Part III: A Legal Perspective

Chapter 6: Who Owns the Firm?

1. Chapter 6 Summary

Chapter 6 investigates the history of the corporation

in order to challenge the myth that the primary
responsibility of managers and directors is to
operate the organization in the interests of its
shareholders.
In the United States and the United Kingdom (and
most other economies), this widespread belief is not
grounded in legal reality.

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2. A Brief History of the Corporation
• Remember our Tutorial?

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5. In the United States . . .
• The avenue to corporate personhood came via the Supreme
Court and the Fourteenth Amendment to the Constitution.

• Ironically, the same legal argument that limits the liability of

the investors (saying they are not responsible for the
corporation’s debts) also determines that they do not own
the firm.

• In other words, the corporation exists independently of its

shareholders.

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6. “Ownership”--The Law
• Two components to the legal definition:
• The law as it is written by the legislature (i.e., legislation)
• The law as it is interpreted by the courts (i.e., legal precedent)
• In the United States, most corporate law is
conducted at the state level, and Delaware is the
most important state because:

The vast majority of Fortune 500 companies are

incorporated in Delaware, and an even higher percentage
of newly formed corporations are incorporated there.

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7. Delaware General Corporation Law

“. . . the purpose of the corporation is to engage in any lawful act or

activity for which corporations may be organized under the General
Corporation Law of Delaware, and by such statement all lawful acts
and activities shall Delaware
be within the purposes of the corporation.”
corporate
§ 102law
(3) makes
Contentsno
of certificate of incorporation
mention of the
shareholder as owner
“[The directors] shall manage the affairs of the corporation and may
of the
do whatever is necessary and firm
proper to perfect the organization of
the corporation.”
§ 107 Powers of incorporators

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8. Shareholders Own Stock

“This argument [that shareholders own the firm] is based on a

misinterpretation of the legal position on the issue of share ownership.
. . . Once shareholders subscribe to shares in the corporation, payment
made in consideration for the shares is considered property of the
corporation, and the shareholders are not free to withdraw the sum
invested except for payments through dividends, selling their shares,
and other permitted means. Shareholders own the shares, not the
corporation itself, which is an autonomous legal entity.”
--Lan & Heracleous, “Rethinking Agency Theory: The View from Law,”
Academy of Management Review, Vol. 35, No. 2, 2010, p. 301.

The firm is an independent legal entity.

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9. Shareholders General Rights

The most important rights that all common

shareholders possess include:
• The right to share in the company's profitability,
income, and assets
• A degree of control and influence over company
management selection
• Preemptive rights to newly issued shares.
• General meeting voting rights

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12. First Global Crash
Historically, records of stock market crashes date back to the
year 1634, when the first speculative bubble, on Dutch tulips,
created the first market crash. After it was first imported from
the Ottoman Empire (now Turkey) to Europe, the rare, exotic
beauty of the tulip created high demand among the Dutch elite,
who saw the plant as a status symbol. Prices skyrocketed from
1634 to 1637, and soon speculators -- also middle-class -- began
buying up all the tulips they could as prices soared. But as
interest waned in tulips, prices cratered, bankrupting
speculators who had assumed the run-up in the value of tulips
would last forever.
The "ripple effect" from the tulip crash sent the Dutch economy
into a depressionary tailspin from which it took years to recover.
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13. Directors’ Fiduciary Duty to Shareholders

“Oddly, no previous management research has looked at what the legal

literature says about the topic, so we conducted a systematic analysis
of a century’s worth of legal theory and precedent. It turns out that the
law provides a surprisingly clear answer: . . . when directors go against
shareholder wishes--even when a loss in value is documented--courts
side with directors the vast majority of the time.”
--Heracleous & Lan , “The Myth of Shareholder Capitalism,”
Harvard Business Review, April 2010.

The business judgment rule.

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15. Primary Versus Secondary Markets for
Securities

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18. What Legal “Rights”
Do Shareholders Have?
• Right to the company’s assets?
• All assets are owned by the corporation as an independent legal entity.

• Right to the company’s future profits?

• No “right” to dividends unless the company issues them.

• Right to vote at company’s Annual General Meeting?

• Many votes are nonbinding.
• It's extremely difficult to nominate candidates for the board.

• Right to sell their shares at the time of their choosing?

• Yes, that is about the only meaningful shareholder legal “right.”

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19. Shareholder Rights in the United States

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20. Shareholders Have No Ownership Rights
“If I own an object I can use it, or not use it, sell it, rent it, give it to
others, throw it away and appeal to the police if a thief
misappropriates it. And I must accept responsibility for its misuse and
admit the right of my creditors to take a lien on it. But shares give their
holders no right of possession and no right of use. . . . They have no
more right than other customers to the services of the business they
‘own.’ The company’s actions are not their responsibility, and corporate
assets cannot be used to satisfy their debts. Shareholders do not have
the right to manage the company in which they hold an interest, and
even their right to appoint the people who do is largely theoretical.
They are entitled only to such part of the income as the directors
declare as dividends, and have no right to the proceeds of the sale of
corporate assets--except in the event of the liquidation of the entire
company, in which case they will get what is left; not much, as a rule.”
John Kay, Financial Times, November 11, 2015, p. 9.

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21. The Result?

“Today, . . . there seems to be substantial agreement among

legal scholars and others in the academy that shareholders
do not own corporations.”
University of Illinois Law Review, Vol. 2010, No. 3, 2010, p. 899.

• Conclusion:
• The corporation (LLC) is an independent legal entity.
• The board of directors is the principal of the corporation.

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22. CEOs on Shareholders
“Reducing or even eliminating quarterly earnings guidance won’t, by itself,
eliminate all short-term performance pressures that U.S. public companies
currently face, but it would be a step in the right direction.”
Jamie Dimon (JP Morgan Chase) & Warren E. Buffett (Berkshire Hathaway)
“If you want me to do things only for ROI reasons, you should get out of this
stock.”
Tim Cook (Apple)
“Unilever has been around for 100-plus years. We want to be around for
several hundred more years. So if you buy into this long-term value-creation
model, which is equitable, which is shared, which is sustainable, then come
and invest with us. If you don’t buy into this, I respect you as a human being,
but don’t put your money in our company.”
Paul Polman (Unilever)
“On the face of it, shareholder value is the dumbest idea in the world. . . . Your
main constituencies are your employees, your customers and your products.”
Jack Welch (General Electric)

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27. Why Is This Important?

It is central to broadening executives’ outlook so that the

firm is run in the interests of stakeholders, broadly defined.

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28. Conclusion of Book from Chapter 6

No one owns the publicly traded, limited liability

corporation. It is an independent person in the eyes of the
law. The firm’s principals are its directors (not its
shareholders), and their fiduciary responsibility is to make
decisions in the best interests of the organization, period.
Importantly, entrepreneurs should not want to own their
firm. It is the separation between risk and reward (limited
liability) that protects the entrepreneur from financial ruin
and results in so much economic creativity.

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29. Strategic CSR Debate

• Motion:

The shareholders are its most important stakeholder group.

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30. Questions for Discussion and Review
1. Who owns the publicly traded, limited liability corporation? Why is
this true?
2. Why was the concept of limited liability introduced? What are its
main advantages? Does it have any disadvantages?
3. When you own a share, what are the main rights that accompany
that legal contract with the firm?
4. Why is it important for advocates of CSR that the belief that
shareholders own the firm is undermined?
5. If the idea that shareholders do not own the limited liability
corporation became widely accepted, what consequences do you
think this would have for the stock market and or wider society?
Would this be a good thing or a bad thing?

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 CORPORATE SOCIAL
RESPONSIBILITY (CSR)
Lecturer: Dr. Xuanwei Cao
Office: BS226
Office Hour: 15:00-17:00 Wed.
Email: xuanwei.cao@xjtlu.edu.cn