which will act like a hinder in firm’s economic activity. Even if financial funds of partnerships are generally superior to that of sole proprietorship, they still may not be enough to ensure the rapid growth of a successful business.
   The continuity of partnership may be limited. If one of the partners die this economic unit should be reorganized or dissolved. Like in sole proprietorships partners risk to lose their wealth if one of the partners has a bad performance. So, wealthy partners risk their money on the prudence of less affluent partners.
 
   Corporations, although are small in number, they are large in size and produce great number of economic operation. This is the most effective form of business for raising financial capital. They have unique methods of getting financial resources- the selling of stocks and bonds- that enable to collect a great amount of people from a large number of people.
    Stocks are shares of ownership, but bonds are promises to repay a loan at a specific rate. Financing via bonds and stocks is very effective. Such kind of financing help households do own a part of business and share the revenues without participating at organizing or managing a firm. Corporations are better risks, so banks are more likely to become profitable clients of banks.
      Corporations have limited liability, which means than stockholders risk only what they paid for the stocks if the corporation becomes bankrupt. Creditors can sue the only the corporation as a legal economic entity, but not the stockholders. Because of their ability to attract enormous financial resources, corporations may develop very quickly. The may take advantage of division of labor and mass-production technologies.
   As a legal entity corporations have an independent life from their stockholders. The transfer of stocks through inheritance or sale of stock doesn’t disrupt life of this economic unit, which permits to have a long-ranged life and grow.
   Even if there are a lot of advantages, corporations have some drawbacks. One of them is that some business owners can avoid personal responsibility from some questionable business activity. Another drawback is double taxation of income. Corporate profit is divided among stockholders as dividends and taxed twice- once as corporate profit another time as stockholders’ income.
Principal-Agent Problem
      Corporations are extremely large so that their managing may create a potential problem. Here stockholders can’t manage entire economic operations of corporations, so that they hire other to do it.
   This action can produce a principal-agent problem. Principals here are stockholders, ones who own the corporation and hire executive as their agents to run business on their behalf. Interests of these managers (agents) don’t always coincide with the interests of corporation’s stockholders. Owners want more profit and maximum stock price, while agents want prestige, power to control the whole enterprise, independent of revenue and stock price. So a problem of interests may occur.
   Many corporations solved this problem by providing a big part of managers’ pay as shares of the companies’ stock. The idea is to combine interests of executive to ones of the owners.
   By getting high profits and share price, owners get high dividends, but executive enhance their revenues.

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