Introduction

• Pages: 1-4
• Author: William A. Klein,John C. Coffee Jr.,Frank Partnoy

1

INTRODUCTION

We begin with an overview describing briefly (a) the people, or

participants, involved in business ventures, categorized according to

their economic roles, (b) the business issues with which they should be

concerned (the economic elements of their relationship) and the con-

straints on their ability to achieve their goals, and (c) the legal rules and

devices that are used to achieve their organizational or contractual

objectives.

I. PARTICIPANTS

The central figures in business organization are the owners and

managerial employees, but lenders may also play an important role (for

example, by imposing limitations on an owner’s freedom to hire or fire a

manager or to expand the business), and often it is important to consider

relationships with suppliers, customers, franchisees, and other people

who may affect the way the business operates.

An owner has what is called an equity or residual interest in the

business. Consider, by analogy, a person, Pamela, who buys a house, for

use as her personal residence, using $25,000 of her own money, plus

$75,000 borrowed from a bank, to pay the total purchase price of

$100,000. The bank has a fixed claim for periodic interest payments and

for ultimate repayment of the $75,000. The bank is sometimes said to

hold the debt interest or debt claim in the house and Pamela the equity.

Pamela’s equity gives her a residual claim because when the house is

sold and the debt must be paid (or assumed by the new buyer), Pamela

receives whatever is left of the total sale price. For example, if the house

is sold for $90,000, then, assuming none of the $75,000 debt has

previously been paid off, Pamela will wind up with $15,000; if the house

is sold for $120,000, she will wind up with $45,000. If Pamela were to

rent the house to a tenant, she would receive the rent payments (barring

misfortune) and would retain whatever is left of these amounts after

paying the loan interest, taxes, and other expenses; that is, she would

retain the residual. The holder of a residual claim is subject to greater

risk of gain or loss than is the holder of a fixed claim. (These ideas are

examined more fully in Chapter 1, Sec. II(F).)

Like the owner of a house, the owner of a business has a residual

claim in the cash flows that it generates. The owner of a business will

also have control—that is, the right to decide how the business is

operated. The control of an owner may, however, be limited by agree-

ment with a lender or other participant or by the practical necessity of

delegating decision-making power to managerial employees.