4.3 Corporations: Limiting Your Liability
- How does the corporate structure provide advantages and disadvantages to a company, and what are the major types of corporations?
When people think of corporations, they typically think of major, well-known companies, such as Meta, Costco, JPMorgan Chase, and Verizon. But corporations range in size from large multinationals with thousands of employees and billions of dollars in sales to midsize or even smaller firms with few employees and revenues well under the millions of dollars that large corporations garner.
A corporation is a legal entity subject to the laws of the state in which it is formed, where the right to operate as a business is issued by state charter. A corporation can own property, enter into contracts, sue and be sued, and engage in business operations under the terms of its charter. Unlike sole proprietorships and partnerships, corporations are taxable entities with a life separate from their owners, who are not personally liable for its debts.
At launch, the founder of Executive Property Management Services chose to incorporate to obtain the liability protection of the corporate form of business organization. The company specialized in providing customized property management services to corporate executives with long-term work assignments abroad. Taking care of substantial properties in the million-dollar range and above was no small responsibility. Therefore, the protection of a corporate business structure, along with carefully detailed contracts outlining the company’s obligations, were crucial in providing the liability protection needed—and the peace of mind to focus on running the business without constant worry. Note that an LLC does not provide unlimited protection; you can still get in trouble for such things as mingling personal and business funds.2
Managing Change
PacSun's Golden Glow
It all started as a little surf shop in 1980 in Newport Beach, California. It wasn’t called PacSun then. It wasn’t even all that different from other shops carrying surfboards and wax, except for one thing. The founders had a better idea.
During Southern California’s wet, cool winters, the beaches got empty, and the surf store business went dry. Where did everyone go? To the mall, of course. Their idea—to be the first surf shop to move into California’s popular mall locations—worked. The company soon grew to 21 stores, selling such popular name brands as Billabong, Gotcha, Stussy, and Quiksilver, as well as its own private-label brands.
What began as a little surf shop became a leading mall-based specialty retailer in the fast-growing surf, skate, and hip-hop apparel markets. With close to a thousand stores in the United States and Puerto Rico and sales topping $1 billion, how did the founders make the leap from selling and waxing surfboards to being a major player in the youth apparel market? How has Pacific Sunwear of California, Inc. (https://www.pacsun.com) succeeded when thousands of other clothing companies failed?
“We listen and we change,” says the CEO of Pacific Sun. “The kids have the answers, so we listen to get the trends, the solutions, and find out what we are doing right.” To remain on the cutting edge of teen tastes, the company regularly hosted an open house at its corporate headquarters in Anaheim, California, where vendors presented their wares to PacSun's savvy team of buyers. In 2025, PacSun organized the Purpose Partner Summit, which gathered leaders from various industries to discuss aspects of youth culture. Being able to distinguish between short-lived fads and actual trends is important when making merchandise choices. The company’s focus on “active brand management” is what kept its sales climbing.
The founders’ philosophy had served their business well. In 1993, the 60-store company sold stock to the public. It had grown to over 1,000 stores in 50 states and Puerto Rico, with 12,000 employees. The company’s PacSun stores cater to a completely different customer than its d.e.m.o. hip-hop stores. In April 2006, PacSun launched its third concept, One Thousand Steps, a footwear store.
With changing trends and online shopping challenges facing many brick-and-mortar retailers, companies such as Wet Seal and Quicksilver filed for bankruptcy in 2015, and PacSun filed for bankruptcy in April 2016. At the time of bankruptcy filing, the company had 593 PacSun stores employing approximately 2,000 employees. In September 2016, PacSun emerged from the bankruptcy after it cut debt and closed stores. The company also turned over all of its stock to the private equity firm Golden Gate Capital, its senior lender.
As its business took off, PacSun successfully made the leap from the small sole proprietorship form of business organization to corporate retailing giant. Facing changing trends and technologies, the firm hit a bump in the road, worked hard to reestablish, and has continued to remain at the forefront of youth culture and trends. The company is indeed a thousand steps away from its humble beginnings.
- How did PacSun manage its evolution from a small, local business to a leading mall-based specialty retailer? What could be the reasons for its missteps resulting in the bankruptcy filing?
- What form of business organization might PacSun have chosen when it started, and what might have prompted it to change as it grew?
Sources: Marie Driscoll, “Pacific Sun’s Golden Glow,” Business Week Online, November 9, 2004, https://www.businessweek.com; Ron Ehlers (VP Information Services, Pacific Sunwear of California, Inc.) “Pacific Sunwear: Maintain a Fresh Brand by Anticipating Consumer Needs,” presentation to the Retail Systems MIX Summit, May 25, 2005, https://www.retailsystems.com; Samantha Masunaga, “PacSun files for Chapter 11 bankruptcy protection, plans to go private,” Los Angeles Times, https://www.latimes.com, accessed August 17, 2017; Steven Church, “Pacific Sunwear Has ‘Retailer’s Dream’ as Bankruptcy Wraps Up,” Bloomberg, https://www.bloomberg.com, accessed August 2017; "The Pacsun Purpose Partner Summit Unites Powerful Voices in Youth Culture and Community through Purpose-Driven Leadership," PR Newswire, https://www.prnewswire.com, September 22, 2025.
Corporations play an important role in the U.S. economy. As previously discussed, corporations account for a small portion of all businesses but generate the vast majority of all revenues and profits. Company type and size vary; however, when you look at the top companies by revenue in the United States or globally, they include many familiar names that affect our daily lives.
In the United States, according to Fortune magazine, the top three corporations in 2025 were (1) Walmart (revenue: $681.0 billion), (2) Amazon (revenue: $638.0 billion), and (3) UnitedHealth Group (revenue: $400.3 billion). According to the Forbes Global 2000 list for 2025, which ranks companies using a composite score of sales, profits, assets, and market value, the top three U.S. corporations are: JPMorgan Chase (revenue: $285.1 billion), Berkshire Hathaway (revenue: $371.4 billion), and Amazon (revenue: $638.0 billion). Note that while Amazon ranks third on the Global 2000 list, it actually has the highest revenue of the top three because the Forbes ranking uses a composite methodology that factors in not just revenue/sales, but also profits, assets, and market capitalization. By comparison, the top three companies according to December 2025 market capitalization rankings are (1) Nvidia (market cap: ~$4.9–5.0 trillion), (2) Apple (market cap: ~$4.0–4.2 trillion), and (3) Microsoft (market cap: ~$3.9 trillion). These corporations rise and fall on the various lists based on the differing metrics used in the ranking processes, which often include measures beyond simply ranking by revenues. Although the lists do not always align, it is clear that corporations have a significant impact on the economy.3
The Incorporation Process
Setting up a corporation is more complex than starting a sole proprietorship or partnership. Most states base their laws for chartering corporations on the Model Business Corporation Act of the American Bar Association, although registration procedures, fees, taxes, and laws that regulate corporations vary from state to state.
A firm does not have to incorporate in the state where it is based and may benefit by comparing the rules of several states before choosing a state of incorporation. Although Delaware is a small state with few corporations actually based there, its procorporate policies make it the state of incorporation for many companies, including about half the Fortune 500. Incorporating a company involves the following phases:
- Select the company's name
- Choose a company location
- Decide on a corporate classification
- Write the articles of incorporation (see Table 4.2) and file them with the appropriate state office, usually the secretary of state
- Obtain an EIN (employer identification number) from the IRS
- Establish a business bank account
- File the required state licenses and permits and pay fees/taxes
The state issues a corporate charter based on information in the articles of incorporation. Once the corporation has its charter, it holds an organizational meeting to adopt bylaws, elect directors, and pass initial operating resolutions. Bylaws provide legal and managerial guidelines for operating the firm.
| Articles of Incorporation |
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Articles of incorporation are prepared on a form authorized or supplied by the state of incorporation. Although they may vary slightly from state to state, all articles of incorporation should include the following elements:
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The Corporate Structure
As Exhibit 4.4 shows, corporations have their own organizational structure with three important components: stockholders, directors, and officers.
Stockholders (or shareholders) are the owners of a corporation, holding shares of stock that provide them with certain rights. They may receive a portion of the corporation’s profits in the form of dividends, and they can sell or transfer their ownership in the corporation (represented by their shares of stock) at any time. Stockholders can attend annual meetings, elect the board of directors, and vote on matters that affect the corporation in accordance with its charter and bylaws. Each share of stock generally carries one vote.
The stockholders elect a board of directors to govern and handle the overall management of the corporation. The directors set major corporate goals and policies, hire corporate officers, and oversee the firm’s operations and finances. Laws vary by state, but small firms may have as few as 3 directors, whereas large corporations usually have 9 to 12.
The boards of large corporations typically include both corporate executives and outside directors (not employed by the organization) chosen for their professional and personal expertise. Outside directors often bring a fresh view to the corporation’s activities because they are independent of the firm.
Hired by the board, the officers of a corporation are its top management and the CEO (chief executive officer), the chief financial officer (CFO), and the lead operations officer, who are responsible for achieving corporate goals and policies. Officers may also be board members and stockholders.
Advantages of Corporations
The corporate structure allows companies to merge financial and human resources into enterprises with great potential for growth and profits:
- Limited liability. A key advantage of corporations is that they are separate legal entities that exist apart from their owners. Owners’ (stockholders’) liability for the obligations of the firm is limited to the amount of the stock they own. If the corporation goes bankrupt, creditors can look only to the assets of the corporation for payment.
- Ease of transferring ownership. Stockholders of public corporations can sell their shares at any time without affecting the status of the corporation.
- Unlimited life. The life of a corporation is unlimited. Although corporate charters specify a life term, they also include rules for renewal. Because the corporation is an entity separate from its owners, the death or withdrawal of an owner does not affect its existence, unlike a sole proprietorship or partnership.
- Tax deductions. Corporations are allowed certain tax deductions, such as operating expenses, which reduces their taxable income.
- Ability to attract financing. Corporations can raise money by selling new shares of stock. Dividing ownership into smaller units makes it affordable to more investors, who can purchase shares of stock which represent portions of ownership in the company. The large size and stability of corporations also helps them get bank financing. All these financial resources allow corporations to invest in facilities and human resources and expand beyond the scope of sole proprietorships or partnerships. Sole proprietorships and partnerships do not have access to the same level of financing as corporations. As such, it can be challenging for these entities to obtain the capital necessary for large-scale operations.
Disadvantages of Corporations
Although corporations offer companies many benefits, they have some disadvantages:
- Double taxation of profits. Corporations must pay federal and state income taxes on their profits. In addition, any profits (dividends) paid to stockholders are taxed as personal income, although at a somewhat reduced rate.
- Cost and complexity of formation. As outlined earlier, forming a corporation involves several steps, and costs can vary based on the location and complexity of the corporation but could be several thousand dollars, including state filing, registration, and license fees, as well as the cost of attorneys and accountants.
- More government restrictions. Unlike sole proprietorships and partnerships, corporations are subject to many regulations and reporting requirements. For example, corporations must register in each state where they do business and must also register with the Securities and Exchange Commission (SEC) before selling stock to the public. Unless it is closely held (owned by a small group of stockholders), a firm must publish financial reports on a regular basis and file other special reports with the SEC and state and federal agencies. These reporting requirements can impose substantial costs, and published information on corporate operations may also give competitors an advantage.
Types of Corporations
Three types of corporate business organization provide limited liability. The C corporation is the conventional or basic form of corporate organization. Small businesses may achieve liability protection through S corporations or limited liability companies (LLCs). An S corporation is a hybrid entity, allowing smaller corporations to avoid double taxation of corporate profits as long as they meet certain size and ownership requirements. Organized like a corporation with stockholders, directors, and officers, an S corporation is taxed like a partnership. Income and losses flow through to the stockholders and are taxed as personal income. S corporations are allowed a maximum of 100 qualifying shareholders and one class of stock. The owners of an S corporation are not personally liable for the debts of the corporation.
A newer type of business entity, the limited liability company (LLC), is also a hybrid organization. Like S corporations, they appeal to small businesses because they are easy to set up and not subject to many restrictions. LLCs offer the same liability protection as corporations as well as the option of being taxed as a partnership or a corporation. LLCs are most often taxed as pass-through entities wherein the LLC itself does not pay taxes; instead, the income is passed to the members of the LLC who then report the income on their individual tax returns much like a sole proprietorship. First authorized in Wyoming in 1977, LLCs became popular after a 1988 tax ruling that treats them like partnerships for tax purposes. Today all states allow the formation of LLCs.
Table 4.3 summarizes the advantages and disadvantages of each form of business ownership.
| Advantages and Disadvantages of Major Types of Business Organization | ||
|---|---|---|
| Organization Type | Advantages | Disadvantages |
| Sole Proprietorship |
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| Partnership |
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| Corporation |
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Concept Check
- What is a corporation? Describe how corporations are formed and structured.
- Summarize the advantages and disadvantages of corporations. Which features contribute to the dominance of corporations in the business world?
- Why do S corporations and limited liability companies (LLCs) appeal to small businesses?