Shareholders as Owners: Legal Reality Or Urban Legend?

Shareholder primacy thinking is mistaken, says this legal scholar.

It’s common practice for shareholders who advocate changes in corporate law to claim that sharholders “own” the corporation and that corporate directors should seek only to “maximize shareholder value.” Whether proposing a change in a company’s bylaws or a major shift in national securities law, their proposals, comment letters, op-eds and speeches are full of ownership language. The media repeats and amplifies their claims.

Web hits prove the point. In early 2010, a web search yielded nearly 4 million hits for the word-for-word phrase: “Shareholders are the owners of the company.” By contrast, the wishful notion that “Osama bin Laden is dead” appeared only 410,000 times, and the happier belief that “Elvis is alive” appeared merely 52,200 times. It’s obvious many people believe shareholders own com-panies. But is that belief correct?

The answer is: No, shareholders do not own the corporation. Rather, they own (or in some cases, temporarily hold) a type of security commonly called stock. Both corporate law and economic reasoning support the limited nature of this ownership, and also undermine the claim that directors should always strive to maximize shareholder value.

The Legal Case
Although it can be difficult for non-lawyers to wrap their heads around the idea, no human being can own a corporation. This is because corporations are legal persons—independent entities with their own rights, including the right to hold property in the corporate name. In effect, corporations, like human beings, own themselves.

As a legal matter, shareholders who purchase shares of stock in a corporation own nothing more than that—shares of stock. Simi-larly, bondholders own only bonds, and executives with employment contracts own their contracts. None of these types of ownership give shareholders, bondholders or executives the right to control the firm. The right to control the firm’s assets and actions rests in the hands of its board of directors, and only when they act as a body and follow proper board procedures.

An important consequence of this governance structure is that shareholders not only have no legal right to control the firm, they also have no legal right to help themselves to the corporation’s assets. In fact, the only time shareholders receive any funds directly from the corporation’s coffers is when they receive a dividend or the corporation repurchases their shares. This only happens when the directors vote to declare a dividend or a corporate repurchase.

In judicial opinions, directors are usually described as owing fiduciary duties “to the corporation and its shareholders”—implying the two are not the same, and that directors’ duties are broader than just duties to shareholders. Even more important, under the doctrine known as the business judgment rule, a shareholder can’t successfully sue a board for failing to maximize shareholder value. To the contrary, directors enjoy wide legal discretion to sacrifice “shareholder value” in order to protect employees, customers, creditors and the community.

This is why fans of shareholder primacy almost always cite the nearly century old case of Dodge v. Ford as their primary legal support for the idea of shareholder primacy. But Dodge v. Ford was really a shareholder-versus-shareholder dispute in a close corporation. Similarly, the second case typically cited—Revlon v. Mac- Andrews & Forbes Holdings, Inc., is also legally irrelevent. In Revlon, the Delaware Supreme Court held that an end-game situation where the directors of a publicly traded firm had decided to sell the company with a controlling shareholder—in effect, terminating the corporation’s existence as a public firm—the board had a duty to maximize shareholder wealth. But subsequent Delaware cases have made it clear that if the directors of the firm decide not to sell at all, or prefer to do a stock-for-stock exchange with another public company, the infamous Revlon doctrine no longer applies. For example, inParamount Communications, Inc. v. Time, Inc., the Delaware Supreme Court upheld directors’ right to “just say no” to a hostile offer, even though the offer was at a premium over the market price for the company’s stock.