Home > Economic & Trade > Outline of U.S. Economy > Small Business and the Corporation

Small Business
Many visitors from abroad are surprised to learn that even today, the U.S. economy is by no means dominated by giant corporations. Fully 99 percent of all independent enterprises in the country employ fewer than 500 people. These small enterprises account for 52 percent of all U.S. workers, according to the U.S. Small Business Administration (SBA). Some 19.6 million Americans work for companies employing fewer than 20 workers, 18.4 million work for firms employing between 20 and 99 workers, and 14.6 million work for firms with 100 to 499 workers. By contrast, 47.7 million Americans work for firms with 500 or more employees.
     Small businesses are a continuing source of dynamism for the American economy. They produced three-fourths of the economy's new jobs between 1990 and 1995, an even larger contribution to employment growth than they made in the 1980s. They also represent an entry point into the economy for new groups. Women, for instance, participate heavily in small businesses. The number of female-owned businesses climbed by 89 percent, to an estimated 8.1 million, between 1987 and 1997, and women-owned sole proprietorships were expected to reach 35 percent of all such ventures by the year 2000. Small firms also tend to hire a greater number of older workers and people who prefer to work part-time.
     A particular strength of small businesses is their ability to respond quickly to changing economic conditions. They often know their customers personally and are especially suited to meet local needs. Small businesses -- computer-related ventures in California's "Silicon Valley" and other high-tech enclaves, for instance -- are a source of technical innovation. Many computer-industry innovators began as "tinkerers," working on hand-assembled machines in their garages, and quickly grew into large, powerful corporations. Small companies that rapidly became major players in the national and international economies include the computer software company Microsoft; the package delivery service Federal Express; sports clothing manufacturer Nike; the computer networking firm America OnLine; and ice cream maker Ben & Jerry's.
     Of course, many small businesses fail. But in the United States, a business failure does not carry the social stigma it does in some countries. Often, failure is seen as a valuable learning experience for the entrepreneur, who may succeed on a later try. Failures demonstrate how market forces work to foster greater efficiency, economists say.
     The high regard that people hold for small business translates into considerable lobbying clout for small firms in the U.S. Congress and state legislatures. Small companies have won exemptions from many federal regulations, such as health and safety rules. Congress also created the Small Business Administration in 1953 to provide professional expertise and financial assistance (35 percent of federal dollars award for contracts is set aside for small businesses) to persons wishing to form or run small businesses. In a typical year, the SBA guarantees $10,000 million in loans to small businesses, usually for working capital or the purchase of buildings, machinery, and equipment. SBA-backed small business investment companies invest another $2,000 million as venture capital.
     The SBA seeks to support programs for minorities, especially African, Asian, and Hispanic Americans. It runs an aggressive program to identify markets and joint-venture opportunities for small businesses that have export potential. In addition, the agency sponsors a program in which retired entrepreneurs offer management assistance for new or faltering businesses. Working with individual state agencies and universities, the SBA also operates about 900 Small Business Development Centers that provide technical and management assistance.
     In addition, the SBA has made over $26,000 million in low-interest loans to homeowners, renters, and businesses of all sizes suffering losses from floods, hurricanes, tornadoes, and other disasters.

Small-Business Structure
The Sole Proprietor. Most businesses are sole proprietorships -- that is, they are owned and operated by a single person. In a sole proprietorship, the owner is entirely responsible for the business's success or failure. He or she collects any profits, but if the venture loses money and the business cannot cover the loss, the owner is responsible for paying the bills -- even if doing so depletes his or her personal assets.
     Sole proprietorships have certain advantages over other forms of business organization. They suit the temperament of people who like to exercise initiative and be their own bosses. They are flexible, since owners can make decisions quickly without having to consult others. By law, individual proprietors pay fewer taxes than corporations. And customers often are attracted to sole proprietorships, believing an individual who is accountable will do a good job.
     This form of business organization has some disadvantages, however. A sole proprietorship legally ends when an owner dies or becomes incapacitated, although someone may inherit the assets and continue to operate the business. Also, since sole proprietorships generally are dependent on the amount of money their owners can save or borrow, they usually lack the resources to develop into large-scale enterprises.
     The Business Partnership. One way to start or expand a venture is to create a partnership with two or more co-owners. Partnerships enable entrepreneurs to pool their talents; one partner may be qualified in production, while another may excel at marketing, for instance. Partnerships are exempt from most reporting requirements the government imposes on corporations, and they are taxed favorably compared with corporations. Partners pay taxes on their personal share of earnings, but their businesses are not taxed.
     States regulate the rights and duties of partnerships. Co-owners generally sign legal agreements specifying each partner's duties. Partnership agreements also may provide for "silent partners," who invest money in a business but do not take part in its management.
     A major disadvantage of partnerships is that each member is liable for all of a partnership's debts, and the action of any partner legally binds all the others. If one partner squanders money from the business, for instance, the others must share in paying the debt. Another major disadvantage can arise if partners have serious and constant disagreements.
     Franchising and Chain Stores. Successful small businesses sometimes grow through a practice known as franchising. In a typical franchising arrangement, a successful company authorizes an individual or small group of entrepreneurs to use its name and products in exchange for a percentage of the sales revenue. The founding company lends its marketing expertise and reputation, while the entrepreneur who is granted the franchise manages individual outlets and assumes most of the financial liabilities and risks associated with the expansion.
     While it is somewhat more expensive to get into the franchise business than to start an enterprise from scratch, franchises are less costly to operate and less likely to fail. That is partly because franchises can take advantage of economies of scale in advertising, distribution, and worker training.
     Franchising is so complex and far-flung that no one has a truly accurate idea of its scope. The SBA estimates the United States had about 535,000 franchised establishments in 1992 -- including auto dealers, gasoline stations, restaurants, real estate firms, hotels and motels, and drycleaning stores. That was about 35 percent more than in 1970. Sales increases by retail franchises between 1975 and 1990 far outpaced those of non-franchise retail outlets, and franchise companies were expected to account for about 40 percent of U.S. retail sales by the year 2000.
     Franchising probably slowed down in the 1990s, though, as the strong economy created many business opportunities other than franchising. Some franchisors also sought to consolidate, buying out other units of the same business and building their own networks. Company-owned chains of stores such as Sears Roebuck & Co. also provided stiff competition. By purchasing in large quantities, selling in high volumes, and stressing self-service, these chains often can charge lower prices than small-owner operations. Chain supermarkets like Safeway, for example, which offer lower prices to attract customers, have driven out many independent small grocers.
     Nonetheless, many franchise establishments do survive. Some individual proprietors have joined forces with others to form chains of their own or cooperatives. Often, these chains serve specialized, or niche, markets.

Corporations
Although there are many small and medium-sized companies, big business units play a dominant role in the American economy. There are several reasons for this. Large companies can supply goods and services to a greater number of people, and they frequently operate more efficiently than small ones. In addition, they often can sell their products at lower prices because of the large volume and small costs per unit sold. They have an advantage in the marketplace because many consumers are attracted to well-known brand names, which they believe guarantee a certain level of quality.
     Large businesses are important to the overall economy because they tend to have more financial resources than small firms to conduct research and develop new goods. And they generally offer more varied job opportunities and greater job stability, higher wages, and better health and retirement benefits.
     Nevertheless, Americans have viewed large companies with some ambivalence, recognizing their important contribution to economic well-being but worrying that they could become so powerful as to stifle new enterprises and deprive consumers of choice. What's more, large corporations at times have shown themselves to be inflexible in adapting to changing economic conditions. In the 1970s, for instance, U.S. auto-makers were slow to recognize that rising gasoline prices were creating a demand for smaller, fuel-efficient cars. As a result, they lost a sizable share of the domestic market to foreign manufacturers, mainly from Japan.
     In the United States, most large businesses are organized as corporations. A corporation is a specific legal form of business organization, chartered by one of the 50 states and treated under the law like a person. Corporations may own property, sue or be sued in court, and make contracts. Because a corporation has legal standing itself, its owners are partially sheltered from responsibility for its actions. Owners of a corporation also have limited financial liability; they are not responsible for corporate debts, for instance. If a shareholder paid $100 for 10 shares of stock in a corporation and the corporation goes bankrupt, he or she can lose the $100 investment, but that is all. Because corporate stock is transferable, a corporation is not damaged by the death or disinterest of a particular owner. The owner can sell his or her shares at any time, or leave them to heirs.
     The corporate form has some disadvantages, though. As distinct legal entities, corporations must pay taxes. The dividends they pay to shareholders, unlike interest on bonds, are not tax-deductible business expenses. And when a corporation distributes these dividends, the stockholders are taxed on the dividends. (Since the corporation already has paid taxes on its earnings, critics say that taxing dividend payments to shareholders amounts to "double taxation" of corporate profits.)
     Many large corporations have a great number of owners, or shareholders. A major company may be owned by a million or more people, many of whom hold fewer than 100 shares of stock each. This widespread ownership has given many Americans a direct stake in some of the nation's biggest companies. By the mid-1990s, more than 40 percent of U.S. families owned common stock, directly or through mutual funds or other intermediaries.
     But widely dispersed ownership also implies a separation of ownership and control. Because shareholders generally cannot know and manage the full details of a corporation's business, they elect a board of directors to make broad corporate policy. Typically, even members of a corporation's board of directors and managers own less than 5 percent of the common stock, though some may own far more than that. Individuals, banks, or retirement funds often own blocks of stock, but these holdings generally account for only a small fraction of the total. Usually, only a minority of board members are operating officers of the corporation. Some directors are nominated by the company to give prestige to the board, others to provide certain skills or to represent lending institutions. It is not unusual for one person to serve on several different corporate boards at the same time.
     Corporate boards place day-to-day management decisions in the hands of a chief executive officer (CEO), who may also be a board's chairman or president. The CEO supervises other executives, including a number of vice presidents who oversee various corporate functions, as well as the chief financial officer, the chief operating officer, and the chief information officer (CIO). The CIO came onto the corporate scene as high technology became a crucial part of U.S. business affairs in the late 1990s.
     As long as a CEO has the confidence of the board of directors, he or she generally is permitted a great deal of freedom in running a corporation. But sometimes, individual and institutional stockholders, acting in concert and backing dissident candidates for the board, can exert enough power to force a change in management.
     Generally, only a few people attend annual shareholder meetings. Most shareholders vote on the election of directors and important policy proposals by "proxy" -- that is, by mailing in election forms. In recent years, however, some annual meetings have seen more shareholders -- perhaps several hundred -- in attendance. The U.S. Securities and Exchange Commission (SEC) requires corporations to give groups challenging management access to mailing lists of stockholders to present their views.

How Corporations Raise Capital
Large corporations could not have grown to their present size without being able to find innovative ways to raise capital to finance expansion. Corporations have five primary methods for obtaining that money.
     Issuing Bonds. A bond is a written promise to pay back a specific amount of money at a certain date or dates in the future. In the interim, bondholders receive interest payments at fixed rates on specified dates. Holders can sell bonds to someone else before they are due.
     Corporations benefit by issuing bonds because the interest rates they must pay investors are generally lower than rates for most other types of borrowing and because interest paid on bonds is considered to be a tax-deductible business expense. However, corporations must make interest payments even when they are not showing profits. If investors doubt a company's ability to meet its interest obligations, they either will refuse to buy its bonds or will demand a higher rate of interest to compensate them for their increased risk. For this reason, smaller corporations can seldom raise much capital by issuing bonds.
     Issuing Preferred Stock. A company may choose to issue new "preferred" stock to raise capital. Buyers of these shares have special status in the event the underlying company encounters financial trouble. If profits are limited, preferred-stock owners will be paid their dividends after bondholders receive their guaranteed interest payments but before any common stock dividends are paid.
     Selling Common Stock. If a company is in good financial health, it can raise capital by issuing common stock. Typically, investment banks help companies issue stock, agreeing to buy any new shares issued at a set price if the public refuses to buy the stock at a certain minimum price. Although common shareholders have the exclusive right to elect a corporation's board of directors, they rank behind holders of bonds and preferred stock when it comes to sharing profits.
     Investors are attracted to stocks in two ways. Some companies pay large dividends, offering investors a steady income. But others pay little or no dividends, hoping instead to attract shareholders by improving corporate profitability -- and hence, the value of the shares themselves. In general, the value of shares increases as investors come to expect corporate earnings to rise. Companies whose stock prices rise substantially often "split" the shares, paying each holder, say, one additional share for each share held. This does not raise any capital for the corporation, but it makes it easier for stockholders to sell shares on the open market. In a two-for-one split, for instance, the stock's price is initially cut in half, attracting investors.
     Borrowing. Companies can also raise short-term capital -- usually to finance inventories -- by getting loans from banks or other lenders.
     Using profits. As noted, companies also can finance their operations by retaining their earnings. Strategies concerning retained earnings vary. Some corporations, especially electric, gas, and other utilities, pay out most of their profits as dividends to their stockholders. Others distribute, say, 50 percent of earnings to shareholders in dividends, keeping the rest to pay for operations and expansion. Still other corporations, often the smaller ones, prefer to reinvest most or all of their net income in research and expansion, hoping to reward investors by rapidly increasing the value of their shares.

Monopolies, Mergers, and Restructuring
The corporate form clearly is a key to the successful growth of numerous American businesses. But Americans at times have viewed large corporations with suspicion, and corporate managers themselves have wavered about the value of bigness.
     In the late 19th century, many Americans feared that corporations could raise vast amounts of capital to absorb smaller ones or could combine and collude with other firms to inhibit competition. In either case, critics said, business monopolies would force consumers to pay high prices and deprive them of choice. Such concerns gave rise to two major laws aimed at taking apart or preventing monopolies: the Sherman Antitrust Act of 1890 and the Clayton Antitrust Act of 1914. Government continued to use these laws to limit monopolies throughout the 20th century. In 1984, government "trustbusters" broke a near monopoly of telephone service by American Telephone and Telegraph. In the late 1990s, the Justice Department sought to reduce dominance of the burgeoning computer software market by Microsoft Corporation, which in just a few years had grown into a major corporation with assets of $22,357 million.
     In general, government antitrust officials see a threat of monopoly power when a company gains control of 30 percent of the market for a commodity or service. But that is just a rule of thumb. A lot depends on the size of other competitors in the market. A company can be judged to lack monopolistic power even if it controls more than 30 percent of its market provided other companies have comparable market shares.
     While antitrust laws may have increased competition, they have not kept U.S. companies from getting bigger. Seven corporate giants had assets of more than $300,000 million each in 1999, dwarfing the largest corporations of earlier periods. Some critics have voiced concern about the growing control of basic industries by a few large firms, asserting that industries such as automobile manufacture and steel production have been seen as oligopolies dominated by a few major corporations. Others note, however, that many of these large corporations cannot exercise undue power despite their size because they face formidable global competition. If consumers are unhappy with domestic auto-makers, for instance, they can buy cars from foreign companies. In addition, consumers or manufacturers sometimes can thwart would-be monopolies by switching to substitute products; for example, aluminum, glass, plastics, or concrete all can substitute for steel.
     Attitudes among business leaders concerning corporate bigness have varied. In the late 1960s and early 1970s, many ambitious companies sought to diversify by acquiring unrelated businesses, at least partly because strict federal antitrust enforcement tended to block mergers within the same field. As business leaders saw it, conglomerates -- a type of business organization usually consisting of a holding company and a group of subsidiary firms engaged in dissimilar activities, such as oil drilling and movie-making -- are inherently more stable. If demand for one product slackens, the theory goes, another line of business can provide balance.
     But this advantage sometimes is offset by the difficulty of managing diverse activities rather than specializing in the production of narrowly defined product lines. Many business leaders who engineered the mergers of the 1960s and 1970s, found themselves overextended or unable to manage all of their newly acquired subsidiaries. In many cases, they divested the weaker acquisitions.
     The 1980s and 1990s brought new waves of friendly mergers and "hostile" takeovers in some industries, as corporations tried to position themselves to meet changing economic conditions. Mergers were prevalent, for example, in the oil, retail, and railroad industries, all of which were undergoing substantial change. Many airlines sought to combine after deregulation unleashed competition beginning in 1978. Deregulation and technological change helped spur a series of mergers in the telecommunications industry as well. Several companies that provide local telephone service sought to merge after the government moved to require more competition in their markets; on the East Coast, Bell Atlantic absorbed Nynex. SBC Communications joined its Southwestern Bell subsidiary with Pacific Telesis in the West and with Southern New England Group Telecommunications, and then sought to add Ameritech in the Midwest. Meanwhile, long-distance firms MCI Communications and WorldCom merged, while AT&T moved to enter the local telephone business by acquiring two cable television giants: Tele-Communications and MediaOne Group. The takeovers, which would provide cable-line access to about 60 percent of U.S. households, also offered AT&T a solid grip on the cable TV and high-speed Internet-connection markets.
     Also in the late 1990s, Travelers Group merged with Citicorp, forming the world's largest financial services company, while Ford Motor Company bought the car business of Sweden's AB Volvo. Following a wave of Japanese takeovers of U.S. companies in the 1980s, German and British firms grabbed the spotlight in the 1990s, as Chrysler Corporation merged into Germany's Daimler-Benz AG and Deutsche Bank AG took over Bankers Trust. Marking one of business history's high ironies, Exxon Corporation and Mobil Corporation merged, restoring more than half of John D. Rockefeller's industry-dominating Standard Oil Company empire, which was broken up by the Justice Department in 1911. The $81,380 million merger raised concerns among antitrust officials, even though the Federal Trade Commission (FTC) unanimously approved the consolidation.
     The Commission did require Exxon and Mobil agreed to sell or sever supply contracts with 2,143 gas stations in the Northeast and mid-Atlantic states, California, and Texas, and to divest a large California refinery, oil terminals, a pipeline, and other assets. That represented one of the largest divestitures ever mandated by antitrust agencies. And FTC Chairman Robert Pitofsky warned that any further petroleum-industry mergers with similar "national reach" could come close to setting off "antitrust alarms." The FTC staff immediately recommended that the agency challenge a proposed purchase by BP Amoco PLC of Atlantic Richfield Company.
     Instead of merging, some firms have tried to bolster their business clout through joint ventures with competitors. Because these arrangements eliminate competition in the product areas in which companies agree to cooperate, they can pose the same threat to market disciplines that monopolies do. But federal antitrust agencies have given their blessings to some joint ventures they believe will yield benefits.
     Many American companies also have joined in cooperative research and development activities. Traditionally, companies conducted cooperative research mainly through trade organizations -- and only then to meet environmental and health regulations. But as American companies observed foreign manufacturers cooperating in product development and manufacturing, they concluded that they could not afford the time and money to do all the research themselves. Some major research consortiums include Semiconductor Research Corporation and Software Productivity Consortium.
     A spectacular example of cooperation among fierce competitors occurred in 1991 when International Business Machines, which was the world's largest computer company, agreed to work with Apple Computer, the pioneer of personal computers, to create a new computer software operating system that could be used by a variety of computers. A similar proposed software operating system arrangement between IBM and Microsoft had fallen apart in the mid-1980s, and Microsoft then moved ahead with its own market-dominating Windows system. By 1999, IBM also agreed to develop new computer technologies jointly with Dell Computer, a strong new entry into that market.
     Just as the merger wave of the 1960s and 1970s led to series of corporate reorganizations and divestitures, the most recent round of mergers also was accompanied by corporate efforts to restructure their operations. Indeed, heightened global competition led American companies to launch major efforts to become leaner and more efficient. Many companies dropped product lines they deemed unpromising, spun off subsidiaries or other units, and consolidated or closed numerous factories, warehouses, and retail outlets. In the midst of this downsizing wave, many companies -- including such giants as Boeing, AT&T, and General Motors -- released numerous managers and lower-level employees.
     Despite employment reductions among many manufacturing companies, the economy was resilient enough during the boom of the 1990s to keep unemployment low. Indeed, employers had to scramble to find qualified high-technology workers, and growing service sector employment absorbed labor resources freed by rising manufacturing productivity. Employment at Fortune magazine's top 500 U.S. industrial companies fell from 13.4 million workers in 1986 to 11.6 million in 1994. But when Fortune changed its analysis to focus on the largest 500 corporations of any kind, cranking in service firms, the 1994 figure became 20.2 million -- and it rose to 22.3 million in 1999.
     Thanks to the economy's prolonged vigor and all of the mergers and other consolidations that occurred in American business, the size of the average company increased between 1988 and 1996, going from 17,730 employees to 18,654 employees. This was true despite layoffs following mergers and restructurings, as well as the sizable growth in the number and employment of small firms.