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22 - Organizational forms and investment decisions

Published online by Cambridge University Press:  05 June 2014

Eugene Fama
Affiliation:
University of Chicago
Michael Jensen
Affiliation:
Harvard University
Randall S. Kroszner
Affiliation:
Booth School of Business, University of Chicago
Louis Putterman
Affiliation:
Brown University, Rhode Island
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Summary

Introduction

Different organizational forms are distinguished by the characteristics of their residual claims on net cash flows, for example, restrictions on the extent to which residual claimant status is separable from decision roles, or restrictions on the alienability of the residual claims. Different restrictions on residual claims imply different rules for optimal investment decisions. This paper analyzes the relations between characteristics of residual claims and investment decision rules in open and closed corporations, partnerships, proprietorships, financial mutuals, and nonprofits. Our purpose is to determine whether the decisions of each of these organizations can be modeled “as if” they come from the maximization of an objective function – for example, the value maximization rule of the financial economics literature. We focus on investment decisions, but the rules are applicable to all decisions. We ignore the effects of taxes.

We first analyze the investment decision rule implied by the common stock residual claims of open corporations. We compare this rule to the decision rules implied by the more restricted residual claims of proprietorships, partnerships, and closed corporations, and we discuss aspects of the choice of organizational form. Finally, we analyze the investment decision rules implied by the even more specialized residual claims of financial mutuals and nonprofits.

The decision rule implied by the common stock of open corporations

The least restricted residual claims in common use are the common stocks of large corporations. These residual claims have property rights in net cash flows for an indefinite horizon.

Type
Chapter
Information
The Economic Nature of the Firm
A Reader
, pp. 304 - 312
Publisher: Cambridge University Press
Print publication year: 2009

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References

Fama, Eugene and Jensen, Michael, “Organizational Forms and Investment Decisions,” Journal of Financial Economics 14 (1985): 101–119CrossRefGoogle Scholar

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