THE relationship between shareholders and directors of a company is a subject that is often shrouded in mystery. Why is the relationship important? The role of shareholders in a company’s affairs is important not least because of the generally held view that ownership of a company is vested in shareholders but also because, it is shareholders who appoint the directors of a company.
The issue of the role of shareholders in a company was a contentious issue in a conversation that I had with some business colleagues last week. In contention was my provocative view that the relationship between shareholders and a company is no different from the relationship between parents and their children. Parents do not own their children and equally holders of shares in a company do not have an ownership relationship with companies that issue shares to them.
The dispute regarding ownership becomes pronounced when one is confronted with the identities and control of corporate entities in post-colonial states where the race card is often associated with the actions and perceived control corporate institutions. As many people attempt to better understand the true causes of poverty, unemployment and inequality, it is not unusual to link the causes of the triple challenges to colonialism and, invariably, the race factor often used to explain present ills.
It dawned on me that the debate of the need to broaden and deepen the debate about role of race in limiting opportunities to the majority. It also became clear to me that there is a need to continuously improve our shared understanding on corporate animals and how they are structured and regulated.
The assumption that shareholders own and control companies is so pervasive that it would be futile to dismiss it entirely simply on the basis of what many may regard as a semantic argument that a company is a juristic person that once created has its own life that is operationally independent of its holders of shares.
In advancing an argument against my thesis that shareholders are located outside the company they hold shares in, it was pointed out to me that directors are accountable to shareholders who are vested with the power to appoint and dismiss them. It was argued that it would be absurd for shareholders to have the power to appoint and dismiss directors yet be unable to exercise absolute control over directors. No dispute was raised regarding the fact that the control and management of a company is vested in directors.Advertisement
However, my argument was and remains that once appointed, directors owe a fiduciary duty to the company and not to a certain class of stakeholders. In the case of South Africa, the moral and legal basis of black economic empowerment policies and programs is premised on the acceptance of the role of shareholders as controllers of companies. It is also the case that indigenization programs are premised on the same approach to corporate existence and control.
There is also a belief that the purpose of establishing companies is to maximize shareholder value and, therefore, shareholders have a legitimate legal claim on the profits generated by a company. To the extent that a company fails to deliver the promise of profits, it is then held that the shareholders would be entitled to remove directors who fail to discharge this duty.
Conflicts do arise between shareholders and directors. Directors are personally liable for their actions and choices. Shareholder liability is normally limited to the value of the investment made in acquiring shares in a business. It is the question of fiduciary duties that we ought to focus on to better appreciate the argument that shareholders lack the legal authority to control the administration of companies in which they may hold controlling stakes.
In the corporate world, the only individuals clothed with legal power are directors. Fiduciary duties can only be owed by those who have the power over other people’s persons or property. It is the case that shareholders may have indirect power or influence, but it cannot be denied that they have no legal power over corporate property, certainly no legal power over corporate assets.
Although shareholders have and ought to have power over their own property (shares), a fact the law recognizes by protecting the shareholders’ right to vote like is the case for eligible citizens in any democratic dispensation. The right, title and interest to the shares can only be negotiated by the property owner. Accordingly, in the case of listed securities, the sale and purchase of shares is typically intermediated through the securities exchange and the movement of shares has no direct monetary impact on the company concerned.
I can buy securities from a holder of such securities through a registered broker. So it is the case that the movement of shares from one set of shareholders to others will and should not impact on the affairs of a company as such transfer of funds will go directly to the property owner and not to the company. However, in the case of an initial public offering, it is the company that receives the funds as is the case when the company is established.
It cannot be denied that shareholders owe no legal duty to a company in which they hold shares. The concept of fiduciary duty, arose in the ad hoc common law context which provides that what makes a fiduciary, a fiduciary is the person’s power to make decisions with regard to another person’s property or person. Because of the power, the fiduciary is compelled to act in the best interests of the other person. A power creates a fiduciary duty if it enables the fiduciary to make decisions that are legally enforceable and can result in liability for the beneficiary.
The beneficiary in this case is the company and not the shareholder. Although the fiduciary has the legal power to bind the beneficiary, the beneficiary sometimes has the legal right to control the fiduciary. The control that the shareholders exercise over a company is an essential feature of the existence of an agency relationship between a director and the company. Other beneficiaries like shareholders, however, cannot and do not have control over their fiduciaries.
If a director is appointed to a board, the shareholder has no power to instruct such a director to make choices as an agent and, if the director (s) refuse (s) to be such an agent, the shareholder including the company have no legal redress. It is an accepted legal fact that corporations do not have control over their fiduciaries. In order to give rise to a fiduciary duty, the fiduciary’s power over the beneficiary must be a legal one. That is, it must create legal liability on the part of the beneficiary. Only the company as the beneficiary has power and capacity to create legal liability.
It is often the case that in small corporations, for example, the shareholders and the directors may be the same. It is also the case that in very large corporations, there may be no actual relationship at all between any of the shareholders and the board, except to the extent the board members themselves own shares and to the extent the occasional shareholder shows up at the annual meeting. In such circumstances, the company will have an “investor relations” page on its public website from which shareholders without favour or prejudice access the information.
The shareholders subscribe in the shares of a company in the hope that the company will make money, but have no legal obligation to work for the company in which they hold shares. Accordingly, shareholders need not care about how the company accomplishes that goal of maximizing profits. Shareholders typically rely on the board to make business decisions based on the board’s judgment and expertise, not based on some idea of what the shareholders might want.
Most corporations, especially the listed ones, function as any republic constitutional order rather than a democracy. The kind of issues that fall within the purview of shareholders and for which they are required to vote upon, include: the election of directors, the amendment of the certificate of incorporation, and fundamental changes such as mergers and the sale of all or substantially all the assets. The procedures applicable to such matters, such as voting structures and anti-takeover devices, are also relevant to the shareholders.
In conclusion, it is a legal fact that shareholders have no legal role in the corporation and no further legal relations after appointment with the directors. However, shareholders can bring a derivative suit and thereby attract the attention of the board, but there is no requirement that the board make itself available for shareholder input. In short, the shareholders have no legal position vis-à-vis the corporation other than the contractual one established by the articles of incorporation.