Compiled and Edited by
Muhammad Abubakar Siddique,
Lecturer, Int’l Institute of Islamic Economics (IIIE),
Int’l Islamic University, Islamabad.
Before, we explain the corporate governance and its various characteristics, it would be better to understand first what is corporation?
Origin of the Corporation
During the early Middle Age, corporations existed in the form of universities and ecclesiastical orders and were barred from making profits. While some authors believe that the early Middle Ages was the harbinger of the modern corporate form, others argue that since corporations during this period existed only to serve the society and also since economic motive that is so very ingrained in the corporation as we see today was absent, Middle Ages was certainly not the forerunner of today’s corporate form.
Business history studies have been few and far between; that leaves us with scant literature to trace the exact origins of today’s corporations. However, most business historians concur that not until the East India Company received a charter from Queen Elizabeth in 1600 AD to commence its trading business, was the real corporation born.
Prior to the formation of the East India Company, a few enterprising individuals engaged independently in trading. They would buy tea, raw silk and spices from India and sell them at a profit in their home countries. These individual traders owned their ships and deployed them in their trading business. But as business grew bigger and bigger, the need to raise more capital to shore up shipping vessels for transportation grew, necessitating individual traders to come together and form a syndicate. A closer look at the operations of the East India Company suggests that it was truly the predecessor of the modern corporate form.
What is a Corporation?
A corporation is a private legal entity with rights and duties distinct from those of its members. The liability of the members can often be limited should the corporation fail. Nowadays people are familiar with huge private corporations, including Coca-Cola, McDonald’s, and Toyota. However, the rise of the modern corporation was a twentieth-century phenomena.
There are various forms of businesses, but not all forms of business organization are called corporations. Sole proprietorship, partnership, and company are the best known and most widely discussed forms of businesses.
What comes to your mind when you see a beauty parlor, a small-sized eatery, a grocery shop or a medical shop? Most such small business ventures are funded and managed by individuals and hence the term ‘sole proprietorship.’ You will observe that most businesses around you are sole proprietorships. Why? That is mainly because of the ease in obtaining a license and minimum capital requirement to set up such sole proprietorship businesses. All business decisions are subject to the volition of the proprietor. There are no shareholders to convince.
The biggest limitation of such a form of business is that it cannot grow beyond a certain point, unless the owner is enormously wealthy and is desirous of expanding his/her scope of operations.
When two or more than two people come together to own and manage a business entity, it is called partnership. Each partner contributes towards the total capital of the business organization. Also, each partner may bring in a unique skill or expertise to the partnership firm.
Unlike sole proprietorships, partnership firms are legal entities. To set up a partnership firm, a partnership deed that details out the capital contributions, shares, rights, duties and obligations of the partners has to be executed. Partners, as specified by the executed deed, reap the rewards of the business and also assume any resultant liabilities. In partnerships, owners share the business’s risks and benefits.
Corporation, thus, is a legal entity that is owned and financed by a diverse group of owners known as the shareholders, who enter into a contract with professional managers to run the day-to-day operations of the company. Together they strive to meet the demands of their stakeholders, be it providing products and services to the consuming public, meeting the operational norms set by the government and regulatory bodies, providing employment opportunities or fulfilling social commitments in societies they operate in
Unlike to partnership, a corporation is owned by shareholders. It can be for-profit or nonprofit. For-profit corporations reinvest profits in the business and pay out dividends to shareholders. Partners in a partnership are at risk if something goes wrong with the business, but corporate shareholders are generally protected. Corporations don’t hold individuals (its shareholders) liable for company obligations or business debt. Because the corporation is a separate legal entity, it’s responsible for assuming legal fees and debts. Shareholders’ personal assets remain protected.
Characteristics of a Corporation
There are a number of features that distinguish the corporation from any other form of business. Some of them are
A corporation has a distinct legal identity. It is recognized by law as a legal entity, separate from its owners/ promoters and other shareholders. It can sue and be sued in its name. Also, it may own property, borrow or lend money, enter into contracts, own assets or incur liabilities and pay taxes.
2. Limited Liability:
A corporation is owned by multiple shareholders and the liability of each shareholder is limited to the amount invested in the corporation by them. Creditors cannot claim from the personal wealth of shareholders. Should there be any liabilities, the shareholders bear no obligation once their portion of the share capital is paid up.
3. Easy Transferability of Ownership:
Do you or your relatives own shares of any public company? Have you ever seen shareholders sell their shares in the stock market? What does this mean? One can transfer one’s share of ownership rights to a buyer who is interested in buying the stock of the company. A corporation has no say in the trading of shares in the stock markets. It cannot restrain a seller from selling nor can it prevent a buyer from becoming a part owner of the corporation. A corporation can only play the role of a record keeper of its owners.
Corporations are characterized by professional managers. In closely held companies, promoters usually double up as managers. In publicly held companies, investors entrust management to professional managers. These professional managers are responsible for running the day-to-day operations of the corporation.
5. Capital Acquisition:
Corporations have the liberty to sell their stocks or bonds in the market to raise additional capital and fund projects that need additional investment. Easy transferability of ownership and limited liability come as a boon to corporations desirous of raising additional capital.
6. Unlimited Life:
Corporations can acquire an immortal status provided they have the charter to conduct business. Death of investors and shareholders does not deter the corporation from continuing its operations. As long as it has the necessary capital to keep itself operational, the corporation lives on. In some cases, despite bankruptcy, corporations live on expecting bail-outs.
7. Multiple Stakeholders:
Corporations live in societies and affect the day-to-day living of a multitude of stakeholders. Managers and employees who serve the corporation, collaboration partners or joint ventures that help it provide its services, suppliers who supply raw materials, customers who buy its products, investors who invest in its shares, creditors who provide debt capital, governments that legislate and facilitate its existence, communities and environment around which it exists and that are affected by its policies—all these are stakeholders of the corporation.