CHAPTER 7

Shareholders

From a corporate governance perspective, a shareholder is an individual

or an institution that owns voting shares of the public company. The
shareholders take limited risk of ownership while at the same time
relegating the duties of management to hired professional hands. They
have residual rights to assets of the firm; in case of liquidation of the
company, after the creditors are paid the amount owed, the residual
amount of resources belongs to the shareholders. From the agency
theory perspective, shareholder is the principal and the management,
the agent in the principal-agent relationship. Shareholders elect board
members to direct and control the management.

SHAREHOLDER DEMOCRACY
Monks and Minow (2011, pp. 140–141) draw an analogy between
political democracy and shareholder, or corporate, democracy. While
the political democracy guarantees the legitimacy of governmental or
public power, corporate democracy harnesses the power of the company
management. In the corporate governance arena, shareholders are
voters, boards of directors are electoral representatives, proxy solicita­
tion is like an election campaign, and corporate charters, bylaws, and
codes operate as constitutions. Like any democracy, the shareholder
democracy thrives only if the actors involved are vigilant of their duty
and play an active role in the process.
Shareholder democracy is vividly present in how Berkshire Hathaway
makes decisions on charitable contributions of the company. Each
Berkshire Class A shareholder is able to designate recipients of

93
94 ■ Corporate Governance

charitable contributions proportionate to the shareholder’s ownership.

Shareholder names the charity, Berkshire writes the check, and there are
no personal tax consequences on the shareholder. According to Warren
Buffett, this is unusual, for the corporation behaves more like
a partnership for its philanthropy.

Control through Voting Rights

One share, one vote is generally the norm, giving equal voice to every
owner of “a piece of the rock”; the more pieces you own, the greater the
number of votes you exercise. In essence, the control is through voting
rights. At any given time, the number of shares issued and outstanding
determines the aggregate number of votes that could be exercised by the
universe of shareholders at that time. Because purchase and sale of
shares is ongoing, the number of shareholders changes over time.
Company founders often deliberate over how they would control the
company’s voting power once it goes public. They would prefer to keep
control while going public. For this to happen, they should hold a majority
of voting shares; however, this may not be feasible. It may be that the
founders don’t have the funds to continue to own a majority of voting
shares. To get around this challenge, founders may prefer to issue two
classes of shares: ordinary shares and super-voting shares. While ordinary
shares carry one vote per share, super-voting shares give the investee
a multiple number of votes per share, say 30 votes for every share held. As
a result, the investors in super-voting shares, typically the founders, execu­
tives, and their families, often control the votes and thus ensure that their
influence on the company continues to persist while the company enjoys
access to public equity market. Fundamentally, the common investor’s
influence over control and monitoring of the company is marginalized.
There are some benefits of having dual-class equity structure. The
founders control the destiny of the company, shielding it from investors
who want quick, short-term gains. In this regard, the company enjoys
the freedom of a private company. Presumably, the stability of the
company and execution of its vision and strategy could remain unper­
turbed, as in the case of Berkshire, a company with dual-class equity
structure. However, there could be disadvantages, too. The company’s
control could lead management to abuse its power, for example, by
making imprudent acquisitions. Shielding itself from any risks of losing
 Shareholders ■ 95

control, management may become lax and produce unsatisfactory

return on investment, lower sales growth, or higher capital expendi­
tures. In a study of dual- and single-class U.S. corporations, Amoako-
Adu and colleagues found that dual-class companies pay out lower cash
dividends and repurchase fewer shares. At the heart of the issue lies the
motivation and incentives of those with ownership control. However,
there is no unequivocal judgment on companies with dual-class shares;
some have risen up to the challenge of fiduciary duty to all share­
holders, while others have not.

DIVERSITY AMONG SHAREHOLDERS

In the universe of shareholders of a company, there may exist several
diverse groups with unique investment objectives of their own. It might
be helpful to think of investors as individual investors with limited
stakes and institutional investors with potentially significant interests in
the ownership of the company. Institutional investors include pension
plans, mutual funds, exchange-traded funds, and hedge funds.

Individual Investors
It is conceptually sound and legally proper to describe any investor in
a company’s shares as a shareholder. Unfortunately, the ownership of
a few shares is unlikely to motivate the shareholder to rise up to the spirit
of guiding and controlling the management. Even if desired, this may not
be possible for a small stock owner, since the number of votes is limited
and may not make any difference in the governance decisions. Besides,
small holdings may not justify the amount of time or cost involved in
exercising vigilance beyond normal reviews of company performance,
price fluctuations in the company’s share price, and proxy voting.
Perhaps because of perceived lack of control over the governance process
(“My vote won’t count”), most small stock owners may rely on the stock
exchange where they would buy and sell shares and determine the timing
of such actions. Sometimes labeled as “revolving door” investors, these
shareholders may be more market focused; the timing of action (buy, sell,
hold) is important to them. This is what they might believe they truly
control. In this situation, shareholder rights are not necessarily abrogated,
they are merely perceived as ineffective in generating return on their
investment, causing inaction on the part of the individual investor.
96 ■ Corporate Governance

As such, every investment is truly a risk for the investor, and

managing that risk is an important duty of the investor. However, as
Monks and Minow explain, in the case of a shareholder, there could be
an “ownership failure” due to the difference between the tangible and
intangible investments. Take, for example, the owner of a rental prop­
erty. Wouldn’t the owner feel the duty to ensure that rent is collected
every month, that the property is not abused by the renter, and that the
property does nor remain vacant for a long period of time? Isn’t this
true regardless of whether the owner hires an agent or does it himself?
Because stocks are intangible in some sense, the stockholder could
choose to miss the experience of having to actively manage the invest­
ment. Not that anyone asks the investor to be passive; if anything,
shareholders as investors should be equally vigilant in guarding their
investments, exercising the rights assigned to them as owners, and thus
controlling risks of the investment.

Institutional Investors
In contrast to individual investors, large stock owners wield proportionately
greater influence. These entities in all likelihood have invested in the firm
on behalf of other investors, such as employees who subscribe to the
pension fund, or the investor who invests in a mutual fund or an exchange-
traded fund. For this reason, institutional investors are also called delegated
investors who serve as the trustees of the investors. This position of trust
puts institutional investors in an additional layer of the principal-agent
relationship, representing a large number of investors who contributed to
the investment funds. Institutional investors have a duty to vote; they
should disclose their voting policy to investors. Their vote probably counts
since the institutional investor is often in a relationship with the investee
and also has greater voice due to the size of the investment. Their relation­
ship with the investee company is formed by the policies of the institutional
investors. For example, they invest for the long haul, exercise due diligence,
and support their decisions with considerable analysis of fundamentals of
the investee business. Because of the massive number of shares owned,
institutional investors wield much greater influence on the board and the
company’s top executives. It is possible, for example, that an unsatisfied
institutional investor may propose their own representatives for election to
the board of directors or may push for replacement of the CEO.
 Shareholders ■ 97

Thus, the size of the voting shares held matters. The larger the size, the
greater the influence. Because of the size, the returns on their holdings
could be better if they make a positive impact on the company’s govern­
ance actions. Thus, the high stakes of institutional investors in the com­
pany invariably tie the future of their financial performance with the
company’s performance. Therefore, it is likely that institutional investors,
individually and collectively, would be more vigilant and active in influen­
cing how well the company is directed and controlled. Perhaps a good
barometer of potentially strong governance is the aggregate slice of institu­
tional shareholders in the company’s voting shares. The larger the presence
of institutional investors, the greater the likelihood that the company is
stable and trustworthy.
Even among the institutional investors, the motivations and goals could
vary, as could the behavior of the fund manager. While most institutional
investors are in it for the long run, there is no assurance that this would
happen. A manager of a mutual fund, for example, may lighten up on the
fund’s investment in a company’s shares based on internal evaluation of
the company’s current condition and future expectations. On the other
hand, a manager of an exchange-traded fund (ETF) mimicking an index in
her portfolio may not have much flexibility but to remain invested so as to
be true to the weights assigned in the index. Hedge funds may be even
more volatile as they are focused on targeted returns in the short term and
will not remain inactive in the event that things don’t go their way!

SHAREHOLDER RETURN ON INVESTMENT

Conceptually, the present value of all anticipated cashflows from an
investment in shares is what the shareholder gets in return for the cost
of shares. Since cashflows, such as the dividends, occur periodically over
time, it is necessary to discount the cashflows using a risk-adjusted rate,
called the discount rate. Assume that a shareholder, over the life of his
holding, gets four quarterly dividends and obtains cash by selling his
shares in the stock market at the year-end. The aggregate present value
of all cash inflows (the selling price (net of commissions and charges) at
the end of the year and the four dividends at the end of each quarter),
compared to the present value of the investment, shows whether the
investment yielded the expected return implicit in the discount rate. If the
present value of cash inflows is greater (smaller) than the present value of
98 ■ Corporate Governance

cash outflows, the net present value is positive (negative), suggesting that
the return on investment was better (worse) than expected. If the cash-
flows are estimates instead of actual amounts, the return calculated is the
expected rate of return from the planned investment in shares. Assuming
the only goal is the return on investment, the investor would invest in
shares only if the risk-adjusted expected rate of return meets the expecta­
tions of the investor.
As a practical matter, most individual investors may divide income
attributable to shareholders by the amount of stockholder equity to
determine their return in a designated time period for which the
financial information is compiled. In any case, past performance does
not in any way guarantee the future; history may not fully reflect the
future potential or upcoming hazards.

Uncertainties Surrounding the Return

Clearly, future cashflows from investment in voting shares are not
guaranteed. The board may increase or decrease the dividend distributed,
and the share price will most likely vary with the investor expectations of
how the company might perform in future. The company may experience
a catastrophic cyberattack resulting in data leakage, or some other risks
may materialize (e.g., increased cost of foreign sales due to previously
unanticipated tariffs, or losses due to currency fluctuations), resulting in
losses or reduced profits. During 2017–2019, GE had to cut dividends due
to restructuring maneuvers that would shrink the company size and
streamline its business segments for future success. The California elec­
tric utility PG&E was doing well until the forest fires in some areas caused
major problems in 2017 and 2018. State fire investigators concluded that
one of the utility’s transmission lines sparked the deadliest fire in
California. Lawsuits mounted and claims settlements drained resources.
According to a Wall Street Journal report, PG&E had recorded by
August 2019 wildfire-related charges that in the aggregate exceeded its
current market capitalization. As PG&E’s experience shows, risks of
investing are real and need to be managed all the time.

Company Perspective on Shareholder Returns

A listed public company is going to need new investments from various
sources as it grows over time. The company remains an attractive client
 Shareholders ■ 99

for financing if its financial health is considered good. A nonperforming

company loses the interest of prospective investors and, thus, may
sacrifice its market capitalization due to a lower share price. A growing
market cap is most likely a healthy sign; the company would be able to
borrow funds at attractive rates or issue more shares to generate cash to
fund its planned actions. Therefore, satisfied shareholders are important
to the company. However, their satisfaction depends on how well the
firm is doing financially. This mutuality hinges upon trust in each other.
If the shareholders think that the company whose shares they own is
going through a tough time but will eventually prevail, chances are, they
will not liquidate their investment in the company in the short run.
Institutional investors are often under pressure to generate superior
returns on their portfolio of investments. To this end, they want the
company to broadcast quarterly earnings guidance and meet or beat the
guidance estimates, which may not happen all the time. As Warren
Buffett puts it, “earnings simply don’t advance smoothly.” When the
performance falls well below guidance, investors may punish the com­
pany by liquidating their investment in it.
Companies attempt to meet investor expectations of return on
investment in various ways. For example, the board may declare
a stock dividend (dividend in the form of additional shares rather than
cash) in times when the company is cash-strapped due to continuing
growth. This permits shareholders to sell the extra shares received (or
some of the shares they hold) to generate cash, in case they need cash.
Companies also declare stock splits, multiplying the number of shares
issued and outstanding, thus increasing the number of shares in the
hands of a shareholder by a multiple used for the stock split. A stock
split potentially increases the mobility of shares in the market, for there
are more shares issued and outstanding and each share is more afford­
able. A stock split would result in at least a temporary reduction in the
share price (e.g., a two-for-one split could temporarily result in one-half
of the pre-split share price), but if the company is doing well, the share
price would likely trend upwards. With more shares on hand, share­
holders may sell some and keep the rest, depending on their cash need
or alternative investment opportunities.
The board of directors often approves a relatively large budget for the
company to purchase its own shares from the open market, especially if
100 ■ Corporate Governance

the board feels that the shares are undervalued by the market. The share
buyback results in fewer shares outstanding, that is, in the hands of
shareholders; thus, the participation in the growth of the company
belongs to fewer shares, resulting in higher earnings per share and
consequently, perhaps higher share price. As a tactic, share buyback is
a controversial move, for there are strong pros and cons to the decision
to buyback. In the end, however, the goal is to optimize the long-term
return to the shareholder. If the company is flooded with cash and has
no way to invest the funds profitably, it might as well buy back shares
or lighten up on an existing debt.

SHAREHOLDER RIGHTS
As owners, shareholders have specific rights, such as the right to elect
board members, to ratify the appointment of independent auditors,
approve executive compensation plans, and propose changes to the
governance of the company through submission of shareholder propo­
sals. Each is discussed in the following paragraphs.

Election of Board Members

The first and perhaps the most impactful job of investors is to elect their
representatives facing the management, the board of directors. This small
group of individuals is charged with the accountability to direct and
control management’s actions with a view to generate long-term share­
holder return on their investment in the company. No other duty of
a shareholder comes close to this one; if the company is led by weak or
submissive directors lacking their own voice, the board could be a totally
ineffective agent of the shareholders and management would rule.
The board’s governance and nomination committee proposes a slate
of board members which is approved by the board. The names of board
candidates are included in the proxy ballot for vote by the shareholders.
A candidate may be elected by an overwhelming majority, or may
struggle to get even a majority of votes cast. The shareholders have the
right to vote for a write-in candidate whose name does not appear on
the ballot, but for whom the shareholders may vote by writing the
person’s name. Write-in candidates are uncommon; however, in a proxy
fight, a group of investors may suggest the candidacy of someone not on
the ballot.
 Shareholders ■ 101

The result of votes cast in the election of directors is only advisory to

the board, even where a board candidate does not muster a majority of
votes. However, even when these results do not change the board make
up, the board should be alert regarding the election outcomes and
should consider them in deliberations for preparing a slate of future
directors.

Ratification of the Auditor Appointment

The auditor is a coregulator in the company’s governance. The assur­
ance of the auditor is the most significant and trusted signal that the
financial information shareholders are getting is truthful and fairly
presents the financial statements of the company. Therefore, it is
essential for the shareholders to ratify the appointment of the external
auditors by the audit committee of the board.
The ratification vote is advisory to the board. Even where the
ratification fails to muster enough votes, the board may continue to
engage the auditor as intended. However, discounting the voice of the
shareholders is not in the interest of good governance. The board may
have to explain why the auditor appointment is appropriate and how it
would take into consideration the shareholders’ voice for future auditor
appointments.

Approval of Executive Compensation Plan

The agency costs, which include executive compensation, need to be
controlled. Hence the shareholders would have a “say on pay” (SOP).
The shareholders are asked to approve equity compensation, both short-
and long-term, of the senior management, especially the chief executive.
Information regarding the executive compensation is usually discussed
in the Compensation Discussion & Analysis (CD&A) section of the
proxy statement.
Executive compensation has remained a challenge for the board. If
the compensation is low relative to management expectations, the
executives may leave the company or, if they stay, they may not be
motivated to strive for goals that are attainable but challenging. On the
other hand, the single most vocal complaint about executive compensa­
tion is that the rewards to the management are too high. The board is
“giving away the barn.”
102 ■ Corporate Governance

To determine compensation levels in the best possible manner, the

board might retain an outside expert, a compensation consultant who
likely has multi-year compensation data for the industry and peer
organizations. Besides, the consultant’s insights may prove invaluable
in doing what is best for the company.
Finally, the approval of compensation by shareholders is required at
a frequency determined by the vote of the shareholders. Unless there are
any modifications made to the current compensation formula, there
may not be any need to discuss compensation every year. The board
would desire and anticipate a majority vote in favor of the compensa­
tion plan; however, this does not always happen. In the event of a low
vote, the board should communicate with the shareholders their posi­
tion and changes, if any, in their approach going forward.

Shareholder Proposal Submission

Another way that investors may seek to communicate with directors,
management, and each other is by submitting shareholder proposals for
consideration at the annual meeting. The SEC rules address when
a company is required to include a shareholder proposal in its proxy
materials. For the shareholder, these rules include both substantive and
procedural requirements they must meet:

• The shareholder must own at least one percent of the company’s

shares, have owned it for a minimum of one year, and will
continue to own until the voting date.
• The shareholder is restricted to submit only one proposal.
• The length of the proposal should not exceed 500 words.
• The proposal must not address any prohibited content.

Such proposals cover a spectrum of issues that shareholders are con­

cerned about. They range from ouster of the CEO, executive compensa­
tion, board member tenure, environmental concerns, corporate
philanthropy, and sustainability, to social issues such as the rights of
LGBTQ employees. For example, at its 2019 annual general meeting,
 Shareholders ■ 103

Google’s parent company Alphabet faced 13 such proposals, while

Amazon had to deal with 12. Here are a few examples:

• Consider separation of the two roles, chairman of the board and

the CEO, where the two roles are combined into one position.
• Consider providing a report on sustainability initiatives by the
company.
• Realign the chief executive’s compensation structure.

Upon receipt of a proposal in proper form and by set due date, the
board may place the proposal that meets the requirements in the proxy
statement for a nonbinding vote of the shareholder. Normally, the
board would append its own understanding of the proposal and what
the company is currently working on, or is planning to work on in
respect of the issue underlying the proposal. For each proposal under
consideration, the board would offer its recommendation regarding
whether one should vote for or against the proposal. If a proposal
constrains the management’s prerogative to run the operations of the
company, it would be considered a step toward limiting the manage­
ment’s freedom or micromanaging the company. If such a proposal is
included in the proxy, the board recommendation would be to vote
against the proposal.
An overwhelming majority of shareholder proposals are rejected.
Exceptions are found where a group of shareholders or a hedge fund
with an influential amount of voting stock proposes an action. In such
cases, however, it may be that the board would work with the proposer
in advance of the meeting and arrive at an action plan acceptable to the
proposer. For example, in 2019, when Mr. Carl Icahn, who has a 10%
stake in the Caesars Entertainment Corp. asked for some changes, the
board responded. Caesars replaced three of its board members and gave
Mr. Icahn the right to appoint an additional director if a permanent
CEO was not named within 45 days of the agreement. Mr. Icahn also
asked the company to undertake a thorough strategic review with a view
to sell parts of the company or merge businesses to produce greater
synergy.
104 ■ Corporate Governance

While influential shareholders can express their voice with some

degree of ease, other shareholders may be heard as well. Although
every shareholder proposal, if voted in, is nonbinding, it does convey
to the board and the management what is on the mind of many
shareholders. If not directly, the issue underlying the voted and rejected
proposal may be addressed by the company in other ways, such as by
charting a specific course of action. Over recent years, the shareholder
voice via their proposals has become a major force in corporate
governance. The issue for the regulators is this: how to empower this
force to make it even more effective?
These are routinely acknowledged and honored shareholder rights.
But what if shareholders are frustrated about issues that are deemed
urgent, need timely response, or just don’t neatly fall in any of these
rights? They still have various ways in which they could attempt to
bring about change. Such actions are discussed in Chapter 12, Share­
holder Communication and Engagement.

BIBLIOGRAPHY
Amoako-Adu, B., Baulkaran, V. and Smith, B. F. 2014. Analysis of dividend
policy of dual and single class U.S. corporations. Journal of Economics and
Business 72 (March–April): 1–29.
Blunt, K. and Chin, K. 2019. PG&E losses widen as fire costs rise, Blunt, K. and
Chin, K., The Wall Street Journal, https://www.wsj.com/articles/pg­
e-reports-3-9-billion-in-wildfire-related-charges-11565357268?mod=sear
chresults&page=1&pos=3, Accessed August 15, 2019.
Buffett, W. 2002. Letter to shareholders. https://www.berkshirehathaway.com/
letters/2002.html Accessed October 9, 2019.
Monks, R. A. G. and Minow, N. 2011. Corporate Governance. New York: John
Wiley & Sons.