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Economics. Chapter 6 Ownership, Expansion and Integration of Firms. Firm. Definition A firm is a unit that makes decisions regarding the employment of factors of production and the production of goods and services Types Public enterprise – owned by the government - PowerPoint PPT Presentation
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Economics
Chapter 6
Ownership, Expansion and Integration of Firms
Firm
Definition A firm is a unit that makes decisions regarding the
employment of factors of production and the production of goods and services
Types Public enterprise – owned by the government Private enterprise – privately owned
Public enterprise
2 kinds of management Managed by the government
Directly run by the government Department under governmental structure E.g. The Hong Kong Police Force,
The Fire Service Department,The Water Supply Department…
See reference: Organisation Chart of the Gov’t of HKSAR http://www.gov.hk/en/about/govdirectory/govchart/index.htm
Public enterprise
2 kinds of management Managed by the public corporations
Established with government funds Managed by government-appointed directors Operation funds come from service charges E.g. The Airport Authority of Hong Kong,
Hospital Authority,Hong Kong Art Centre,Urban Renewal Authority8 universities…
See reference: Government and Related Organisations http://www.gov.hk/en/about/govdirectory/govwebsite/index.htm#p7
Characteristics of public enterprise
Management Directly by government Managed by the public corporations
Capital Receiving capital from the government Independent account Public corporations are responsible for the success or failure to their own
business. Provision of lowly-priced services and facilities to the public
Might not be aiming at profit maximization Services or facilities provided might be free of charge Provide services or facilities which are necessary to the society but not be
given by private sectors E.g.
Police Force to keep social orderHousing Department to provide lowly-priced public housingWater Supplies Department to provide stable and reliable water supply
Characteristics of public enterprise
Advantages Provision of necessary services to the citizens, more stable living
environment Lower the living cost
Disadvantages Not aiming at profit maximization
no response to market changes lack incentive to modify (lower the cost or improve management)
Mismatch with market demand / price, violate the postulate of maximization
High cost of complaints
Private enterprise
Forms of business ownership Sole proprietorship Partnership Limited company
Main differences
Legal entities Limited liability
Sole proprietorship
Partnership Limited company
Legal entities
An independent entity with rights and obligations like an ordinary individual.
To sole proprietorship and partnership the owner of the firm needs to bear all obligations from any legal
dispute can’t initiate or receive lawsuit
To limited company the company bears the legal obligation owner(s) of the firm need not to be legally responsible Can initiate or receive lawsuit
Liability
Limited liability Owner is liable to the amount of investment he has in the firm. Illustration:
1. An investor invested $100,000 into the Firm A2. The firm applied debt from Bank L3. When time was due, Firm A couldn’t pay for the debt.4. Bank L demanded Firm A liquidation, assets were sold to pay
for the debt.5.The investor needed not to pay for more, his $100,000
investment will be the upper limit of his loss.[ In conclusion: The investor loses $100,000 in maximum.]
Liability Unlimited liability
Owner(s) of sole proprietorship and partnership is/are liable to all debts of the firm.
Illustration:1. An investor invests $50,000 into the Firm B2. The firm applies debt (let say $200,000) from Bank M.3. When time is due, Firm B can’t pay for the debt.4. The investor needs to sell the assets of the firm (let say $100,000).5. If not enough pay for the debt, the investor needs to sell personal assets (let say $50,000).6. If still not enough, the owner goes bankrupt.[ In conclusion: The investor loses more than $50,000.]
Types of ownership Sole proprietorship
Single owner No independent legal entity. Unlimited liability. Advantages:
Simple set-up procedure Registration: Inland Revenue Department
Quick decision making No requirement of information disclosure All profit belongs to the sole owner
Disadvantages: Limited ways of / Difficulties in fund raising Unlimited liabilities Bear all legal obligations Lack of continuity
Death Retirement Ownership transfer Bankruptcy of owner
Types of ownership Partnership
2 or more owners No independent legal entity. Unlimited liability. Advantages:
Simple set-up procedure Registration: Inland Revenue Department
Quick decision making (comparing with limited company) Sharing risk and work, or benefit from division of labour (experience sharing) No requirement of information disclosure
Disadvantages: Slower decision making (comparing with sole proprietorship) Limited ways of / Difficulties in fund raising Unlimited liabilities Bear all legal obligations Lack of continuity, as if one of the partners…
Death Retirement Ownership transfer Bankruptcy of owner
Types of ownership Limited Company (Ltd. Co.)
Private limited company Public limited company
Common features Complicated set-up procedures
To Companies Registry: Memorandum and Articles of Association To Inland Revenue Department: Business registration
Ownership Divided into a number of shares Decision making by voting Shareholders ( w/ > 50% shares, absolute control)
Types of ownership Common features
Structure Ownership ≠ Management General meeting Vote for decision Board of directors Formulates policies, supervises operations & ensures
the resolution of general meeting Legal entity
The company itself is a legal entity Lasting continuity
Death of one owner does not mean end of company Ended unless liquidation
Limited liability Information disclosure
Must be audited by authorized accountants
Types of ownership Private vs. Public limited company
Private company Public / Listed company
No. of shareholders 1 to 50 Unlimited
Transfer -Consent from the BoD-Preference to existing shareholders-Shares not traded on the HKEx
-Free transferal-No need to have consents from the BoD-Exchange through HKEx.
Ways to raise Capital -Can’t invite public to buy shares and bonds
-Rely on debts
-Shares and bonds to public-Equity and debt funding
Disclosure of financial info.
-To shareholders only-Can keep secret to the public
- Disclose to public
Ways for Ltd. Co. to raise capital Debts from financial institutes
Bank loan Loan from financial companies Payment: Interest
Issuing shares (both Private and Public Ltd. Co.) Selling of ownership Investors buy the shares of the companies Share companies’ profit Payment: Dividends
Issuing bonds (only Public Ltd. Co.) Bonds to creditors as certificates A bond is a statement of debt info.: Amount / interest rate / due date Payment: Interest
Borrower = Bond issuer Lender (Creditor) = Bondholder
Bond
Bond
Shares BondsNature Proof of ownership Certificates of debt
Return -Different in price (exchange market)-Dividends
-Different in price (bond market)-Interest
Priority for obtaining returns
Priority to get back the capital if liquidation
Voting right
Shares vs. Bonds
Issuing shares Issuing bondsAdvantages -Capital kept forever
-No need to repay-Dividends are not mandatory.
-Ownership and control not to be weaken.-Signal of rapid growth
Disadvantages -Risk of price drop, decrease in asset value-Spread of ownership and controlling power-Slow economic growth
-Risk of liability-Interest payment-Payback of loan on due date
Pros and Cons
Return and Risk
Once you want to invest: Expected rate of returns
Shares > Bonds > Bank Deposit > Cash Risks
Shares > Bonds > Bank Deposit > Cash
∴Risk ReturnRisk Return
Expansion
Expansion Enlarge the scale of production Aim at achieving economies of scales
Ways of expansion New branches New products New business
Integration
Integration Take over or merge with other companies Aim at achieving economies of scales
Types of integration Horizontal Vertical Lateral Conglomerate
Integration Horizontal Integration
Merge with another firm producing the same type of products Reasons:
Defeat competitor, more market share Same product Lower cost of production New market
Example: A mobile service company takes over another mobile service company
Cases: Cathay Pacific took over Dragonair (2006) Sony & Ericsson (2005) HP took over Compaq (2002) IBM took over Lotus (1995) Panasonic and Rasonic (1994)
Integration Vertical Integration
Merge with another firm in different stage of production
Backward integration Another firm in the preceding/earlier stage of production Reason:
Ensure the supply of resources or services Lower the cost of supply of resources
Example: A clothing company takes over a button company Cases:
Dairy Farm and Nestle Reliance Industries (Garment producer): from textiles into polyester fibres
and further into petrochemicals. Esso+Exxon+Mobil: SeaRiver Maritime, a petroleum shipping company.
Integration Vertical Integration
Merge with another firm in different stage of production
Forward integration Another firm in the next stage of production Reason:
Ensure the channel of product and service sales Lower the cost of information from market
Example: A clothing company takes over a retailer
Cases: Cathey Pacific & Hong Kong Air Cargo Terminals Limited Vodafone Airtouch PLC took over Mannesmann (Germany)
Integration Lateral Integration
Merge with another firm producing related nut not directly competing products
Reason: Risk diversification Lower the cost of sales of products and services (market economi
es, R&D economies) Example:
A garment company takes over a shoe factory A mp3 player factory takes over a headphone factory
Cases: Citigroup & Travelers Group (1998) China Strategic Holdings(中策集團 ) & Primus Financial Holdings
Limited (博智金融控股 ) suggested acquisition over AIG Nan Shan Life Insurance Company, Ltd. (南山人壽 ) (2009)
Integration Conglomerate Integration
Merge with another firm with different business Reason:
Risk diversification Lower the cost of sales of products and services (market economies, R&D economies)
Example: A garment company takes over a toy factory
Cases:
Hutchison Whampoa Ltd. owns:
Hong Kong International Terminals
Hutchison Whampoa Property
A.S. Watsons Group
Cheung Kong Infrastructure Holding Ltd.
Hutchison Telecommunications International Limited
CITIC Group owns:
CITIC Ka Wah Bank Limited
CITIC Pacific
CITIC Resources Holdings Ltd.
中信文化傳媒集團Asia Satellite Telecommunications Co. Ltd.
CITIC Travel Co.
China CITIC Press
Western Harbour Tunnel Co. Ltd.
The motives of expansion
General motives Economies of scale
scale of production Lower the production market share profit
Simplify structure Reorganizing business Efficiency in management Flexible allocation of resources Cut down over-abundant expenditure
Acquisition of technology New technology R & D
Acquisition of brands Takeover the brand from other firms Save time and cost to develop new brand
The motives of expansion
Specific motives
Types Motives
Horizontal -Defeat competitors-Market share-Influence on the market
Vertical Backward-Ensure supply of resources
Forward-Stable sales outlets-First-hand market information
Lateral -Risk diversification-Extension of brands, save costConglomerate