This Document Contains Chapters 3 to 4 CHAPTER 3 Exploring Global Business 3.1 A WORD FROM THE AUTHORS In this chapter, we provide an overview of the issues involved in international trade. We state the rationale for international business in terms of specialization—that is, the absolute and comparative advantages that make trade among nations a matter of mutual benefit. We discuss exporting, importing, balance of trade, and balance of payments. We devote the next two sections of the chapter to an examination of trade restrictions. First, we introduce tariffs, import quotas, embargoes, foreign exchange controls, and currency devaluations; we also present arguments for and against such measures. Next, we describe the most important international organizations working to reduce trade barriers. Then, we outline eight approaches by which a firm may enter international markets: licensing, exporting, joint ventures, totally owned facilities, strategic alliances, trading companies, countertrade, and multinational enterprises. Next, we describe the various sources of export assistance available from federal agencies. We close the chapter with a look at the institutions that offer financing for international operations, including the Export-Import Bank of the United States, multilateral development banks, and the International Monetary Fund. 3.2 TRANSITION GUIDE New in Chapter 3: Exploring Global Business • A new Inside Business feature describes how Volkswagen is shifting into high gear to become the world’s largest and most profitable automaker by 2018. • The Samsung Electronics opening vignette has been deleted. • New URL information about the student Web site is provided in the first part of the chapter. • The Spotlight feature, “The Growing Deficit,” has been deleted. • Figure 3.1, “The Top Ten Merchandise-Exporting States,” has been updated with 2011 data. • In the “Exporting and Importing” section, all data about exports and imports have been updated. • Figure 3.2, “U.S. International Trade in Goods and Services,” has been updated with 2011 data. • A new Career Success feature describes how to get ready now if you want to work overseas. • In the section “Types of Trade Restrictions,” a new subheading “Cultural Barriers” has been added to illustrate the examples of nontariff trade barriers. • A new Personal Apps describes how cultural attitudes can influence peoples’ feelings about goods in the global marketplace. • “The World Economic Outlook for Trade” section has been thoroughly revised and updated with the latest growth projections for Canada and Western Europe, Mexico and Latin America, Japan, Other Asian Countries, and Commonwealth of Independent States. • A new example of China’s emergence as the world’s largest economy and the world’s leading exporter has been added. • Table 3.1, “Global Growth Is Picking Up Gradually,” has been revised to include available 2012 data from the IMF. • In the “Exports and the U.S. Economy” section, a new discussion of how U.S. exports have exceeded $2.1 trillion and supported 9.7 million jobs has been provided. • Table 3.2, “Value of U.S. Merchandise Exports and Imports, 2011,” has been updated with the latest data available from the International Trade Administration. • Figure 3.3, “U.S. Goods Export and Import Shares in 2011,” has been updated with the latest data available from the Federal Reserve Bank of St. Louis. • Figure 3.4, “WTO Members Share in World Merchandise Trade, 2010,” has been revised and updated with the latest data available from the World Trade Organization. • The “World Trade and Global Economic Crisis” section now includes quotes from WTO Director-General, Pascal Lamy’s speech that was delivered in 2012. • The “International Economic Organizations Working to Foster Trade” section has been thoroughly revised and streamlined with subheadings for different economic communities. • A new discussion about NAFTA’s critics and proponents has been included. • The “Pacific Rim” discussion has been deleted. • A new discussion on the Trans-Pacific Partnership of 2012 has been added. • A new Sustaining the Planet feature describes how 2degrees, an online global community, is addressing sustainability worldwide. • The discussion about the OECD has been deleted. • The Going for Success feature, “Lego Builds on Licensing for Global Growth,” has been deleted. • A new Going for Success feature describes how a growing number of U.S.-based service firms are expanding into India by forming joint ventures with local firms. • The Career Success feature, “Volunteer Abroad to Prepare to Work Abroad,” has been deleted. • Table 3.3, “The Ten Largest Foreign and U.S. Multinational Corporations,” has been updated with 2012 data from Fortune magazine. • The “Sources of Export Assistance” section now includes a discussion about the National Export Initiative launched in 2010. • A new Personal Apps describes what you will need to know about international finance if you are interested in doing business abroad. • In the “Multilateral Development Banks” section, a discussion of the World Bank’s loan activities has been added. • A new section called “The Challenges Ahead” has been added. • A new Video Case 3.1 explains why Brazil’s economy is growing so well. • The Building Skills for Career Success section contains a new Social Media Exercise. • The Exploring the Internet feature in Building Skills for Career Success has been deleted. 3.3 QUICK REFERENCE GUIDE Instructor Resource Location Transition Guide IM, p. 81 Learning Objectives Textbook, p. 69; IM, p. 84 Brief Chapter Outline IM, pp. 84–85 Comprehensive Lecture Outline IM, pp. 85–93 At Issue: Should Americans learn the language of foreign nations, or should everyone speak English? IM, p. 92 Career Success Want to Work Overseas? Get Ready Now! Textbook, p. 74 Sustaining the Planet 2degrees: A Global Community for Sustainable Business Textbook, p. 85 Going for Success Services Team Up to Enter India Textbook, p. 88 Inside Business Volkswagen Speeds Along on Global Sales Textbook, p. 70 Return to Inside Business Textbook, p. 94 Questions and Suggested Answers, IM, p. 94 Marginal Key Terms List Textbook, p. 95 Review Questions Textbook, pp. 95–96 Questions and Suggested Answers, IM, pp. 94–96 Discussion Questions Textbook, p. 96 Questions and Suggested Answers, IM, p. 97 Video Case 3.1 (Keeping Brazil’s Economy Hot) and Questions Textbook, pp. 96–97 Questions and Suggested Answers, IM, pp. 97–98 Case 3.2 (Global Profits Are a Menu Mainstay at McDonald’s) and Questions Textbook, p. 97 Questions and Suggested Answers, IM, p. 98 Building Skills for Career Success Textbook, p. 98 Suggested Answers, IM, pp. 99–101 IM Quiz I & Quiz II IM, pp. 102–104 Answers, IM, p. 105 Classroom Exercises IM, pp. 105–107 3.4 LEARNING OBJECTIVES After studying this chapter, students should be able to: 1. Explain the economic basis for international business. 2. Discuss the restrictions nations place on international trade, the objectives of these restrictions, and their results. 3. Outline the extent of international business and the world economic outlook for trade. 4. Discuss international trade agreements and international economic organizations working to foster trade. 5. Define the methods by which a firm can organize for and enter into international markets. 6. Describe the various sources of export assistance. 7. Identify the institutions that help firms and nations finance international business. 3.5 BRIEF CHAPTER OUTLINE I. The Basis for International Business A. Absolute and Comparative Advantage B. Exporting and Importing II. Restrictions to International Business A. Types of Trade Restrictions 1. Tariffs 2. Nontariff Barriers 3. Cultural Barriers B. Reasons for Trade Restrictions C. Reasons Against Trade Restrictions III. The Extent of International Business A. The World Economic Outlook for Trade 1. Canada and Western Europe 2. Mexico and Latin America 3. Japan 4. Other Asian Countries 5. Commonwealth of Independent States 6. Exports and the U.S. Economy IV. International Trade Agreements A. The General Agreement on Tariffs and Trade and the World Trade Organization 1. The Kennedy Round (1964–1967) 2. The Tokyo Round (1973–1979) 3. The Uruguay Round (1986–1993) 4. The Doha Round (2001) B. World Trade and the Global Economic Crisis C. International Economic Organizations Working to Foster Trade 1. The European Union 2. The North American Free Trade Agreement 3. The Central American Free Trade Agreement 4. The Association of Southeast Asian Nations 5. The Commonwealth of Independent States 6. Trans-Pacific Partnership (TPP) 7. The Common Market of the Southern Cone (MERCOSUR) 8. The Organization of Petroleum Exporting Countries V. Methods of Entering International Business A. Licensing B. Exporting 1. Exporting to International Markets C. Joint Ventures D. Totally Owned Facilities E. Strategic Alliances F. Trading Companies G. Countertrade H. Multinational Firms VI. Sources of Export Assistance VII. Financing International Business A. The Export-Import Bank of the United States B. Multilateral Development Banks 1. The Inter-American Development Bank 2. The Asian Development Bank 3. The African Development Bank 4. European Bank for Reconstruction and Development C. The International Monetary Fund D. The Challenges Ahead 3.6 COMPREHENSIVE LECTURE OUTLINE Theoretically, international trade is as logical and worthwhile as, say, trade between California and Washington. Yet, nations tend to restrict the import of certain goods for a variety of reasons. In spite of such restrictions, international trade has increased almost steadily since World War II. I. THE BASIS FOR INTERNATIONAL BUSINESS. International business encompasses all business activities that involve exchanges across national boundaries. A. Absolute and Comparative Advantage 1. An absolute advantage is the ability to produce a specific product more efficiently than any other nation. Saudi Arabia and Siberia have an absolute advantage in the production of crude oil and petroleum products, South Africa in diamonds, and Australia in wool. 2. A comparative advantage is the ability to produce a specific product more efficiently than any other product. Goods and services are produced more efficiently when each country specializes in the products for which it has a comparative advantage. B. Exporting and Importing 1. Exporting is selling and shipping raw materials or products to other nations. 2. The top 10 merchandise-exporting states are shown in Figure 3.1. 3. Importing is purchasing raw materials or products in other nations and bringing them into one’s own country. 4. A nation’s balance of trade is the total value of its exports less the total value of its imports, over some period of time. If a country imports more than it exports, its balance of trade is negative and is said to be unfavorable. 5. A trade deficit is an unfavorable balance of trade. (See Figure 3.2.) 6. A nation’s balance of payments is the total flow of money into the country less the total flow of money out of the country over some period of time. Balance of payments is thus a much broader concept than balance of trade. Teaching Tip: Use the “Who Does What?” exercise here to quickly demonstrate absolute and comparative advantage. II. RESTRICTIONS TO INTERNATIONAL BUSINESS. Specialization and international trade can result in the efficient production of want-satisfying goods and services on a worldwide basis. Yet, the nations of the world continue to erect barriers to free trade. A. Types of Trade Restrictions 1. Tariffs. Perhaps the most commonly applied trade restriction is the customs (or import) duty. a) An import duty (or tariff) is a tax that is levied on a particular foreign product entering a country. This tax has the effect of raising the price of the product in the importing nation. (1) Revenue tariffs are imposed to generate income for the government. (2) Protective tariffs are imposed to protect domestic industry from foreign competition. b) Dumping is the exportation of large quantities of a product at a price lower than that of the same product in the home market. Thus, dumping drives down the price of the domestic item. 2. Nontariff Barriers. A nontariff barrier is a nontax measure imposed by a government to favor domestic over foreign suppliers. Types of nontariff barriers are as follows: a) An import quota is a limit on the amount of a particular good that may be imported into a country during a given period of time. b) An embargo is a complete halt to trading with a particular nation or in a particular product. The embargo is used most often as a political weapon. c) A foreign-exchange control is a restriction on the amount of a particular foreign currency that can be purchased or sold. This has the effect of limiting imports from the country whose foreign exchange is being controlled. d) Currency devaluation is the reduction of the value of a nation’s currency relative to the currencies of other countries. Devaluation increases the cost of foreign goods, while it decreases the cost of domestic goods to foreign firms. e) Bureaucratic red tape can be one of the most frustrating trade barriers of all. 3. Cultural Barriers. Cultural barriers can impede acceptance of products in foreign countries. When customers are unfamiliar with particular products from another country, their perceptions about the country might affect their attitude toward the products and help to determine whether they will buy them. B. Reasons for Trade Restrictions. Reasons for restricting trade include the following: 1. To equalize a nation’s balance of payments 2. To protect new or weak industries 3. To protect national security 4. To protect the health of citizens 5. To retaliate for another nation’s trade restrictions 6. To protect domestic jobs (however, protecting these jobs can be expensive) C. Reasons Against Trade Restrictions. Trade restrictions have immediate and long-term economic consequences—both within the restricting nation and in world trade patterns. These include the following: 1. Higher prices for consumers 2. Restriction of consumers’ choices 3. Misallocation of international resources 4. Loss of jobs III. THE EXTENT OF INTERNATIONAL BUSINESS. Restrictions or not, international business is growing. Although the worldwide recessions of 1991 and 2001–2002 slowed the rate of growth, and the global economic crisis of 2008–2009 caused a sharp decline, globalization is a reality of our time. As trade barriers decrease, new competitors enter the global marketplace, creating more choices for consumers and new opportunities for job seekers. Use of the Internet will result in additional growth in international business. Teaching Tip: The “Match the Brand to the Country” fun quiz can be used here. This can be done as an individual or a group activity and takes approximately 10 minutes. A. The World Economic Outlook for Trade. While the global economy continued to grow robustly until 2007, the growth in advanced economies slowed and then stopped in 2009 while emerging and developing economies continued to grow. Looking ahead, the International Monetary Fund (IMF) expects gradual growth to continue in 2012 and 2013 in both advanced and emerging developing economies. 1. Canada and Western Europe. Canada has projected growth of 1.7 percent in 2012 and 2.0 percent in 2013. The euro area is expected to grow 0.8 percent in 2013. The United Kingdom is expected to grow 0.6 percent in 2012 and 2.0 percent in 2013. 2. Mexico and Latin America. Mexico suffered its largest recession ever in 1995, and in 2009, but its growth rate in 2012 and 2013 is expected to be 3.5 percent. In general, the Latin American and Caribbean economies are recovering at a robust pace. 3. Japan. Japan’s economy is regaining momentum after multiple crises in 2011. The estimated growth is 1.7 percent in 2012 and 1.8 percent in 2013. 4. Other Asian Countries. The economic growth in Asia remained strong in 2010 and 2011 despite the global recession. Growth was led by China, where its economy expanded by 9.2 percent in 2011, and is expected to grow at 8.2 percent and 8.8 percent in 2012 and 2013, respectively. Growth of 5.2 percent and 5.6 percent in 2012 and 2013, respectively, is expected in the ASEAN-5 countries—Indonesia, Malaysia, the Philippines, Thailand, and Vietnam. In short, the key emerging economies in Asia are leading the global recovery. 5. Commonwealth of Independent States. These independent states are expected to continue to grow at 3.7 percent in 2012 and 3.8 percent in 2013. The countries that made the transition from communist to market economies quickly have recorded positive growth for several years—those that did not continue to struggle. Table 3.1 shows growth rates for most regions of the world. 6. Exports and the U.S. Economy. In 2008, U.S. exports supported more than 10.3 million full- and part-time jobs during a historic time, when exports as a percentage of GDP reached the highest levels since 1916. Table 3.2 shows the value of U.S. merchandise exports to, and imports from, each of the nation’s10 major trading partners. Figure 3.3 shows the U.S. goods export and import shares in 2011. IV. International Trade Agreements A. The General Agreement on Tariffs and Trade and the World Trade Organization. At the end of World War II, the United States and 22 other nations organized the General Agreement on Tariffs and Trade that came to be known as GATT. GATT is an international organization of 153 nations dedicated to reducing or eliminating tariffs and other barriers to world trade. (See Figure 3.4.) GATT has sponsored several rounds of negotiations including the following: 1. The Kennedy Round (1964–1967). In 1962, the U.S. Congress passed the Trade Expansion Act. This law gave President Kennedy the authority to negotiate reciprocal trade agreements that could reduce U.S. tariffs by as much as 50 percent. 2. The Tokyo Round (1973–1979). In 1973, representatives of approximately 100 nations gathered in Tokyo for another round of GATT negotiations—the Tokyo Round, which was completed in 1979. The participants negotiated tariff cuts of 30 to 35 percent, which were to be implemented over an eight-year period. 3. The Uruguay Round (1986–1993). In 1986, the Uruguay Round was launched to extend trade liberalization and to widen the GATT treaty to include textiles, agricultural products, business services, and intellectual-property rights. a) The Uruguay Round also created the World Trade Organization (WTO) on January 1, 1995. The World Trade Organization is a powerful successor to GATT that incorporates trade in goods, services, and ideas. b) The WTO’s 153 member nations must observe GATT rules and resolve any trade disputes under the provisions of the Uruguay Round. 4. The Doha Round (2001). In November 2001, in Doha, Qatar, the WTO members agreed to further reduce trade barriers through multilateral trade negotiations over the next three years. Some experts suggest that U.S. exporters of industrial and agricultural goods and services should have improved access to overseas markets, whereas others disagree. Negotiations between the developed and developing countries continued in 2012. Teaching Tip: Use the “Let’s Negotiate!” role-play activity here. This activity will take approximately 40 minutes. The exercise illustrates the difficulty of achieving cooperation from all participants. B. World Trade and the Global Economic Crisis. According to WTO economists, world trade was set to rebound in 2010. Exports from developed economies increased almost 13 percent, whereas exports from the rest of the world increased by 16.5 percent in 2010. C. International Economic Organizations Working to Foster Trade. An economic community is an organization of nations formed to promote the free movement of resources and products among its members and to create common economic policies. 1. The European Union. The European Union (EU), also known as the Common Market, was formed in 1957 by six countries—France, Germany, Italy, Belgium, the Netherlands, and Luxembourg. Its objective was to freely conduct commerce among these nations and others that might later join. As shown in Figure 3.5, more nations are now part of the EU. 2. The North American Free Trade Agreement. The North American Free Trade Agreement (NAFTA) joined the United States with its first- and second-largest trading partners, Canada and Mexico. a) Implementation of NAFTA on January 1, 1994, created a market of over 462 million people. b) NAFTA is built on the Canadian Free Trade Agreement (FTA), signed by the United States and Canada in 1989, and on the trade reforms undertaken by Mexico since the mid-1980s. c) NAFTA gradually eliminated all tariffs on goods produced and traded among the United States, Canada, and Mexico and provided a totally free-trade area by 2008. d) Chile is expected to eventually become the fourth member of NAFTA. 3. The Central American Free Trade Agreement. The Central American Free Trade Agreement (CAFTA) was created in 2003 by the United States and four Central American countries—El Salvador, Guatemala, Honduras, and Nicaragua. It became CAFTA-DR when the Dominican Republic joined in 2007. Costa Rica joined on January 1, 2009. 4. The Association of Southeast Asian Nations. The Association of Southeast Asian Nations (ASEAN) was established in 1967 to promote political, economic, and social cooperation among its members. Currently, ASEAN’s 10 members represent America’s fifth-largest trading partner. 5. The Commonwealth of Independent States. The Commonwealth of Independent States (CIS) was established as an association of 11 republics of the former Soviet Union. 6. Trans-Pacific Partnership (TPP). The Trans-Pacific Partnership (TPP) is a partnership of nine countries—Australia, Brunei Darussalam, Chile, Malaysia, New Zealand, Peru, Singapore, Vietnam, and the United States. This partnership will boost economies of the member countries, lower barriers to trade and investment, increase exports, and create more jobs. 7. The Common Market of the Southern Cone (MERCOSUR). The Common Market of the Southern Cone (MERCOSUR) was established in 1991 under the Treaty of Asuncion to unite Argentina, Brazil, Paraguay, and Uruguay as a free-trade alliance. Colombia, Ecuador, Peru, Bolivia, and Chile joined later as associates. 8. The Organization of Petroleum Exporting Countries. The Organization of Petroleum Exporting Countries (OPEC) was founded in 1960 in response to reductions in the prices that oil companies were willing to pay for crude oil. The organization was conceived as a collective bargaining unit to provide oil-producing countries with some control over oil prices. V. METHODS OF ENTERING INTERNATIONAL BUSINESS. A firm that has decided to enter international markets can do so in several ways. Typically, a firm begins its international operations at the simplest level. A. Licensing. Licensing is a contractual agreement in which one firm permits another to produce and market its product and use its brand name in return for a royalty or other compensation. The advantage of licensing is that it provides a simple method of expanding into a foreign market with virtually no investment. B. Exporting. A firm may also manufacture its products in its home country and export them for sale in foreign markets. Like licensing, exporting can be a relatively low-risk method of entering foreign markets. However, it opens up several levels of involvement to the exporting firm. At the most basic level, the exporting firm may sell its products to an export/import merchant, which is essentially a merchant wholesaler. 1. Exporting to International Markets. Some American companies make products in the United States and export them to foreign markets. A letter of credit is issued by a bank upon request of an importer stating that the bank will pay an amount of money to a stated beneficiary (exporter). A bill of lading is issued by the transport carrier to the exporter to prove that merchandise has been shipped. A draft is issued by the exporter’s bank, ordering the importer’s bank to pay for the merchandise thus guaranteeing payment once it is accepted by the importer’s bank. The exporting firm may ship its products to an export/import agent, which arranges for the sale of the products to foreign intermediaries for a commission or fee. An exporting firm may establish sales offices or branches in foreign countries. These installations are international extensions of the firm’s distribution system. Teaching Tip: The classroom activity “Choose Your Country” can be used here. C. Joint Ventures. A joint venture is a partnership formed to achieve a specific goal or to operate for a specific period of time. A joint venture may be used to produce and market an existing product in a foreign country or to develop an entirely new product. D. Totally Owned Facilities. A firm may develop its own production and marketing facilities in one or more foreign nations. This direct investment provides complete control over operations, but it carries a greater risk than the joint venture. The firm is really establishing a subsidiary in a foreign country. 1. Direct investment may take either of two forms: the firm builds or purchases manufacturing and other facilities in the foreign country or the firm purchases an existing company under an arrangement that allows it to operate independently of the parent company. E. Strategic Alliances. A strategic alliance is a partnership formed to create competitive advantage on a worldwide basis. It is similar to a joint venture. Strategic alliances are growing at a rate of about 20 percent per year. F. Trading Companies. A trading company provides a link between buyers and sellers in different countries. It buys in one country at the lowest price and sells to buyers in another country. G. Countertrade. Countertrade is an international barter transaction in which goods and services are exchanged for goods and services. H. Multinational Firms. A multinational enterprise operates on a worldwide scale, without ties to any specific nation or region. The multinational firm represents the highest level of involvement in international business. It is equally “at home” in most countries of the world. Table 3.3 shows the 10 largest foreign and U.S. multinational corporations. Table 3.4 describes steps in entering international markets. VI. SOURCES OF EXPORT ASSISTANCE. In August 2010, President Obama announced the National Export Initiative (NEI) to revitalize U.S. exports. Table 3.5 provides an overview of selected export assistance programs. VII. FINANCING INTERNATIONAL BUSINESS. International trade compounds the concerns of financial managers. Currency exchange rates, tariffs, foreign-exchange controls, and the tax structures of host nations all affect international operations and the flow of cash. In addition, financial managers must be concerned both with the financing of their international operations and with the means available to their customers to finance purchases. Fortunately, a number of banks, along with business in general, have become international in scope. A. The Export-Import Bank of the United States. The Export-Import Bank of the United States, or Ex-Im Bank, is an independent agency of the U.S. government whose function is to assist in financing the exports of American firms. Ex-Im Bank also cooperates with commercial banks in helping American exporters offer credit to overseas customers. B. Multilateral Development Banks. A multilateral development bank (MDB) is an internationally supported bank that provides loans to developing countries to help them grow. The most familiar is the World Bank, which operates worldwide. Four other MDBs operate primarily in Africa, Asia, Central and South America, and Eastern and Central Europe. 1. The Inter-American Development Bank (IDB) 2. The Asian Development Bank 3. The African Development Bank 4. European Bank for Reconstruction and Development C. The International Monetary Fund. The International Monetary Fund (IMF) is an international bank that makes short-term loans to nations experiencing balance-of-payment deficits. This financing is contributed by its 188 member nations, and it must be repaid with interest. Loans are provided primarily to fund international trade. D. The Challenges Ahead. In 2012, the global economic recovery remained sluggish and financial challenges in some euro-area economies slowed economic growth. But WTO rules have assisted governments in keeping markets open. Trade growth is expected with improvement expected in the global economy. CHAPTER 4 Choosing a Form of Business Ownership 4.1 A WORD FROM THE AUTHORS Chapter 4 focuses on specific forms of business organization and introduces a number of basic terms and definitions. The greater part of this chapter is devoted to the three most common forms of business ownership—the sole proprietorship, the partnership, and the corporation. We discuss the advantages and disadvantages of each form, using Figures 4.1 and 4.2 to emphasize the relative proportions ranked by headcount and sales revenue for each form within the total business community. Then, we outline the process of incorporation and examine the role of a corporation’s board of directors. Next, we discuss S corporations, limited-liability companies, and other special forms of business ownership. Examples from actual corporations illustrate various patterns of corporate growth through mergers and acquisitions. 4.2 TRANSITION GUIDE Chapter 4: Choosing a Form of Business Ownership • A new Inside Business feature explains how Kimpton Hotel & Restaurant Group generates annual revenues of more than $700 million while satisfying its customers. • In the section “Sole Proprietorships,” a new example explains how Annie Withey’s entrepreneurial spirit led to the formation of Annie’s Homegrown. • Figure 4.1 has been updated with the latest information on the number of sole proprietorships, partnerships, and corporations. • Figure 4.2 has been updated with the latest information on total annual sales revenues for sole proprietorships, partnerships, and corporations. • A new Personal Apps describes how some of the advantages and disadvantages of the sole proprietorship form of ownership affect an individual. • The Entrepreneurial Success feature, “Student Business Incubators,” has been deleted. • A new Entrepreneurial Success feature, “Why Sell a Small Business to a Big Business?,” explains the factors to consider when selling a business to a larger company. • New information on master limited partnerships has been provided in the section “Limited Partners.” • “Advantages and Disadvantages of Partnerships” is now a major section in this chapter. • A new Social Media feature, “Going Social with Score,” illustrates how SCORE uses Facebook, Twitter, blogs, and YouTube. • The Spotlight feature, “Where the Jobs Are,” has been deleted. • Updated information about Procter & Gamble has been provided in the “Corporations” section. • A new example of a closed corporation—Mars—has been added to the “Corporate Ownership” section. • New information about the most popular states for incorporation (Delaware, Nevada, and Wyoming) has been provided in the “Forming a Corporation” section. • A new Personal Apps explains how an individual with only one share of a corporation is an owner and entitled to vote at a corporate annual meeting. • A new Ethical Success or Failure? Feature, “Do We Need More Women in the Board Room?,” discusses attempts to increase the number of women in corporate board rooms. • Additional information about LLCs has been provided in the “Limited-Liability Companies” section. • The Career Success feature, “Choosing a Career in a Not-for-Profit Corporation,” has been deleted. • In the “Joint Ventures” section, information about the Walmart–Bharti Enterprises joint venture has been updated. • A new example of how Wall Street firms formed a syndicate to help Facebook sell shares of stock has been included in the “Syndicates” section. • In the “Growth from Within” section, updated information on the number of Walmart stores and number of countries that have Walmart stores has been provided. • Updated financial information about Oracle Corporation has also been provided in the “Growth from Within” section. • Information about the proposed (and failed) merger between AT&T and T-Mobile has been provided in the “Horizontal Mergers” section. • The acquisition of Summify by Twitter is a new example used to illustrate a vertical merger. • The acquisition of Wesco Financial Corporation by Berkshire Hathaway is a new example used to illustrate a conglomerate merger. • A new Return to Inside Business featuring Kimpton Hotel & Restaurant Group has been provided at the end of the chapter. • A new Video Case 4.1 explains what went wrong with the attempted merger of AT&T and T-Mobile. • The Building Skills for Career Success section contains a new Social Media Exercise. • The Exploring the Internet feature in Building Skills for Career Success has been deleted. 4.3 QUICK REFERENCE GUIDE Instructor Resource Location Transition Guide IM, pp. 125–126 Learning Objectives Textbook, p. 104; IM, p. 128 Brief Chapter Outline IM, pp. 128–130 Comprehensive Lecture Outline IM, pp. 130–139 At Issue: Can a small sole proprietorship or partnership ever hope to compete successfully with a large corporation? IM, p. 136 Entrepreneurial Success Why Sell a Small Business to a Big Business? Textbook, p. 109 Ethical Success or Failure? Do We Need More Women in the Board Room? Textbook, p. 118 Social Media Going Social with Score Textbook, p. 120 Inside Business Kimpton Hotel & Restaurant Group Strives for Perfection! Textbook, p. 105 Return to Inside Business Textbook, p. 127 Questions and Suggested Answers, IM, p. 140 Marginal Key Terms List Textbook, pp. 128–129 Review Questions Textbook, p. 129 Questions and Suggested Answers, IM, pp. 140–143 Discussion Questions Textbook, p. 129 Questions and Suggested Answers, IM, pp. 143–144 Video Case 4.1 (AT&T and T-Mobile: What Went Wrong with Their Merger?) and Questions Textbook, pp. 129–130 Questions and Suggested Answers, IM, pp. 144–145 Case 4.2 (The Conglomerate Success of Berkshire Hathaway) and Questions Textbook, pp. 130–131 Questions and Suggested Answers, IM, p. 146 Building Skills for Career Success Textbook, pp. 131–132 Suggested Answers, IM, pp. 146–149 IM Quiz I & Quiz II IM, pp. 150–152 Answers, IM, p. 152 Classroom Exercises IM, pp. 153–154 4.4 LEARNING OBJECTIVES After studying this chapter, students should be able to: 1. Describe the advantages and disadvantages of sole proprietorships. 2. Explain the different types of partners and the importance of partnership agreements. 3. Describe the advantages and disadvantages of partnerships. 4. Summarize how a corporation is formed. 5. Describe the advantages and disadvantages of a corporation. 6. Examine special types of corporations, including S-corporations, limited-liability companies, and not-for-profit corporations. 7. Discuss the purpose of a cooperative, joint venture, and syndicate. 8. Explain how growth from within and growth through mergers can enable a business to expand. 4.5 BRIEF CHAPTER OUTLINE IV. Sole Proprietorships A. Advantages of Sole Proprietorships 1. Ease of Start-Up and Closure 2. Pride of Ownership 3. Retention of All Profits 4. No Special Taxes 5. Flexibility of Being Your Own Boss B. Disadvantages of Sole Proprietorships 1. Unlimited Liability 2. Lack of Continuity 3. Lack of Money 4. Limited Management Skills 5. Difficulty in Hiring Employees C. Beyond the Sole Proprietorship V. Partnerships A. Types of Partners 1. General Partners 2. Limited Partners B. The Partnership Agreement III. Advantages and Disadvantages of Partnerships A. Advantages of Partnerships 1. Ease of Start-Up 2. Availability of Capital and Credit 3. Personal Interest 4. Combined Business Skills and Knowledge 5. Retention of Profits 6. No Special Taxes B. Disadvantages of Partnerships 1. Unlimited Liability 2. Management Disagreements 3. Lack of Continuity 4. Frozen Investment C. Beyond the Partnership IV. Corporations A. Corporate Ownership B. Forming a Corporation 1. Where to Incorporate 2. The Corporate Charter 3. Stockholders’ Rights 4. Organizational Meeting C. Corporate Structure 1. Board of Directors 2. Corporate Officers V. Advantages and Disadvantages of Corporations A. Advantages of Corporations 1. Limited Liability 2. Ease of Raising Capital 3. Ease of Transfer of Ownership 4. Perpetual Life 5. Specialized Management B. Disadvantages of Corporations 1. Difficulty and Expense of Formation 2. Government Regulation and Increased Paperwork 3. Conflict Within the Corporation 4. Double Taxation 5. Lack of Secrecy VI. Special Types of Business Ownership A. S Corporations B. Limited-Liability Companies C. Not-for-Profit Corporations VII. Cooperatives, Joint Ventures, and Syndicates A. Cooperatives B. Joint Ventures C. Syndicates VIII. Corporate Growth A. Growth from Within B. Growth Through Mergers and Acquisitions 1. Horizontal Mergers 2. Vertical Mergers 3. Conglomerate Mergers C. Merger and Acquisition Trends for the Future 4.6 COMPREHENSIVE LECTURE OUTLINE The three most common forms of business ownership in the United States are the sole proprietorship, the partnership, and the corporation. I. SOLE PROPRIETORSHIPS. A sole proprietorship is a business that is owned (and usually operated) by one person. It is the simplest form of business ownership and the easiest to start. There are approximately 23 million nonfarm sole proprietorships in the United States. (See Figure 4.1.) They account for 72 percent of the country’s business firms. As shown in Figure 4.2, sole proprietorships account for about $1.3 trillion, or about 4 percent of total annual sales. A. Advantages of Sole Proprietorships 1. Ease of Start-Up and Closure. No contracts, agreements, or other legal documents are required to start or end a sole proprietorship, and there are no minimum capital requirements. 2. Pride of Ownership. The amount of time and hard work that the owner invests in a sole proprietorship is substantial, and the owner deserves a great deal of credit for assuming the risks and solving the problems associated with operating sole proprietorships. 3. Retention of All Profits. All profits earned by a sole proprietorship become the personal earnings of its owner. Thus, the owner has a strong incentive to succeed. 4. No Special Taxes. The sole proprietorship’s profits are taxed as personal income of the owner. Thus, sole proprietorships do not pay the special state and federal income taxes that corporations do. 5. Flexibility of Being Your Own Boss. The sole owner of a business is completely free to make decisions about the firm’s operations. A sole proprietor can switch from retailing to wholesaling, move a shop’s location, open a new store, or close an old one. Teaching Tip: The main reason people start a business is to fulfill their desire for independence. Ask your students how many of them would trade off high corporate salaries in order to retain the power to make their own decisions. Follow up with a discussion regarding whether or not the current state of the economy will affect their decision. B. Disadvantages of Sole Proprietorships 1. Unlimited Liability. Unlimited liability is a legal concept that holds a business owner personally liable for all of a business’s debts. If the business fails, the sole proprietor’s personal property including savings and other assets can be seized to pay creditors. 2. Lack of Continuity. Legally, the sole proprietor is the business. If the owner retires, dies, or is declared legally incompetent, the business essentially ceases to exist. 3. Lack of Money. Banks, suppliers, and other lenders are usually unwilling to lend large sums to sole proprietorships. The limited ability to borrow can prevent a sole proprietorship from growing. 4. Limited Management Skills. The sole proprietor often is the sole manager—in addition to being the sole salesperson, buyer, accountant, and, on occasion, janitor. The business can suffer in the areas in which the owner is less knowledgeable. 5. Difficulty in Hiring Employees. The sole proprietor may find it hard to attract and keep competent help. Potential employees may feel that there is no room for advancement in a firm whose owner assumes all managerial responsibilities. C. Beyond the Sole Proprietorship. The major disadvantage of a sole proprietorship is the limited amount that one person can do in a workday. One way to reduce the effect of this disadvantage is to have more than one owner. II. PARTNERSHIPS. The U.S. Uniform Partnership Act defines a partnership as a voluntary association of two or more persons to act as co-owners of a business for profit. There are approximately 3 million partnerships in the United States, accounting for about $5 trillion in sales receipts each year. (See Figures 4.1 and 4.2.) However, partnerships represent only about 9 percent of all American businesses. A. Types of Partners 1. General Partners. A general partner is a person who assumes full or shared responsibility for operating a business. a) General partners are active in day-to-day business operations, and each partner can enter into contracts on behalf of all the others. He or she assumes unlimited liability for all debts, including debts incurred by any other general partner without his or her knowledge or consent. b) A general partnership is a business co-owned by two or more general partners who are liable for everything the business does. c) To avoid future liability, a general partner who withdraws from the partnership must give notice to creditors, customers, and suppliers. 2. Limited Partners. A limited partner is a person who contributes capital to a business but who has no management responsibility or liability for losses beyond his or her investment in the partnership. a) A limited partnership is a business co-owned by one or more general partners who manage the business and limited partners who invest money in it. Special rules apply to limited partnerships intended to protect customers and creditors who deal with them. b) A master limited partnership (MLP) is a business partnership that is owned and managed like a corporation but taxed like a partnership. Units of ownership in MLPs can be sold to investors to raise capital and are often traded on organized security exchanges. B. The Partnership Agreement. Articles of partnership are an agreement listing and explaining the terms of the partnership. (See Figure 4.3.) When entering into a partnership agreement, partners would be wise to let a neutral third party assist. III. ADVANTAGES AND DISADVANTAGES OF PARTNERSHIPS A. Advantages of Partnerships 1. Ease of Start-Up. Partnerships are relatively easy to form. As with sole proprietorships, legal requirements are often limited to registering the name of the business and purchasing licenses or permits. 2. Availability of Capital and Credit. Because partners can pool their funds, a partnership usually has more capital available than does a sole proprietorship. This, coupled with the general partners’ unlimited liability, can form the basis for a better credit rating. 3. Personal Interest. General partners are very concerned with the operation of the firm, perhaps even more so than sole proprietors; they are responsible for the actions of all other general partners, as well as for their own. 4. Combined Business Skills and Knowledge. Partners often have complementary skills. The weakness of one partner in a certain area may be offset by another partner’s strength in that area. 5. Retention of Profits. As in a sole proprietorship, all profits belong to the owners of the partnership. 6. No Special Taxes. Like a sole proprietor, each partner is taxed only on his or her share of the profits. B. Disadvantages of Partnerships 1. Unlimited Liability. Each general partner is legally and personally responsible for the debts, taxes, and actions of any other partner, even if that partner did not incur those debts or do anything wrong. Limited partners, however, risk only their original investment. Today, many states allow partners to form a limited-liability partnership (LLP) in which a partner in the business may have limited-liability protection from legal action resulting from the malpractice of the other partners. 2. Management Disagreements. Most of the problems that develop in a partnership involve one partner doing something that disturbs the other partner(s). When partners disagree about decisions, policies, or ethics, distrust may build to the point where it is impossible to operate the business successfully. 3. Lack of Continuity. A partnership is terminated if any one of the general partners dies, withdraws, or is declared legally incompetent. 4. Frozen Investment. It is easy to invest money in a partnership, but it is sometimes quite difficult to get it out. C. Beyond the Partnership. The main advantages of a partnership over a sole proprietorship are the added capital and management expertise of the partners, but it shares the disadvantage of unlimited liability. A third form of business ownership, the corporation, overcomes this disadvantage. IV. CORPORATIONS. A corporation “is an artificial person, invisible, intangible, and existing only in contemplation of the law.” Hence, a corporation is an artificial person created by law, with most of the legal rights of a real person. There are approximately 6 million corporations in the United States. Corporations comprise about 19 percent of all businesses, but they account for 81 percent of all sales revenues. (See Figures 4.1 and 4.2.) Teaching Tip: This would be a good place to introduce the “Brain Food, Anyone?” partnership exercise. This 20-minute group activity requires students to consider a food cart startup business. A. Corporate Ownership. The shares of ownership of a corporation are called stock, and those who own the shares are called stockholders. 1. A closed corporation is a corporation whose stock is owned by relatively few people and is not bought and sold on security exchanges. 2. An open corporation is a corporation whose stock is sold to the general public and can be purchased by any individual. B. Forming a Corporation. The process of forming a corporation is called incorporation. Most experts recommend that a lawyer should be consulted when beginning the incorporation process. (See Table 4.1 for some aspects that may require legal help.) 1. Where to Incorporate. A business is allowed to incorporate in any state it chooses. Most small and medium-sized businesses are incorporated in the state where they do the most business. Some states are more hospitable than others and offer fewer restrictions and other benefits to attract new firms. a) An incorporated business is called a domestic corporation in the state in which it is incorporated. b) In all other states where it does business, it is called a foreign corporation. c) A corporation chartered by another government and conducting business in the United States is an alien corporation. 2. The Corporate Charter. Once a “home state” has been chosen, the incorporators submit articles of incorporation to the state’s secretary of state. A corporate charter is a contract between the corporation and the state in which the state recognizes the formation of the artificial person that is the corporation and usually includes the following: a) Firm’s name and address b) Incorporators’ names and addresses c) Purpose of the corporation d) Maximum amount and types of stock to be issued e) Rights and privileges of stockholders f) Length of time the corporation is to exist 3. Stockholders’ Rights. There are two basic kinds of stock: common stock and preferred stock. Owners of common stock may vote on corporate matters; owners of preferred stock usually have no voting rights, but their claims on dividends are paid before those of common-stock owners. a) Perhaps the most important right of owners of both common and preferred stock is the right to share in the profit earned by the corporation through the payment of dividends. A dividend is a distribution of earnings to the stockholders of a corporation. b) Other rights include receiving information about the corporation, voting on changes to the corporate charter, and attending the corporation’s annual stockholders’ meeting. c) Because common stockholders usually live all over the nation, very few actually attend the annual meeting. Instead, they vote by proxy. A proxy is a legal form listing issues to be decided and enabling stockholders to transfer their voting rights to some other individual or individuals. 4. Organizational Meeting. As the last step in forming a corporation, the incorporators and the original stockholders meet to elect their first board of directors. The board members are directly responsible to the stockholders for the way they operate the firm. C. Corporate Structure 1. Board of Directors. The board of directors is the top governing body of a corporation. Directors are elected by the stockholders and can be chosen either from within or outside the corporation. The major responsibilities of the board of directors are to set company goals and to develop general plans for meeting those goals. Teaching Tip: Before Enron, boards of directors used to defer to CEOs and other operating managers in many areas, including hiring. After Enron and the passage of the Sarbanes-Oxley law, which makes directors responsible for acting in accordance with sound financial practices, boards are no longer content to just rubber stamp CEOs’ decisions, especially where chief financial officers are concerned. In 2010, as part of Wall Street reform, the Securities and Exchange Commission made it easier for shareholders to have a bigger say on corporate leadership at publicly traded companies. Shareholders who own 3 percent or more of company stock for at least three years are now able to nominate candidates for directors on the annual proxy ballot. The intent is to help shareholders hold corporate boards more accountable for their decisions. Ask students if they believe boards of directors should be held responsible for corporate misdeeds or poor decision making. 2. Corporate Officers. Corporate officers (the chairman of the board, president, executive vice presidents, corporate secretary, treasurer, and any other top executives) are appointed by the board of directors. (See Figure 4.4.) These officers help the board make plans, carry out strategies established by the board, hire employees, and manage day-to-day business activities. V. ADVANTAGES AND DISADVANTAGES OF CORPORATIONS A. Advantages of Corporations 1. Limited Liability. One of the most attractive features of corporate ownership is limited liability. If a corporation fails, creditors have a claim only on the assets of the corporation, not on the owners’ personal assets. 2. Ease of Raising Capital. The corporation is by far the most effective form of business ownership for raising capital. 3. Ease of Transfer of Ownership. Ownership is transferred when shares of stock are sold, and practically no restrictions apply to the sale and purchase of stock issued by an open corporation. 4. Perpetual Life. Because a corporation is essentially a legal “person,” it exists independently of its owners and survives them. 5. Specialized Management. Typically, corporations are able to recruit more skilled, knowledgeable, and talented managers than proprietorships and partnerships. B. Disadvantages of Corporations. See Table 4.2 for a comparison of some of the advantages and disadvantages of a sole proprietorship, partnership, and corporation. 1. Difficulty and Expense of Formation. Forming a corporation can be a relatively complex and costly process. 2. Government Regulation and Increased Paperwork. Most government regulation of business is directed at corporations, which must file many reports on their business operations and finances with local, state, and federal governments and make periodic reports to their stockholders. 3. Conflict Within the Corporation. The pressure to increase sales revenue, reduce expenses, and increase profits often leads to stress and tension for both managers and employees. 4. Double Taxation. Unlike sole proprietorships and partnerships, corporations must pay a tax on their profits. Then stockholders must pay a personal income tax on profits received as dividends. 5. Lack of Secrecy. Because open corporations are required to submit detailed reports to government agencies and to stockholders, they cannot keep their operations confidential. VI. SPECIAL TYPES OF BUSINESS OWNERSHIP. Some entrepreneurs choose other forms of organization to meet their special needs. Among these are S corporations, limited-liability companies, and not-for-profit corporations. A. S-Corporations. If a corporation meets certain requirements, its directors may apply to the Internal Revenue Service for status as an S-corporation. An S-corporation is a corporation that is taxed as though it were a partnership. To qualify for this special status, the firm must meet the following criteria: 1. No more than 100 stockholders are allowed. 2. Stockholders must be individuals, estates, or exempt organizations. 3. There can only be one class of outstanding stock. 4. The firm must be a domestic corporation eligible to file for S corporation status. 5. There can be no nonresident-alien stockholders. 6. All stockholders must agree to the decision to form an S corporation. B. Limited-Liability Companies. A limited-liability company (LLC) is a form of business ownership that combines the benefits of a corporation and a partnership while avoiding some of the restrictions and disadvantages of those forms of ownership. Chief advantages of an LLC include the following: 1. LLCs with at least two members are taxed like a partnership and thus avoid the double taxation imposed on most corporations. LLCs with one member are taxed like a sole proprietorship. 2. Like a corporation, an LLC provides limited-liability protection for acts and debts of the LLC. Teaching Tip: Consider using the “Choices, Choices!” group activity here. It takes approximately 15 to 20 minutes and enables students to contrast the positives and negatives of the corporate structure versus an LLC. 3. The LLC provides more management flexibility when compared with corporations. An LLC is generally run by the owners or managers who make all the management decisions. (See Table 4.3 for help in understanding the differences between regular corporations, S-corporations, and limited-liability companies.) C. Not-for-Profit Corporations. A not-for-profit corporation is a corporation organized to provide a social, educational, religious, or other service rather than to earn a profit. Various charities, museums, private schools, and colleges are organized in this way, primarily to ensure limited liability. Once approved by state authorities, not-for-profit corporations must meet specific Internal Revenue Service guidelines in order to obtain tax-exempt status. VII. COOPERATIVES, JOINT VENTURES, AND SYNDICATES A. Cooperatives. A cooperative is an association of individuals or firms whose purpose is to perform some business function for its members. Cooperatives are found in all segments of our economy, but they are most prevalent in agriculture. B. Joint Ventures. A joint venture is an agreement between two or more groups to form a business entity to achieve a specific goal or to operate for a specific period of time. C. Syndicates. A syndicate is a temporary association of individuals or firms organized to perform a specific task that requires a large amount of capital and is dissolved as soon as its purpose has been accomplished. Syndicates are most commonly used to underwrite large insurance policies, loans, and investments. VIII. CORPORATE GROWTH. Growth is a basic characteristic of business. Larger firms generally have greater sales revenue and thus greater profit to facilitate growth. If a business does not grow, it is actually shrinking relative to the economy. Growth is also a means by which some executives boost their power, prestige, and reputation. A. Growth from Within. Most corporations grow by expanding their present operations. Growth from within can have relatively little adverse effect on the firm. Because this type of growth is anticipated, it can be gradual, and the firm can usually adapt to it easily. B. Growth Through Mergers and Acquisitions. Another way for a firm to grow is by purchasing some other company. The purchase of one corporation by another is called a merger. An “acquisition” is essentially the same thing as a merger, but the term is usually used in reference to a large corporation’s purchase of another corporation. A hostile takeover is a situation in which the management and board of directors of the firm targeted for acquisition disapprove of the merger. When a merger or an acquisition becomes hostile, a corporate raider—another company or a wealthy investor—may make a tender offer or start a proxy fight to gain control of the target company. A tender offer is an offer to purchase the stock of a firm targeted for acquisition at a price just high enough to tempt stockholders to sell their shares. In a proxy fight, the raiders attempt to gather enough stockholder votes to control the targeted company. Faced with the prospects of takeover, existing management may try several techniques (sometimes referred to as “poison pills,” “shark repellents,” or “porcupine provisions”) to maintain control of the firm and avoid the hostile takeover. Mergers can be horizontal, vertical, or conglomerate. (See Figure 4.5.) 1. Horizontal Mergers. A horizontal merger is a merger between firms that make and sell similar products or services in similar markets. 2. Vertical Mergers. A vertical merger is a merger between firms that operate at different but related levels in the production and marketing of a product. 3. Conglomerate Mergers. A conglomerate merger is a merger between firms in completely different industries. Teaching Tip: Use the “We Need to Merge!” activity here. C. Merger and Acquisition Trends for the Future. The recent economic crisis has changed the dynamics of how and why firms merge. Recently, mergers and acquisitions have been fueled by the desire of financially secure firms to take over firms in financial difficulties. For a firm experiencing financial difficulties, a merger or acquisition is often a better option than bankruptcy. During the recent economic crisis, this trend was especially evident in the financial services and banking industry. 1. Economists, financial analysts, corporate managers, and stockholders still hotly debate whether takeovers are good for the economy—or for individual companies—in the long run. 2. Takeover advocates argue that firms that are taken over are more profitable and productive. 3. Some critics of hostile takeovers claim that this wave of mergers and buyouts has forced top management to devote time to defending their companies—time that could be invested in new product development and other vital business activities. 4. Most experts now predict that mergers and acquisitions after the economic crisis will be the result of cash-rich companies looking to acquire businesses that will enhance their position in the marketplace and involve companies or investors from other countries. Future mergers and acquisitions will be driven by solid business logic and the desire to compete in the international marketplace. Instructor Manual for Business William M. Pride, Robert J. Hughes, Jack R. Kapoor 9781133595854, 9780538478083, 9781285095158, 9781285555485, 9781133936671, 9781305037083
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