Rule #1 Finance Blog

With Investor Phil Town

SHAREHOLDERS ARE BUSINESS OWNERS

Stephen Bainbridge, a corporate law professor at UCLA, is proposing that state law be amended to reflect his position on corporate management: specifically that we ‘shareholders‘ are not owners of the business at all and certainly do not need to be treated as such.

You can imagine how — as I see myself as a owner of several businesses — it is more than a bit disconcerting to discover that my shares only represent some sort of claim on the equity of the business and are not in any real world sense a claim of ownership.

Actually, what the professor is encouraging is a pretty accurate reflection on how we owners are treated by most CEOs and boards, and his view represents a paradigm that we owners need to overthrow.  We need to see ourselves as owners in every sense and then force boards and managers to see us that way, too.

Besides, and I hate to say it so emphatically, the idea that the shareholders are not real owners is ridiculous.

The idea of being a shareholder does not differentiate between someone who holds 1% of the business and a shareholder who holds 80% of the business. Both are shareholders, but is there any question that the 80% shareholder is as much an owner as if the business were not incorporated and she — the shareholder — owned it all outright?  As a shareholder, she can elect the board and put herself on it, and through that mechanism fire the CEO. She could cause herself to be hired as CEO. She could change the by-laws of the business. She could cause the business to be liquidated or sold. In other words, in any important sense of the business there is zero difference between an 80% shareholder and an 80% private owner.

No one would claim the private owner is not an ‘owner’. Yet in the professor’s theory of corporate governance the 80% public shareholder is thought of as ‘someone who does not own the corporation’. In actual fact everyone realizes that an 80% shareholder owns the business, so the professor’s idea would remain academic if there weren’t a double standard in place. As long as the shareholders are many and unorganized, the board can pretend that the shareholders are not really the owners in ways they would never consider when dealing with just a few major owners.

Since in most corporations there are no majority shareholders to prevent it, Professor Bainbridge is encouraging boards (and by extension the CEO) to treat themselves as ‘as a sort of Platonic guardian’ for all us little guys. This phrase is a big giveaway to the sort of governance that the professor is encouraging. The reference to ‘Platonic guardian’ calls up a kind of government whereby the fallible masses are governed by the perfect few. ‘Platonic guardian’ is the excuse for every dictatorship, whether communist, fascist or religious in kind.

As a nation we reject that sort of government. Our governing bodies, whether federal, state or corporate, are modeled on another concept: our nation was built on the idea that there is no such thing as a ‘platonic guardian’ and is structured to guard against the rise of such a class. Why? Because the history of such a group is one of oppression, injustice and wholesale thievery.

Actually, now that I think of it, and considering the recent actions of many boards and CEOs, it may be that the professor’s point of view has already been adopted and the wholesale theft of the owner’s property is well begun. Certainly it would appear so in businesses like WorldCom, Tyco, Enron and HealthSouth, to name just a few where the ‘platonic guardians’ ripped the owners off good and proper.

But that only gives us the more reason as owners to reject his theory of corporate management and provide an alternate suggestion more in keeping with the needs of the owners: when I own stock in a business I expect to be treated like the owner in all regards. The fact that I’ve hired a board to handle my monthly or quarterly interactions with the CEO of my business just means that that board better be responsive to my requirements — or I’ll fire them all and replace them with someone who will be responsive.

If they try to avoid that very result by setting up poison pills and termination packages, as many have done to protect themselves, they are acting in default of their fiduciary responsibility to the owner, and should consider that their downside of being caught doing this might be time in a minimum security prison for outright theft.

Consider the potential changes in corporate governance if boards were required to view shareholders (whether 1% or 80%) as the true owners of the business:  would they so easily vote to dilute us with stock options? Would they so casually withhold vital information about the business? Would they pay CEOs outrageous fortunes from our pockets (even to the ones who are destroying the business)?

In fact, their job is simple: Hire the CEO and, if they discover that she is not allocating the company’s surpluses to the benefit of the owners, fire her. That’s pretty much it.

If they do a good job of that, they can continue to stick around.

If not, the owners will fire them and hire a new board that will do that simple job more to their satisfaction. Note that this should work pretty much the same way whether there are two owners or 2 million owners. (Naturally 2 million owners will need to vote their views.) Whether I own 80% or a few small shares should not change how I view myself or how the board views me. Either way I’m the owner, and I think it is critical to my not being ripped off by these so-called ‘platonic guardians’ that they respect me as such, respond to me as such and understand that as owner, they serve me primarily.

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