Definition- the unit responsible for making production decisions

A firm needs not to have physical location, it is defined in terms of its role in the production process.

•WHAT? •HOW? •FOR WHOM?

The Firm

Objectives• Profit maximization - profit ensures that it can continue its business

• Sales maximization - maintain a large share of the market

• Growth maximization -enlarge its size or provide a continuous supply of goods of reasonable quality

Forms of Business Ownership:

S olePropr ietorship

GeneralParnership

LimitedPartnership

Partnership

Pr ivateLimited Company

PublicLimited Company

LimitedCompany

Pr ivateEnterpr ise

Sole Proprietorship

1.Featuresa. Only one ownerb.The owner has to bear unlimited liabilityc. No legal distinction between the firm and i

ts ownerd. Simple steps to set up:

i. Register with the Commissioner of Inland Revenue

ii.And obtain a Business Registration Certificate

2. Advantagesa. Strong incentive - earns all profit but bea

r all losses.b. Fast decision-making - owner does not ne

ed others’ agreement.c. Close relationship with employees - small in sc

ale.d. Close contact with customers more perso

nal service is provided.e. Simple set up procedure and low set up cost.

3. Disadvantages

a. Unlimited liability - greater risks.

b. Limited capital for expansion.

c. Lack of continuity

d. Lack of division of labour: Usually the owner is responsible for various tasks.

The Partnership

1. Featuresa. 2-20 ownersb. The partners and the firm have

NO separate legal identity.c. unlimited liability.d. Each partner are held

responsible for all the firm’s debts.

e. All partners are held responsible for contracts made by ANY one partner.]

f. Withdrawal and admission of partners usually require agreement of all partners. If not, the partnership may be dissolved.

g. Setting up of a partnership requires only registration with the Inland Revenue.

2. Types of Partnershipa. General Partnership

Same as above

b. Limited Partnershipi. Some partners may enjoy limited liability,

known as limited partners. They are usually sleeping partners, who do not engage in the running of the business.

ii. at least ONE partner with unlimited liability.iii. Limited partners are not allowed to run or

dissolve the partnership.iv. Their withdrawal will not terminate the

partnership.

Advantages & Disadvantages of

Partnership (Comparing with Limited Company):

Advantages1. Greater incentive to

succeed2. Close relationship

between owners & employees and owners & customers

3. Simple establishment procedure

Disadvantages1. Unlimited liability2. Without legal status3. Lack of continuity

Advantages & Disadvantages of

Partnership (Comparing with sole proprietorship):

Advantages1. Wider source of

capital2. Wider scope of

specialization3. Sharing in

decision-making & risk bearing

Disadvantages1. Possibly delay in

decision making2. Liable for other

partners’ mistake3. Reorganization

difficulties

Limited Company1. Features

A. The shareholders and the company are separate legal entities.

B. Limited liability

- the shareholders enjoy limited liability, their loss and liability to debts are limited to their investment on the shares.

C. Separation of ownership and management- usually a company is managed by a board of directors who are elected by the shareholders.

- the directors may hold only a small percentage of shares.

- most shareholders do not take part in the management of the company.

D. Lasting continuityThe existence of a limited company is not affected by the death of shareholders or transfer of ownership(shares).

2. Private Limited Company and Public Limited Companies

Private Company Public CompanyNumber of shareholders2-50 2-unlimited

Public subscription of shares

Not allowed to invite subscription of shares from the public

It can, and its shares will then be traded on the Stock Exchange

Transfer of shares

Transfer to existing shareholders first, if to outsiders, it requires the approval of B.O.D

No restriction: shares can be transferred freely on stock market

Disclosure requirement

Not required to disclose its financial conditions to the public

Required to disclose its financial conditions to its shareholders.If it is listed, it is required to publish its annual account.

3. Advantages

A. Shareholders enjoy limited liability so that their risk involved in investment is lower.

B. wider source of capital - raise capital by issuing shares. It is especially true for a public limited company.

C. Shares are transferable easily especially for a public limited company. Therefore, shareholders’ liquidity is higher.

D. more efficient management because it can hire professional managers to run the company.

E. lasting continuity - existence of a company is not affected by the transfer of shares, withdrawal or death of shareholders.

4. Disadvantages

A. delay in decision-making - it needs the approval of the board of directors.

B. The employed managers may have lower incentive because they do not have vested interests in the company.

C. lack of communication between the top level of management and low level of employees. It may also be lack of co-ordination across various departments due to its large size.

E. disclose its financial conditions so that it is difficult to keep business secrets.

D. higher profit tax rate than sole proprietorship and partnership.

F. It is more complicated and costly to set up a company.

i. submit two documents (The Memorandum of Association and the Articles of Association) before it is issued a Certificate of Incorporation.

ii. For a public limited company to be listed, it requires the approval of the Hong Kong Stock Exchange Ltd. And it has to publish a prospectus giving full details about the company.

5. Raising Capital1. For most small firms - personal savings, loans from friends and banks

A. Hire purchasei. The banks pays the seller of goods on behalf of the firm, which promises to settle the debt by installment.

ii. Until the debt is fully settled, the goods are only “on hire” to the firm.

B. Delivery on crediti. The supplier allows the firm to have the goods delivered first and pay at a later date.

2. Shares and Debenture

A. Preference shares

i. Fixed dividend rate

ii. Priority in receiving dividend

iii. Priority over other shareholders in claiming capital when the company winds up

iv. Holders have no voting right

v. Two types of preference shares: (1) cumulative preference shares unpaid dividend will be accumulated until there is profit (2) participating preference shares can receive remaining profit (after all shareholders are paid)

B. Ordinary shares

i. Flexible dividend rate, depending on the profit level of the company

ii. Last to receive dividend

iii. Last to claim back capital

iv. Holders have voting right

C. Debentures

i. Holders are not shareholders or owners; they are creditors or lenders.

ii. They receive interest, not dividend, whether the company makes profit or not.

iii. They are redeemable

iv. They have priority to claim back their money before all shareholders

3. Comparison

Creditors withno voting right

Ordinary shares Preference shares Debentures

Status

Profitability

Rate of return

Risk

Right to claim back capital

Owners with voting right

Owners with no voting right

lastAfter creditors but before ordinary shareholders

first

Less risky Least riskyGreatest risks: no earnings if the company does not make profit

Earn possible highest returns if the company makes large profit or if the share price goes upFlexible, depending on the profit level of the company

Less profitable

Fixed

Less profitable

Usually fixed

Public Enterprise

1. Features

A. Government or state ownership

B. Not profit-oriented

C. Aim at providing goods and services of reasonable quality at low price

2. Advantages

A. Government has large capital supply for large scale production.

B. Government departments are access to more up-to-date information.

C. With government subsidization, public enterprise can offer lower prices.

D. BY providing goods and services at lower price, it helps to narrow the gap between rich and poor.

3. Disadvantages

A. less efficient and less innovative : i. Low incentive of government officials as they are not profit orientedii. Bureaucracyiii. lack of competition

B. Public enterprises are less responsive to market demand and waste resources.

C. Low price (i.e. below market equilibrium) lead to excess demand so that resources are misallocated.

In order to improve the efficiency of public enterprises, the following policies are adopted:

A. Inviting private management e.g. public car-parks, tunnels

B. Setting up public corporation e.g. KCRC, MTRC, LDC

Public Corporation

A. Features

i. It is set up by statute

ii. However, it is a legal entity independent of the government

iii. It enjoys limited liability

iv. It is managed by a board of directors

v. It is run on a commercial basis, e.g. it can earn profit, the employees are not civil servants

vi. However, the government is still the largest owner

vii. And it is controlled by the government in some ways, e.g. (1) by appointing the chairman, (2) checking its accounts, (3) laying down some guidelines etc.

B. Advantages over government departments:

i. Higher incentive as it is profit oriented

ii. More market oriented

iii. More flexible as the employment and pricing policies are not strictly regulated by government rules

C. Advantages over a private enterprise

I. Stronger financial power as the government offers credit

ii. It has priority in obtaining resources, e.g. land, information, etc.

Setting up a limited company in Hong Kong

Memorandum of

Association

Articlesof

Association

Registerof

Companies

Formation of

Company

Certificateof

Incorporation

Issuing shares by a public company

Public company

Approval by StockExchange Ltd.

.

Invite subscription from public

Issue prospectus to public

Shares issued to public in primary market through

underwriters

Shares transferred freely on Stock Exchange

(i.e. secondary market)

Internal Growth

• Firms expand within its existing structured management. E.g. A firm starting more branches and these branches are managed by a central management board.External

Growth• Firms expanding the scale or scope

of business by combining or integrating with other firms.

The Integration of Firms

Types of Integration

• Horizontal integration• Vertical integration:

-Vertical backward integration -Vertical forward integration

• Lateral integration• Conglomerate integration

Horizontal Integration

• Firms at the same sage of production or producing the same product combine together

Vertical Integration

• Firms at different stages of producing the same good combine together.

Two types of vertical integration

• Vertical backward integration• vertical forward integration

Two Types of Vertical Integration

• Vertical backward integration: A firm combines with another firm in its preceding stage of production.E.g. A garment factory combines with a weaving factory.

• Vertical forward integration: A firm combines with another firm in

the next stage of production.E.g. A garment factory combines

with a boutique.

Lateral Integration & Conglomerate Integration

• Lateral integration:A firm combines with another

firm producing related but not competitive products.

• Conglomerate integration:Firms in entirely different

lines of production combine together.

Methods of Integration

• Cartel• Takeover• Merger• Consolidation

Cartel

• An association of independent firms producing similar goods or services.

It can be formed to fix price, control production or allocate sales among members.The member firms retain their independent corporate status. E.g. The Hong Kong Association of Banks

Takeover• A firm takes over another firm if it buys

up a controlling percentage of that firm’s shares. The firm being taken over (the acquired firm) retains its own name and corporate status. A holding company may be set up for the purpose of holding the shares of the acquired firm. A trust is said to be formed if it also control its trading policy.

Merger

• A merger occurs when a firm (called the merging firm) absorbs another firm by purchasing its assets. After the merger, the merged firm is dissolved and loses its corporate status.

Consolidation

• Consolidation occurs when two firms dissolve themselves and put their assets together to form a new firm.

General Motives• Benefit from economies of

scale Integration Size of combined firm is larger Produce at a larger scale Benefit from economies of scale

Lower average cost.

Motives of Integration

More efficient use of resources

• Removing the inefficient management:

If a firm is poorly managed, its rate of profit will below. When it is taken over, its existing management will be removed and its resources will be used more efficiently to yield a larger profit.

More efficient use of resources

• Elimination inefficient plants:

If there are too many firms in an industry, and some of them cannot work up to capacity, integration helps them to close down the inefficient plants so that the remaining ones can be worked more efficiently.

Influence the market price

• As firms go on integration, they may become very large. They can control the market output and raise price. Sometimes, they may lower price to drive other competitors out of business.

Specific Motives

• To ensure a steady supply of raw materials:

A firm integrating vertically backwards may desire to ensure a steady of raw materials. With a steady supply of raw materials, it reduces its reliance on outside suppliers, can better plan production and avoid the bottlenecks in production.

• To ensure adequate market outlets:

A firm integrating vertically forward may desire to ensure adequate market outlets. With adequate market outlets, it can reduce its reliance on the middleman, collect market information more easily and adapt to changes in market demand more rapidly.

• Firms engaging in lateral and conglomerate integration may desire to:

Diversify its production so that the harmful effect of failure in one

product line on profit is minimized. Use its resources more flexibly, by moving resources into those pr

oducts with a stronger demand. Extend its brand name and goodwill in one product to other prod

ucts.

•Regulating the integration of firms

As large firms may restrict competition, control market output and set high prices, some government have set up laws regulating business integration. These laws are called anti-trust laws.

Group Members:

Karen Fung Lai Man (8)Sae teo Sze Wing (16)

Angela Yip Tin Yan (23)