“The Fundamental Error: Shareholders & Ownership”

(This was so interestingwith regard to the coredebate about corporate governance,that we have posted much it here.)

From ProfessorBainbridge.com by Steve Bainbridge

Broc Romanek posts:

Bob Monks is one of the long-time warriors in the battle for corporate governance reform. Ever since creating ISS a long time ago, Bob has been on the front lines to get corporate governance even considered when the need for some type of market reform seemed necessary. That's why I find his recent piece where he asks What does it mean to be a shareholder or owner in 2011? so interesting. Under that umbrella question, he also asks these four questions:

1. What do owner and shareholder mean in regards to corporations and governance?
2. Can we lump all stock owners together or do we need multiple classes of stock to accommodate owners with different levels of interest and participation?

3. To whom does management owe fiduciary duty when considering the interest of owners? Does having one class of ownership work in management's favor because it keeps shareholders from ever truly working together to enact change?

4. How can you have shareholder responsibility when there is no possibility of shareholders having a common interest and working together. Because there are today so many different classes and categories of shareholders – arbs, derivatives, borrowed stock, etc – that common purpose is impossible.

The middle two questions are very thought provoking and deserve extended analysis at some point in the future. As for numbers 1 and 4, however, they are old bugbears here at PB.com.

How Many Times Must I Say It? Shareholder Do Not Own the Corporation!

Ownership implies a thing capable of being owned. To be sure, we often talk about the corporation as though it were such a thing, but when we do so we engage in reification. While it may be necessary to reify the corporation for semantic convenience, it can mislead. Conceptually, the corporation is not a thing, but rather simply a set of contracts between various stakeholders pursuant to which services are provided and rights with respect to a set of assets are allocated.

Because shareholders are simply one of the inputs bound together by this web of voluntary agreements, ownership is not a meaningful concept in nexus of contracts theory. Someone owns each input, but no one owns the totality. Instead, the corporation is an aggregation of people bound together by a complex web of contractual relationships.

As I explain in detail in my article The Board of Directors as Nexus of Contracts, the shareholders' contract with the firm has some ownership-like features, including the right to vote and the fiduciary obligations of directors and officers.

Even so, however, shareholders lack most of the incidents of ownership, which we might define as the rights to possess, use, and manage corporate assets, and the rights to corporate income and assets. For example, shareholders have no right to use or possess corporate property. Cf. W. Clay Jackson Enterprises, Inc. v. Greyhound Leasing and Financial Corp., 463 F. Supp. 666, 670 (D. P.R. 1979) (stating that “even a sole shareholder has no independent right which is violated by trespass upon or conversion of the corporation’s property”). Management rights, of course, are assigned by statute solely to the board of directors and those officers to whom the board properly delegates such authority. Indeed, to the extent that possessory and control rights are the indicia of a property right, the board is a better candidate for identification as the corporation’s owner than are the shareholders. As an early New York opinion put it, “the directors in the performance of their duty possess [the corporation’s property], and act in every way as if they owned it.” Manson v. Curtis, 119 N.E. 559, 562 (N.Y. 1918).

This remains true even if a single shareholder (or cohesive group) owns a majority of the corporation's voting stock. To be sure, ownership of such a control block gives shareholders substantial de facto control by virtue of their ability to elect and remove directors, yet this still does not confer either possessory or management rights on such shareholders. Indeed, an effort by such a shareholder to exercise such rights might well constitute a breach of fiduciary duty by the controlling shareholder. In appropriate instances of such misconduct by a controlling shareholder, the board may well have a fiduciary duty to the minority to take steps to dilute the majority shareholder's control (as by issuing more stock). See, e.g., Delaware Chancellor Allen's opinion in Mendell v. Carroll, 651 A.2d 297, 306 (Del. Ch. 1994), in which he suggested that the board of directors could deploy corporate power against the majority stockholders to prevent a threatened serious breach of fiduciary duty by the controlling stock. Granted, as I have observed elsewhere on this blog, corporate law is far more tolerant of hegemony than constitutional law, but Allen's dicta would make no sense if majority voting control equalled ownership.

Let me offer another illustration. As I discuss in my article Unocal at 20, if shareholders own the corporation, the board of directors of a target corporation would have no proper role in reponding to a tender offer. The shareholders' decision to tender their shares to the bidder would no more concern the institutional responsibilities or prerogatives of the board than would the shareholders' decision to sell their shares on the open market or, for that matter, to sell their homes. Both stock and a home would be treated as species of private property freely alienable by their owners. Yet, as we all know, corporate law confers an effective gatekeeping function on the target's board of directors by allowing them to deploy potent takeover defenses.

In discussing corporations, it is easy to lose sight of the overriding fact—that firms are nothing more than groups of people. We often find ourselves using jargon like owners, monitors, team members, agent, principal, partner, manager, employee, and shareholder. We also often find ourselves engaged in a form of reification—treating firms as though they were things having an existence separate from the people who comprise them—when we say things like “General Motors did so and so.” General Motors is a firm; it is pure fiction to say General Motors did anything. Reification is often useful, or even necessary, because it permits us to utilize a form of shorthand—it is easier to say General Motors did so and so than to attempt in conversation to describe the complex process which actually may have taken place. Indeed, it is very difficult to think about large firms without reifying them. Reification, however, can be dangerous. It becomes easy to lose sight of the fact that firms aren't things, they are simply a group of people for whom the law has provided an off-the-rack relationship we call the corporation. There simply is nothing there that can be owned.

Shareholder Activism and Heterogeneity

It's good to see long time shareholder activist Bob Monks has realized that shareholders are heterogenous. But does he realize the extent to which that observation undercuts the case for shareholder activism?

As my colleague Iman Anabtawi observed: “On close analysis, shareholder interests look highly fragmented.” Iman Anabtawi, Some Skepticism About Increasing Shareholder Power 4 (unpublished manuscript on file with author). She documents divergences among investors along multiple fault lines: short-term versus long-term, diversified versus undiversified, inside versus outside, social versus economic, and hedged versus unhedged. Shareholder investment time horizons are likely to vary from short-term speculation to long-term buy-and-hold strategies, for example, which in turn is likely to result in disagreements about corporate strategy. Even more prosaically, shareholders in different tax brackets are likely to disagree about such matters as dividend policy, as are shareholders who disagree about the merits of allowing management to invest the firm’s free cash flow in new projects.

Consequently, as I explain in The Case for Limited Shareholder Voting Rights, it is hardly surprising that the modern public corporation’s decision-making structure precisely fits Kenneth Arrow’s model of an authority-based decision-making system. Overcoming the collective action problems that prevent meaningful shareholder involvement would be difficult and costly, of course. Even if one could do so, moreover, shareholders lack both the information and the incentives necessary to make sound decisions on either operational or policy questions. Under these conditions, it is “cheaper and more efficient to transmit all the pieces of information to a central place” and to have the central office “make the collective choice and transmit it rather than retransmit all the information on which the decision is based.” Accordingly, shareholders will prefer to irrevocably delegate decision-making authority to some smaller group.

What is that group? The Delaware code, like the corporate law of virtually every other state, gives us a clear answer: the corporation’s “business and affairs … shall be managed by or under the direction of the board of directors.” Hence, as an early New York decision put it, the board’s powers are “original and undelegated.” Manson v. Curtis, 119 N.E. 559, 562 (N.Y. 1918).

The central argument against shareholder activism thus becomes apparent. Active investor involvement in corporate decision making seems likely to disrupt the very mechanism that makes the public corporation practicable; namely, the centralization of essentially non-reviewable decision-making authority in the board of directors. The chief economic virtue of the public corporation is not that it permits the aggregation of large capital pools, as some have suggested, but rather that it provides a hierarchical decision-making structure well-suited to the problem of operating a large business enterprise with numerous employees, managers, shareholders, creditors, and other inputs. In such a firm, someone must be in charge: “Under conditions of widely dispersed information and the need for speed in decisions, authoritative control at the tactical level is essential for success.”

For the rest of this post, see: http://www.professorbainbridge.com/

The Board Director Training Institute (BDTI) is a "public interest" nonprofit in Japan dedicated to training about directorship, corporate governance, and related management techniques. It is certified by the Japanese government to conduct these activities as a regulated nonprofit. Read a summary about BDTI here, and see a menu of its services for both corporations and investors here.


  1. First, to say that shareholders do not own the company because a corporation is something that cannot be owned is circular on a very basic level. In any case, the starting point for the common law of property was that land could not be owned either, except by the king. All other interests in land were part of an exceptionally complex system of overlapping tenures and tenancies with multiple parties from villein to baron having different interests in the same piece of land. The fact that modern property law has its roots in a network of feudal contracts does not prevent us from talking about owning land today.

    To deny shareholder ownership of corporations by describing them as a network of contracts seems to put the cart before the horse. The common law of contract developed after the law of property in part as a response to the growing need for remedies that distinguished between ownership and possession. From that standpoint it might be more apt to describe corporations as an extremely complex bailment. Insofar as ownership of anything without physical possession is itself abstract, the fact that the thing being owned is also abstract would seem inconsequential. We accept this type of ownership for intangibles such as intellectual property and the balances in our bank accounts, so why should corporate ownership be any different?

    The real issue would seem to be in what remedies shareholders have when their interests are infringed. Does describing companies as a network of contracts mean anything beyond that they are a network of potential remedies? Probably not, though the remedies available to shareholders are more likely to be based in the concepts of property law than contract. Indeed, despite reference to the “shareholder’s contract with the company”, contract law may not offer a lot of remedies to shareholders, possibly because the most basic conditions for contract formation have not been met as between the company and any holder who acquired their shares from a third party.

    Share certificates are commonly referred to as “indicia of ownership” and courts may exercise in rem jurisdiction over them based on their physical location. Indeed, we seem to have no trouble with shares representing some sort of owned property interest when it comes to taxation, bankruptcy, secured transactions, accounting treatment, the laws of succession and a multitude of other legal and financial contexts. So what is it about the subject of corporate governance that mandates a somewhat mystical denial of the otherwise basic legal reality that shareholders actually own something?

    Furthermore, why should we go so far as to both deny that corporations can be owned while at the same time accepting that they can themselves own property?  Shareholder “ownership” may well be a form of reification, but so what? Corporations have their roots in reification – a solution to the problem of how groups of people (chartered municipalities and religious orders whose property putatively belonged to God and who because of their status were barred from asserting any rights in courts of law) could exercise property rights collectively and perpetually. Reification for the purpose of owning things being a basic reason for corporate existence, it is a bit surprising to see shareholder ownership summarily dismissed as an exercise in reification.

    A pat response to this might be that human beings also can own property but cannot be owned, though of course American common law dealt comfortably with human beings as property for two centuries. A more consiered response might be that trusts can own property but have no owner themselves. However, that would require us to analogize the corporation to something that it clearly is not – a trust. Indeed, one of the defining distinctions between a corporation and a trust would seem to be that one has an owner and the other does not. Not much more needs to be said here because few directors are likely to welcome an analogy which could subject them to the full panoply of duties of a trustee or enable non-shareholder stakeholders to assert remedies as beneficiaries. “Shareholders do not own their companies” is, after all, an argument for reducing the exercise of remedies against directors rather than increasing them.

    Remedies bring us close to the heart of the matter. A company may be described as a network of contracts between different stakeholders, but the fact is that the remedies which different stakeholders have under law depend upon who they are (just as was once the case with land law). The remedies of vendors arise under contract law, those of employees under employment law and so forth. Because shareholder remedies have their roots in property law, they have the most direct claim on what the corporation owns (absent bankruptcy) – as they should, given that this ownership is the reason why we have corporations in the first place.

    Here is where I think the description “network of contracts” fails on a basic level. A corporation that owns a safe full of gold bars may well be a network of contracts, but it is also that plus a safe full of gold bars. That shareholders do not have the right to possess, use or manage the gold is not determinative of whether they own the company, any more than the company’s ownership of the gold would be compromised by the surrender of possession, use and management pursuant to a pledge or bailment.

    The real question, therefore, would seem to be not who (if anyone) owns the company, but who owns the gold? Since the answer would be “the shareholders” if the corporation were liquidated (assuming no creditor claims), it is again hard to understand why they do not own the corporation before it ceases to exist. The “network of contract” theory seems to fail here too because if that was what a corporation actually was, there would seem to be no reason why all of the contracts have to terminate at the same instant when the corporation ceases to exist. One could say that some contracts do in fact remain in force after the liquidation, but that would be to admit that the corporation itself is something distinctly separate from these contracts.

    Of course, the proposition that “the board is a better candidate for identification as the corporation’s owner than are the shareholder” is probably very attractive to many directors, since it gives them dominion over a safe full of gold without having to satisfy any of the requirements that the law of property normally applies to the acquisition of title. To talk about limiting shareholder rights, therefore, seems to be nothing more than a search for a way to render this dominion as close to actual exclusive ownership as is possible without triggering remedies for outright conversion.

    Here in Japan where the notion that companies are actually run for the benefit of a wide range of stakeholders is widely accepted. Whatever merits this view may have, it seems to have the practical effect of limiting the exercise of remedies which the shareholders may actually have under the law. This suppression of remedies is not counterbalanced by any other formally recognized claims that can be asserted by other stakeholders in their capacity as such. The result may thus be a net reduction in the formal remedies available to all stakeholders, leaving stakeholder interests to be advocated by others on their behalf. Since in Japan the government is often the default advocate of interests that are not accorded clearly-identified legal remedies, stakeholder capitalism may be nothing more than a convenient smokescreen behind which regulators can implement policy beyond formal statutory mandates. Under this system employees are able to preserve the safe full of gold as part of their own safety net, and the government is able to encourage companies to function as part of the social welfare system off the government books.  

    Whether this is a good thing or not is beside the point. If we talk about reducing shareholder claims in the United States, where the government does not function this way, by default the only advocate of non-stakeholder interests will be the board of directors. Since they are unlikely to do anything in this respect other than what the law or the “network of contracts” requires them to do, the end result is more freedom for the directors to dispose of the gold as they please with no concrete benefit to any stakeholders. One could argue that “better management” is of benefit to everyone, but that is too speculative and ephemeral to bring into a discussion about legal remedies, which require great specificity.

    Of course most corporate directors are not planning to loot their companies but if all we have done is reduce the scope of remedies that can be exercised by stakeholders against those few who are (or already have), lootings must surely increase. Whether it is couched in terms of stakeholder capitalism, a network of contracts or some other descriptor, “shareholders do not own the company” comes across as nothing more as an argument for increased management freedom without increased management responsibility.

    I have taken the subject far from the subject of managing complex corporations with diverse shareholder interests. The desire to enhance efficient management planning by minimizing the possibility of unpredictable shareholder claims is a perfectly rational technocratic agenda. Whether this agenda justifies minimizing the legal remedies of shareholders is questionable, however, particularly if those shareholders have paid value for their shares in the belief that doing so will render them part owners in a safe full of gold.*

    The countries we live in are extremely complex. One of the reason is because our societies have spent a long time trying to ensure that a diverse variety of stakeholders have more, not fewer remedies against the people who manage them. Corporations are not countries, of course, but I am not sure that the underlying arguments have a fundamentally different basis when it comes to limiting the remedies of shareholders or any other stakeholder.  

    * I will probably hold to my rejection of the view that shareholders do not own their companies until its proponents go so far as to advocate this being made clear in prospectuses: e.g., “Through the Company, its directors own a safe full of gold, but you as shareholders will not.” Managers who accept the notion that shareholders do not really own the company will doubtless be happy to have shareholders continue to think that they do, and will probably have no compunctions about using the phrase “your company” when addressing them. At what point is a manager who acts in this way engaging in a species of fraud?

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