Therefore, if a company becomes insolvent, its creditors cannot target a shareholder’s personal assets. A shareholder, also referred to as a stockholder, is a person, company, or institution that owns at least one share of a company’s stock, which is known as equity. Because shareholders are essentially owners in a company, they reap the benefits of a business’ success. These rewards come in the form of increased stock valuations, or as financial profits distributed as dividends.
It allows early investors and employees to sell company shares and exercise options. It gives investors who come forward when cash is sorely needed a way to realize gains on their investments later. When investors buy shares of a company’s stock, they acquire ownership rights to the organization. A corporation’s bylaws outline the specific rights of shareholders. In most cases, shareholders acquire rights to vote in members of a corporation’s board of directors, and to vote on certain issues that impact the organization.
In legal terms, shareholders don’t own the corporation (they own securities that give them a less-than-well-defined claim on its earnings). In law and practice, they don’t have final say over most big corporate decisions (boards of directors do).
Initial public offerings have been on a downward trend for decades in the United States, interrupted only briefly by the internet stock mania of the late 1990s. One could spin this as a tale of wily, self-interested managers’ taking advantage of investors—because it is.
Companies depend on shareholders to buy their stocks to raise money for growth, research, development and marketing. The importance of shareholders to a business causes some managers to cater to the desires of shareholders without considering how they affect employees. In some cases, shareholders can pressure firm directors by refusing to reelect them, effectively excluding employee interests. Shareholders who exercise their power are usually institutional shareholders with a large financial interest in the company. If an institutional investor buys a large amount of a company’s shares to gain control of the company, the institutional investor is engaging in a hostile takeover.
Shareholder vs. Stakeholder: An Overview
But such behavior is not really encouraged in the current market environment. In the 1980s and 1990s, under pressure from governance activists, institutional shareholders, the financial media, finance scholars, and even the U.S. Congress, boards shifted the bulk of CEO pay from cash to stock and stock options, and became less patient with CEOs at struggling companies. The most straightforward job of the shareholder is to provide funds. Corporations do need capital to invest in growth, but they don’t get it in aggregate from shareholders.
Shareholders are considered partial owners of an organization, although business owners retain majority ownership. Employees work for companies and receive wages for their job performance, but do not own any part of the company unless they purchase stock or acquire it through benefits. Managers who understand the importance of shareholders and employees find ways to maintain shareholder and employee satisfaction. Such changes would give more clout to the shareholders who are presumably least interested in day-to-day stock price and quarter-to-quarter earnings changes—thus tempering short-termism. And separating long-haul shareholders from the rest could enable more communication and trust between them and boards and managers.
Overall, as documented by the Bank of England’s Andrew G. Haldane, stock market volatility in the U.S. and the UK has been much greater over the past two decades than it was before. There’s no evidence that this has had a negative impact generally on corporations’ ability to raise money or transact in their shares. But there are indications that certain companies—namely the cash-hungry start-ups discussed at the beginning of this section—are struggling in the new market environment.
Instead, the profits are allocated to shareholders according to their stake in the company, and the shareholders report those profits as taxable income on their personal returns. This is the case regardless of whether the shareholders actually received any money. Public companies have both shareholders and employees, and must find ways to maximize their value separately.
And although many top managers pledge fealty to shareholders, their actions and their pay packages often bespeak other loyalties. This gap between rhetoric and reality—coupled with waves of corporate scandal and implosion—has led to repeated calls to give outside investors even more say.
The voting power of shareholders is dependent on the number of individual shares owned. Shareholders possess certain rights to a company’s assets and dividends. If a company goes bankrupt, a bankruptcy court may award shareholders the rights to receive money from the liquidation of the company’s assets. Given how many unintended and unwelcome consequences have flowed from the governance and executive pay reforms of the past few decades, we’re wary of recommending big new reforms. But we do think that giving a favored role to long-term shareholders, and in the process fostering closer, more constructive relationships between shareholders, managers, and boards, should be a priority.
Dodd-Frank also called for “proxy access”—allowing some big shareholders to nominate their own director candidates—although the SEC rule to this effect was struck down by the U.S. Supreme Court, and prospects for the proposal are currently unclear. The biggest is that so many investors don’t hold on to their shares for long—and, obviously, short-termers aren’t as good as long-termers at disciplining and guiding managers. Another issue is that big institutions, which own the lion’s share of stock, tend to have widely diversified portfolios.
Conversely, when a company loses money, the share price invariably drops, which can cause shareholders to lose money, or suffer declines in their portfolios’ values. The U.S. tax code provides for a special type of “small business corporation,” known as a Subchapter S corporation. Unlike traditional corporations, an “S corp” does not pay corporate income taxes on its profits.
- Companies depend on shareholders to buy their stocks to raise money for growth, research, development and marketing.
- In some cases, shareholders can pressure firm directors by refusing to reelect them, effectively excluding employee interests.
Know Your Shareholder Rights
The argument here isn’t that managers and boards always know best. It’s simply that widely dispersed short-term shareholders are unlikely to know better—and a governance system that relies on them to keep corporations on the straight and narrow is doomed to fail. It may even make things worse, by spurring a culture of conflict between shareholders and managers and incentivizing the latter to become ever more mercenary and self-interested. Yet the appeal of “shareholder democracy” is so great that most changes in corporate governance over the past few years have involved strengthening the shareholder franchise. Dodd-Frank financial reform legislation that requires companies to put their executive pay practices to a (nonbinding) shareholder vote at least once every three years.
Investors stay away from companies that cannot meet earnings expectations but invest in stocks that consistently beat expectations. In older companies, majority shareholders are frequently descendants of a company founders. For this reason, companies often attempt to avoid having majority shareholders amongst their ranks. Furthermore, unlike the owners of sole proprietorships or partnerships, corporate shareholders are not personally liable for the company’s debts and other financial obligations.
Understanding S Corporations
If only corporations really did put shareholders first, the reasoning goes, capitalism would function much better. As such, maintaining the stock price and dividend payouts are generally the number one concern for any company in the long term. Most of the company’s business is going to be directed towards making the company more valuable for a future buyout, or more valuable in terms of what it can pay its shareholders directly. Shareholders play both direct and indirect roles in a company’s operations. They elect directors who appoint and supervise senior officers, including the chief executive officer and the chief financial officer.
The more influence short-term traders have on market prices, the more volatile those prices will be—because they are less rooted in the fundamental value of the corporations whose shares are being traded. Think of the financial crisis of 2007 and 2008, when uncertainty over prices halted trading in many mortgage-related securities. Or the Flash Crash of 2010, when shares in hundreds of companies suddenly lost half their value—and then regained it within a few minutes.
But most shareholders and most corporations don’t fit these descriptions. The funding role in a typical publicly traded corporation is filled less by shareholders than by the stock market as a whole. Having shares that can easily be bought and sold, with prices that all can see, reassures lenders and business partners.
But it’s also a case of shareholders’ pushing for change and then proving incapable of controlling it. The adversarial, stock-market-oriented approach to pay appears to have motivated executives to think more like mercenaries and less like stewards. Companies with high share prices tend to attract positive attention from the media and from equity analysts. The larger a company’s market capitalization, the wider the coverage it receives. This has a chain effect of attracting more investors to the company, which infuses it with the cash it relies on to flourish over the long haul.
Owning shares in hundreds or even thousands of companies makes it difficult to focus on the governance and performance of any of them. Prices aren’t the only way shareholders convey information to executives. In many instances well-informed investors—from venture capitalists with a start-up to Warren Buffett with the Washington Post Company—have offered crucial information, analysis, and advice to management.
Most companies receive an infusion of capital during their initial public offering (IPO) stages. But down the line, a company may rely on subsequent funding to finance expanded operations, acquire other companies, or pay off debt. This can be achieved with equity financing, which is the process of raising capital through the sale of new shares.
What is the difference between a shareholder and a stakeholder?
The difference between a stockholder and a shareholder. Both the terms stockholder and shareholder refer to the owner of shares in a company, which means that they are part-owners of a business. Conversely, “shareholder” means the holder of a share, which can only mean an equity share in a business.
Net issuance of corporate equity in the U.S. over the past decade has been negative $287 billion, according to the Federal Reserve. That negative number would be much bigger if we left out financial institutions and their desperate fundraising in 2008 and 2009. Factor in dividend payments, and we find a multi-trillion-dollar transfer of cash from U.S. corporations to their shareholders over the past 10 years. Established corporations tend to finance investments out of retained earnings or borrowed money.
This is stakeholder capitalism—not as some sort of do-good imperative but as recognition that today’s shareholders aren’t quite up to making shareholder capitalism work. Paying too much attention to what shareholders say they want may actually make things worse for them. Employees and customers often know more about and have more of a long-term commitment to a company than shareholders do. Tradition, ethics, and professional standards often do more to constrain behavior than incentives do.
The key would be to shed the notion of shareholder democracy that animates much discussion of corporate governance and move toward granting more say to those shareholders most likely to have something to contribute. The California Public Employees’ Retirement System, or CalPERS, chooses certain companies from its portfolio whose performance and corporate governance practices it regards as below par. It then communicates privately and publicly with the boards and management of those companies to encourage changes in their boardrooms and strategies. Early research showed evidence of a positive “CalPERS effect” on the stock price of targeted companies; but since then the effect has faded. Even more activist are the few hedge funds that take large positions in a single company they believe is undershooting its potential and then agitate for changes in strategic direction or the management team.