by Chirantan Basu, Demand Media
Shareholders are the owners of companies. A small business may have just one shareholder, the founder, while a public company may have thousands of individual and institutional shareholders, such as mutual fund companies, pension funds and hedge funds. Shareholders play an important role in the financing, operations, governance and control aspects of a business.
One of the primary reasons for going public is to raise funds from investors. In return, the company’s founders give up part ownership to these new investors. Private companies and startups may also raise funds through private placements, which are share issues to a select group of individuals and institutions. The founders of a startup company, including venture capital backers, may also provide additional capital in exchange for a higher percentage of the ownership. Unlike bond investors, shareholders do not get periodic interest payments or their original investment back from the company.
Shareholders play both direct and indirect roles in a company’s operations. They elect directors who appoint and supervise senior officers, including the chief executive officer and the chief financial officer. They play an indirect role through the stock market. Investors stay away from companies that cannot meet earnings expectations but invest in stocks that consistently beat expectations. Therefore, company management is under constant pressure to meet and beat sales and profit projections. Companies that generate significant free cash flow often face pressure from shareholders to return some of the surplus cash to shareholders in the form of dividends or share buybacks.
Public companies usually have formal corporate governance policies, such as the composition and roles of different board committees, the role of the chairman, codes of conduct and business ethics. Boards of directors answer to shareholders, not to management. Public companies must provide timely and complete disclosures to shareholders. Senior executives often spend a few days each quarter discussing operations and general business conditions with shareholders, market analysts and the business media. The chief executive and the chief financial officer sign off on financial documents, thus making them accountable for errors and omissions.
Shareholders usually determine who controls a public company. A widely held company, in which there is not a single majority shareholder, is vulnerable to hostile takeover attempts. Shareholders can block such moves if they are satisfied with the current management or if they believe the offering price is insufficient. Institutional shareholders may publicly call on company management to consider strategic options, such as selling off the company or merging with another company.
Public companies incur certain additional costs related to shareholders. These include investor communications expenses, legal and other fees related to regulatory disclosures, and the costs of hosting annual general meetings, quarterly conference calls and other investor relations events.