Economics and Finance -The Roots of Corporate Enterprise

What Factors Does Management Consider Before Spending? Where Do Corporations Obtain Their Capital?

Abstract

Corporate economics and finance is by no means a single subject; in fact, it's a whole "barrelful" of them. This paper concerns some of the broader aspects of just two of these subjects. (1) Where does a corporation get its capital? and (2) how does it determine the best way to employ its capital?

It has often been said, "money is the root of all evil." Personally, I don't believe this is true. But it is certainly true that money is the root of all corporate enterprise. A corporation must have it to be born and must use it wisely to stay alive.

Introduction

In corporate finance there are, broadly, two kinds of money, yours and someone else's.

"Your money" is the equity money, the capital invested in the business by the owners when they purchase and retain capital stock. A shareholder owns a fraction of the business and of its profits, and he shares in the risks. His income and the value of his shares vary with the success of the corporation. As a common shareowner he also shares the responsibility for control of the business.

Not all earnings are distributed to the share owners. Usually, a part of earnings is retained by the company and reinvested in the business. These retained earnings, occasionally referred to on the balance sheet as capital surplus, constitute additional equity money. This money also belongs to the share owner and the value of his shares increases as capital surplus accumulates.

How Corporations Are Financed

"Other people's" money may be obtained by borrowing. It can be borrowed directly from banks or other institutions (or from individuals). Bank loans are usually for relatively short terms, five years or less. Or a borrower may obtain money by issuing bonds. The bondholder then becomes a creditor and, as such, has no direct voice in the business. He merely holds a promise that he will be paid a fixed amount of interest each year plus principal by a predetermined maturity date.

Mortgage Bonds and Debentures are Secure Investments

There are broadly two kinds of bonds, the mortgage bond and the debenture.