TYPES OF SHAREHOLDERS
SIGNIFICANT NATIONAL EVENTS IMPACTING SHAREHOLDERS
SHAREHOLDER CONTROL AND CORPORATE DECISION MAKING
STOCK OPTIONS AND COMPENSATION
SHAREHOLDERS AND MANAGEMENT PERSPECTIVE
Shareholders or stockholders own parts or shares of companies. In large corporations, shareholders are people and institutions that simply invest money for future dividends and for the potential increased value of their shares, whereas in small companies they may be the people who established the business or who have a more personal stake in it. When investors buy shares of companies, they receive certificates that say how many shares they own. Owning shares of a company often entitles an investor to a part of the company's profits, which is issued as a dividend. In addition, shareholders are typically offered a fixed payout per share if the company is bought out. Because they are partial owners of a company, shareholders are allowed to vote at shareholder meetings for certain company actions (such as approving or rejecting a merger proposal), review company accounts, and receive periodic reports on company performance. If shareholders cannot attend annual meetings, they are permitted to vote by proxy by mailing in their vote. Furthermore, if a company decides to issue more shares, current shareholders have the option to buy shares before they are offered to the public.
Shareholders are entitled to vote on a variety of issues, although the specific areas where shareholders have a say are determined by state laws and corporate bylaws. Generally, shareholders have the right to appoint a corporate president, elect members to a board of directors, and vote on significant changes in a corporation. These significant changes might include changes in the line of business, change of company name, and company divestments, acquisitions, and mergers. Boards of directors act on behalf of the shareholders and, in practice, make most decisions such as appointing corporate officers and reviewing corporate policies, finances, and strategies.
Shareholders may vote only during a corporation's annual shareholder meeting or at a special shareholder meeting, which would normally be called by the board of directors. A notice of the meeting and a notice of the agenda (the major points of the meeting) must be provided before each shareholder meeting. Shareholder voting power is proportionate to the number of shares each shareholder owns. For example, if a corporation had two shareholders—one with 400 shares and one with 100 shares—the one with 400 shares would wield far greater voting power.
Shareholders may own two kinds of stock: common stock and preferred stock. Owners of common stock have the last claim to company profits and assets and they may receive dividends at the discretion of a company's board of directors. In addition, common stock does not have a fixed value. Holders of common stock, therefore, profit when a company performs well and suffer losses when a company does not perform well. Nonetheless, common stockholders are typically the bulk of a publicly traded firm's shareholders and in many cases enjoy voting privileges that preferred stockholders lack. On the other hand, owners of preferred stock have first claim to a company's
profits and assets. Investors may own three different kinds of preferred stock: (1) stock with preferred dividends that entitles them to a fixed dividend rate, (2) stock with preferred assets that allows them to receive the first cut of the money from a company's sale, and (3) stock with both preferred dividends and preferred assets. Shareholders also may own redeemable and convertible stock. Redeemable stock allows a company to repurchase it at some point, whereas convertible stock enables stockholders to exchange preferred stock for common stock.
Companies sell their stocks to raise money. While they have other financing options such as loans and bonds, companies may choose to issue stocks because they need to raise more capital than they can readily borrow, because equity capital may be viewed as less costly than debt financing, or because favorable stock market conditions may present an opportunity for private owners to receive cash for part or all of their shares. Companies may sell their stocks either through private placement or public offerings. Private placement is usually limited to large institutions or a small group of individuals.
Before the rise of the publicly traded corporation, often the families that founded companies were the shareholders, managers, and members of the board of directors. But because these companies needed to raise increasing amounts of capital to expand, they eventually had to turn to outside investors. As a result, outside parties quickly became managers and members of the board. After offering shares to the public, founding family members still retained control of their corporations in many cases; however, shares also were dispersed among a variety of investors who had small holdings. This structure remained in place until the second half of the twentieth century when institutions such as banks, pension funds, and insurance companies began to accumulate large amounts of stocks in specific companies and became the major shareholders in the United States.
Shareholders are generally classified as individual investors or institutional investors. Individual investors are individuals who invest their own money and institutional investors are organizations that invest the money of others. Institutional investors include insurance companies, banks, pension funds, and investment companies. The number of individual investors has risen over time, with slight decreases during periods of inflation or recession.
Institutional investors also have increased in number and influence. While they once concentrated on short-term investments by planning strategic stock trades, they since have become major players in the long-term investment market. Moreover, institutional investors have long clamored for a voice in company operations and they are the largest shareholders in the United States. The major institutional investors are pension funds, which invest retirement money. As a result of the trend towards concentration of stock in the hands of institutional investors, companies have become more attentive to this group's needs.
Private Equity. Private equity can usher in yet another type of shareholder. As Martin, Casson, and Nisar note, private equity and venture capital firms assume a very high risk for their investments in a company. With these types of arrangements, the investment capital is “illiquid,” meaning that it is very difficult for shareholders to divest themselves of their stake. Because of this, these types of shareholders are likely to be directly involved in a firm's management decisions, though not in routine operations.
Martin, Casson, and Nisar point that it can sometimes be difficult to determine the identity of a shareholder. This is because the realm of financial investment can be complex. For instance, institutional investors not only make direct investments in companies, but also invest in other financial products, such as mutual funds. Because of this, determining who ultimately owns shares in a company can sometimes be difficult.
In the early twenty-first century, two significant events occurred in the United States that directly impacted shareholders: the terrorist attacks of September 11, 2001 and the accounting scandals that were revealed in late 2001.
September 11. On September 11, 2001, terrorists hijacked four planes that targeted major emblematic and financial centers in the United States, with three of the four planes impacting their targets, the World Trade Center Towers in New York City, New York and the Pentagon in Washington, D.C. The impact on the U.S. Stock Market was immediate; the exchanges were closed on September 11 and remained closed for four consecutive days. The economy had slowed down prior to the attacks, with a sharp rise in unemployment rates and sluggish GDP growth; these events, coupled with the attacks, did not bode well for the stock market and the economy. Despite best efforts to reassure shareholders and shore up financial markets, stock market prices plummeted 14 percent as investors reacted in the first weeks following the terrorist attacks.
Accounting scandals. In mid-October 2001, Enron Corporation, one of the largest energy companies in the world, shocked Wall Street by reporting huge losses and
a dramatic reduction in shareholder equity. The U.S. Securities and Exchange Commission launched a formal investigation. On December 2, 2001, Enron filed for Chapter 11 bankruptcy. In January 2002, the U.S. Justice Department began a criminal investigation that ultimately revealed accounting discrepancies in the form of overstated earnings, underreported losses, improper transactions and partnerships created to conceal liabilities from investors, as well as the illegal shredding of thousands of key accounting documents, e-mails, and memorandums by Enron and their accounting firm, Arthur Andersen LLP. Arthur Andersen LLP was indicted by the U.S. Justice Department in March 2002 making it the first major accounting firm ever to be criminally prosecuted.
Starting in 2002 and continuing throughout 2004, various officers of Enron Corp. were prosecuted for their part in the demise of the company. Also in 2004, the remaining accounting firms, now known as the “Big Four,” were audited. The investigation into Enron and its fraudulent accounting acts spawned a flurry of similar investigations into Qwest, WorldCom, Global Crossing Ltd, and Tyco International Ltd, among others.
Shareholder confidence was sorely shaken which negatively impacted stock market prices, industry stability, and holdings in both personal and retirement accounts. In 2002, the government responded by passing regulations and safeguards designed to protect shareholder interests, the most impact being the Sarbanes-Oxley Act. The Sarbanes-Oxley Act provides accounting oversight in the form of the Public Company Accounting Oversight Board; requires chief executive officers to certify the accuracy of a company's financial statements, with harsh penalties for knowingly falsifying financial reports; institutes federal criminal penalties for executives and companies who defraud shareholders; prevents investment firms from retaliating against negative criticisms by analysts and protects employees who act as “whistleblowers” to reveal company misconduct.
Since shareholders elect a corporation's directors, they can exert a significant amount of influence on a company and its policies, because directors know that they might be fired if shareholders are not satisfied with their performance and their decisions. Nevertheless, shareholders traditionally have been interested mostly in return on investment and hence they have not played a major role in company operations or governance, which they have left to boards and management. However, in recent decades investors have at times bought stocks to seize control of companies.
The influential shareholders are usually institutional shareholders who own large quantities of a company's stock and wield proportionate power. In contrast, individual investors have much less control and can influence decisions only by rallying large numbers of investors to support their position. Consumer advocate Ralph Nader introduced this process—often called a proxy fight—in 1969 to influence General Motors' policies towards public transportation, women, and minorities. However, the Securities and Exchange Commission issued a ruling in 1983 that helped prevent shareholders buying stocks solely to influence a company's operations. Despite this ruling, the practice of buying stocks to seize control of a company is common. When a company buys a significant share of stock of another company largely to influence its operations against its will, analysts refer to it as a hostile takeover. To prevent hostile takeovers, managers sometimes devote much effort to keeping stock prices high and other defensive tactics, although this strategy has harmed some companies ultimately. Michael Milken and some of his business associates, including Ron Perelman, were infamous in the 1980s for engineering hostile takeovers.
“Greenmailing” is another issue that involves both shareholders and managers. “Greenmailing” is a practice where a shareholder makes moves toward a hostile take-over though not with the intent to actually gain control of the firm. Instead, the goal is to get a company's managers to buy the greenmailer's shares back, but at an inflated price.
One technique shareholders have used to link top management and shareholder goals has been issuing corporate executives stock options, which allow them to purchase stocks at some point in the future at a predetermined price. If the stock price rises significantly over time (that is, well beyond the predetermined level), these options can provide a substantial profit opportunity for their holders. Therefore, if stock prices rise, both top managers and shareholders benefit and, in theory, their interests are more closely aligned.
However, this concept has not always been the conventional wisdom. The business historian Alfred Chandler, for instance, thought that the separation of a company's management and ownership was a definitive improvement over earlier business arrangements, where an owner's concerns often influenced management operations. Chandler felt that managers who were employees of a firm and not shareholders would favor strategies that would result in long-term benefits for a company.
More recently, paying CEOs and others in the form of stock options has come under criticism. Some have
argued that stock options encourage CEOs to favor strategies that have big rewards. What this means is that these same strategies also have big risks associated with them. Some also point out that payment to high level CEOs in the form of stock options is not always in the best interest of a company's shareholders.
Stock options are also sometimes used as payment to employees of a company. The idea here is to make employees both literally and figuratively invested in a company by making them shareholders. This practice was used during the tech boom of the 1990s. Of course, many of these stock options were ultimately of no value, as many start-up companies failed. Since this bust, the practice is not nearly as widespread.
Two general perspectives on companies and social responsibility exist in the field of management, making successful management inherently difficult in that managers sometimes must choose between shareholder interests and employee interests. Nevertheless, the interests of shareholders, employees, customers, and other stakeholders ultimately are interconnected, not mutually exclusive.
Shareholder Value. Because of direct and indirect influence from shareholders and because of company dependence on shareholders, many companies make increasing shareholder value a key goal, if not the ultimate goal. Shareholder value refers to a company's value less its debt. In other words, companies create value for their shareholders when their investment returns are more than investment costs. Shareholders normally expect a minimum return on their investments that is equal to the going return on a low-risk investment (e.g., U.S. Treasury securities) plus a risk premium for the level of risk associated with a particular company. For example, a new Internet company is expected to deliver a higher return (higher premium) than IBM, but IBM is more certain of delivering its return (lower risk). As a company delivers such returns, in the form of dividends and share price appreciation, the company is said to be enhancing shareholder value or wealth. If a company is perceived as not increasing shareholder wealth over time, investors may lose confidence and either sells off its shares or pressure the company to take steps to improve its performance, such as by replacing the CEO or altering the corporate strategy.
Managers of a company that focuses on shareholder value will strive to remain abreast of shareholder interests. Consequently, Andrew Black et al. suggest in In Search of Shareholder Value that managers must think like entrepreneurs in order to meet shareholders' needs and add to shareholder value, which may require some refocusing if managers are accustomed to simply following the directions of their superiors.
To create additional shareholder value, managers must concentrate on a company's primary revenue-generating functions and running a company as efficiently as possible, which should help a company become a product or service leader and establish closer ties with consumers. Consequently, managers must begin their effort to increase shareholder value by identifying the key revenue-generating functions and then by promoting them. Furthermore, managers must distinguish between the interests of shareholders who have long-term interests in a company's worth and those who have short-term interests. Then they must strive to implement growth strategies that will benefit both kinds of investors insofar as possible, even though these interests may be in conflict with each other, according to J.P. Donlon and John Gutfreund.
However, this approach has come under the attack of employee advocates and other critics. In corporate theory, companies traditionally have been viewed according to the stakeholder model. This model suggests that a company can improve its financial conditions by attending to the needs and desires of its stakeholders, which include not only shareholders but also employees, distributors, customers, and so on. Shareholder and employee interests are sometimes viewed as being at odds with each other, especially around issues such as layoffs. According to the stakeholder model, managers should weigh the interests of one group of stakeholders against the interests of another in order to manage a company fairly. Hence, the shareholder value approach is controversial in that it gives priority to shareholder needs.
Supporters of the shareholder value approach defend their position by arguing that if a company is beholden to more than one interest group, then it will face the dilemma of having to decide between the different groups. If it must decide between competing interests, then the company must base this decision on some additional reason, but companies are hard-pressed to determine what the deciding criterion should be if not increasing shareholder value. The stakeholder model offers no suggestions. Without a decisive criterion, a company would constantly face this kind of dilemma, which would drastically slowdown the decision-making process. Such a dilemma could manifest itself, for example, as a proposal that would increase shareholder value and meet customer needs, but would result in the reducing the workforce. However, a company does not ignore the interests of other stakeholders while concentrating on shareholder value. For example, employees will quit if their interests are not attended to and customers will
patronize the competition if their needs are not met, and so management inevitably must take their needs into consideration. Finally, advocates of this approach contend that if a company fails to be profitable, then it will have to close, which would benefit none of the stakeholders.
Employee/Shareholder Partnerships and the Stakeholder Model. However, not all analysts subscribe to the shareholder value approach to management. Instead, some insist on the stakeholder model, arguing that the needs of both major stakeholder groups—shareholders and employees—can be met if a corporate structure is adopted that breaks down the adversarial relationship between them. The idea is to establish partnerships that empower employees and allow them to play a more active role in company decisions, according to William McDonald Wallace in Postmodern Management. The partnership arrangement makes all members' income dependent on company performance, which makes a company's costs flexible and provides an impetus for members to be flexible. This type of relationship, Wallace argues, enables companies to weather recessions and adjust prices to meet pricing tactics of competitors. Consequently, this approach would benefit both shareholders and employees.
Furthermore, while the shareholder value approach can lead to gains and benefits for shareholders, it can also lead to layoffs and closures that adversely affect employees. Because of the ubiquity of shareholder-oriented practices of hostile takeovers, many states passed laws to discourage such takeovers. These laws generally require corporate directors to consider the ramifications of their takeover plans on other stakeholders, especially employees. In addition, downsizing and layoffs are often attributed to too much emphasis on shareholder interests by management. Indeed, shareholders seem to encourage and applaud downsizing as stock prices typically increase on the announcement of impending layoffs alone.
Despite complaints from other stakeholders and despite alternative approaches, the shareholder orientation is forecast to remain the dominant bent of corporate management, according to William Beaver in his article “Is the Stakeholder Model Dead?” Beaver argues that three factors contribute to the institutionalization of the shareholder orientation: (1) the growing number of investors in the United States, (2) calls for the privatization of social security, and (3) the growth of using the stock market as a means for investing for retirement. If social security is privatized in part or in whole, investors will demand even more from companies in order to ensure that their stocks grow. Moreover, no opposing approach is gaining much ground. The stakeholder model, for example, has no major driving force behind it; for instance, labor unions represent only a small percent of the country's workers.
Nevertheless, management must attend to the needs of other stakeholders besides shareholders—especially employees and customers—in order to attract and retain highly qualified employees and satisfy customers. Clearly, a company's competitive strategy and human assets underlie the kind of economic performance and profitability needed to sustain shareholder value creation; the two need not be seen as opposing interests. Moreover, management can improve shareholder value while meeting the needs of other stakeholders such as employees and customers.
Shareholders also have come to be seen as monitors of corporations and their management. As the former head of the U.S. Labor Department during the Reagan Administration, Robert Monks argued that shareholding was a responsibility, not the mere buying of favorable stocks and selling unfavorable ones. Instead, Monks argued that shareholders have the responsibility to intervene in a company's operations and help implement policies that will increase a company's worth.
Because shareholders are owners of the company and because they hold considerable power, the management of public companies faces two ongoing tasks: (1) meeting shareholder needs and providing shareholders with information on company performance and plans, and (2) maximizing the profit of shareholders. Providing shareholders with both of these is the essence of shareholder relations—and one without the other generally will fail to satisfy shareholder demands. Companies must develop information systems that provide shareholders with periodic reports on company performance, since receiving this information constitutes one of the basic rights of shareholders. While a company is required to provide basic information such as sales, profits, assets, and liabilities in annual and quarterly reports, the investors of the late 1980s and the 1990s began demanding more detailed, frequent, and understandable information. Financial analysts and institutional investors in particular have a need for additional information. The accounting scandals of the 2000s and resulting regulations are also demanding more comprehensive disclosure. Furthermore, Securities and Exchange Commission regulations require public companies to release complete and timely information to shareholders. Hence, managers must make sure that the information they provide is current and not misleading. Management also benefits from putting forth effort to cultivate a knowledgeable pool of shareholders who are informed about company activities and goals, who will
support management decisions, and who have realistic expectations of the company's potential.
To meet the information needs of different types of investors, some companies have two separate investor relations programs: one for individual investors and one for institutional investors. An individual investor program might include issuing a magazine that highlights key aspects of a company, an annual report, quarterly reports, and a proxy statement seeking support for company proposals by proxy. On the other hand, an institutional investor program might include all the reports and information given to individual investors as well as meetings with these investors in various cities where they are concentrated, periodic conference calls to discuss current results and events, and tours of corporate properties.
Shareholder relations responsibilities cut across a company, extending from company executives on down through the corporate structure. Some companies develop special investor relations departments to handle these responsibilities, while others divide them among various departments. Either way, management must set specific goals when developing a shareholder relations program and management can establish these goals by determining what support it seeks from shareholders and what shareholders think of the company, according to H. Peter Converse in his article for Investor Relations: The Company and Its Owners. Since every company is unique to some extent, the goals and methods for achieving the goals will vary from company to company.
Martin, Casson, and Nasir also note that shareholders may increasingly be interested in participating in a company's activities. Specifically, institutional investors may lack the ability to exit a company; they are likely to prefer company practices that benefit the economy as a whole, since such investors are likely to have large diverse investments.
By implementing a successful shareholder and potential investor relations program, companies also can accomplish their business goals of advancing company growth and profitability. Through investor relations, companies can increase their ability to raise funds via stock offerings, offer a competitive stock option program to court talented executives, and prevent hostile takeovers.
SEE ALSO Corporate Governance; Knowledge Management; Stakeholders
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"Shareholders." Encyclopedia of Management. 2009. Encyclopedia.com. (September 25, 2016). http://www.encyclopedia.com/doc/1G2-3273100269.html
"Shareholders." Encyclopedia of Management. 2009. Retrieved September 25, 2016 from Encyclopedia.com: http://www.encyclopedia.com/doc/1G2-3273100269.html