Learning too many things at once can either fry your brain or help you become a jack of all trades! So I try to keep at it, hoping that I fall in the latter category.
As I have just moved from my city, I don’t have access to the physical books, so I thank god for the internet! I read journals, articles, watch videos on YouTube to learn! I am also considering taking up some courses like company law, corporate governance and SEBI regulations, just to fine-tune the ideas. I don’t want my brain to get idle again, and it takes longer to get it up and to run each time!
One of my tasks these days is to work on webinars for students and lawyers. We get an industry or subject expert as a panellist and have them talk about a relevant topic for an hour. Now the problem with me is that by the time the webinar starts, I have reached my full capacity for the day. So I don’t watch the live webinars, but instead, view them the next day.
Recently I was watching a couple of webinars on basics of company law and corporate governance. This made me realise how much I did not know about the practical aspects of a company. So I started researching at the very beginning. In the process, I realised that I had studied for my company law and CS exams about how to establish a company, types of companies, directors’ duties, shareholders rights, etc. I knew quite a bit about the legal provisions, but what I didn’t know where the interests of the stakeholders.
Who are the stakeholders in a company?
Stakeholders are the interested or affected parties of a company. They are the ones who are affected by or can affect the company’s actions, objectives and even policies. Some of the critical stakeholders are directors, shareholders, government, employees, suppliers, creditors, community, etc.
My interest grew in the shareholders as they are the owners of the company. Then I started wondering why do they invest in the first place. Apparently, it was for better returns on their investment. I recalled once working behind the scenes in an annual shareholders meeting. The shareholders were treated like kings!
A whole spread was laid out for them before the meeting, and after. During the session, the shareholders posed various questions to the panel of CEO, CFO, CS and other top bosses. They inquired about the annual report figures, last year’s product launches, revenue growth, next year’s plan of actions, etc. It was an interesting perspective to see the people you answer to, being answerable to someone else.
The questions from the shareholders were several, but it made me think about their underlying reason.
The power of the ownership is that it demands accountability. A company needs to demonstrate the transparency in its functions and effectively communicate that to the shareholders from time to time, This is done through annual reports, general and annual meetings,etc. The company must be governed by an effective corporate governance mechanism to retain the trust of the stakeholders. The company needs to be able to ascertain the requirements of the various stakeholders in order to address them. It helps them fulfill their objectives and satisfy the investors. A employee may want bonus, a shareholder may want controlling rights, government may want fulfillment of new compliance, etc.
What do the shareholders really want?
‘The social responsibility of business is to increase its profits’
Milton Friedman observed this in one of his articles. According to the 1972 article, the famous economist wanted the board and managers to focus on the maximisation of wealth of the shareholders.
Friedman believed that shareholders were the owners of the company. So by that logic, the real want of shareholders should be the maximisation of profits or wealth, right?
But how accurate is that theory? Does a shareholder really want just the profits?
In India, there are generally two types of shares which are issued – equity shares and preference shares. The main difference between the two is the rights offered to the shareholders regarding dividend and voting rights. A preference shareholder gets paid a fixed annual or cumulative dividend, before the equity shareholders. The equity shareholders receive the dividend when the company declares a profit, but they have voting rights. The preference shareholders do not get the voting rights.
Shareholders enter into a shareholder agreement with the company for buying their shares and have the rights and duties laid down for dispute resolutions. The key provisions of a shareholder agreement are available here.
Companies mostly work towards shareholder value thinking, i.e., to increase the value of shares.
Many times, in a quest of increasing the share value in the short run for the investors, the company takes poor and irrational steps like cutting safety corners, or reducing expenditure on research and development, or reducing workplace safety, or cut back on customer support, etc.
While this may generate a short-term increase in the share value and appease the investors, this not what they want. The shareholders invest their money in a company which they trust in as a whole. They want better returns but not only in the short run. They want steady and increasing dividends from their investments. People generally invest for the future both short and long-term.
What happens when a company focuses on short-term wealth maximisation?
If the company is focused only on short-term goals and does not take into account the welfare of the other stakeholders like the employees, customers, suppliers, creditors, etc., the long-term growth of the company will be affected.
Disgruntled employees, unsatisfied customers, unpaid creditors or suppliers will not stick around for long, and it will affect the business and eventually the profits of the company.
In the long term, these tendencies of cutbacks of a company reduce the investors’ faith in the company, it also harms the existing investors in the long-term.
The shareholder wants a stable and continued return on his investments in the next five or ten years instead of just a quarter or two. So for the benefit of all stakeholders involved, a company should have a transparent, accountable system where each stakeholder is taken care of.
There needs to be a balance between managing the shareholders’ investment and the business judgment by the directors. They cannot disregard their corporate responsibility towards other stakeholders and the community they draw from.
Are the shareholders the real owners of the company?
In my attempt to understand the complex relation of stakeholders, especially shareholders, I came across an interesting perspective in a video lecture (at 13:35) by Prof Lynn Stout, the Paul Hastings Distinguished Professor of Corporate and Securities Law at UCLA.
She had said that from a legal point of view the shareholders are not the owners but a mere contractual party, just like an employee or a supplier or a bond holders. The shareholders get the residual payments or dividend only if the company declares dividend after paying off the expenses. According to her from a finance perspective, the shareholders get retained earnings which is nothing but revenue after deduction of expenses. She further clarified that the expenses are not controlled by the shareholder, but the company and its directors
The idea behind this is that employees enter an employment contract which gives some statutory and contractual rights and obligations to them. Same goes for a creditor, supplier, etc. and even the shareholders.
The company is a legal entity which can own property, enter into a contract, has rights and obligations. It comes into being first and then shares are created for the shareholders. The shareholder enters into an agreement with specific rights and responsibilities. Even the name itself suggests someone who holds shares, not ownership.
So are shareholders owners or mere contractual parties?
In India the shareholders are the owners of the company. A company cannot be established without shareholders. It is only when shareholders subscribe to the shares and become members that the company is formed. Shareholders have the ultimate authority in appointment and removal of directors.
So from an Indian perspective, Prof. Lynn Stout although interesting, is not valid.
For us it is imperative to understand the complexities of company laws and the principles of corporate governance for all stakeholders, i.e., the employees, suppliers, creditors, shareholders, even the community. One can read journals, take company law courses, attend workshops, etc. to gain the necessary expertise. But the practical experience is crucial to become an expert in the subject matter.
In conclusion, the objective of a company should not be limited to the shareholders, but to the other stakeholders and community at large. Only then can they gain the trust of their investors in the long term by displaying stability and steady growth. Shareholders want to increase their wealth but not just in the short-term. They really want and value- a wholesome growth in the long run.