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10 Corporations History and Nature of Corporations Organization and Financial Structure of Corporations Management of Corporations Shareholders’ Rights and Liabilities Securities Regulation Legal and Professional Responsibilities of Auditors, Consultants, and Securities Professionals

Shareholders’ Rights and Liabilities 44 C H A P T E R Shareholders’ Rights and Liabilities Management have been allowed to act like owners. But it is the stockholders who own companies …and the stockholders are just beginning to realize it. T.Boone Pickens, Sunday Times (London, Dec. 1, 1985)

Learning Objectives Describe the rights and powers of shareholders, how they exercise their powers, and special liabilities Identify classes of shares Explain how shareholders may enforce corporate rights of actions, especially against managers

Overview Shareholders are the owners, but not the managers of a corporation Shareholder rights in a publicly-owned corporation are limited to electing and removing directors, approving vital matters, and ensuring that management actions are consistent with state corporation statutes, the articles of incorporation, and the bylaws

Shareholder Meetings State statutes and the Model Business Corporation Act (MBCA) require an annual meeting of shareholders to be held Primary purpose: elect directors Special meetings of shareholders may be held whenever a corporate matter arises that requires immediate shareholders’ action Notice must be given to shareholders of record (entitled to vote) The MBCA permits shareholders to act without a meeting if all of the shareholders entitled to vote consent in writing to the action.

Conduct of Meetings A quorum of outstanding shares must be represented at meeting by shareholders A majority of votes cast at shareholders’ meeting will decide issues put to a vote Shareholders have right of full participation, including the right to offer resolutions, speak for or against proposed resolutions, and ask questions of corporate officers

Straight Voting Directors generally are elected by a single class of shareholders in straight voting: each share has one vote for each director-nominee Other methods: With cumulative voting, shareholders may accumulate votes by multiplying the number of directors to elect by the number of shares held With class voting, corporations have classes of shareholders: preferred and common

Shareholder Control Devices Voting Trusts: shareholders transfer their shares to one or more voting trustees and receive voting trust certificates in exchange to achieve control of the corporation (concentrates voting power) Shareholder Voting Agreements: used to agree on how they will vote their shares Proxies: shareholder may appoint a proxy to vote his or her shares allowing minority shareholders to collectively own a majority of shares

Changes Requiring Shareholder Action Amendment of articles of incorporation Merger: First corporation dissolves and second corporation takes business, assets, and liabilities of both corporations Consolidation: Two corporations join to create a new corporation, but both original corporations cease to exist

Changes Requiring Shareholder Action Share exchange: One corporation becomes owner of all outstanding shares of second corporation through compulsory exchange Sale of all or substantially all of assets of the business other than in regular course of business Dissolution: First step in the termination of the corporation’s business

Procedure to Effect Changes To effect fundamental changes, the board of directors must approve, notice must be given to all shareholders whether or not they are entitled to vote, and there must be majority approval of the votes held by shareholders entitled to vote under the statute, articles, or bylaws Dissenters’ rights or a right of appraisal have been created to protect dissenters In general, those who oppose an approved action have little recourse Dissenters’ rights or a right of appraisal have been created to protect dissenters by requiring the corporation to pay dissenting shareholders the fair value of their shares MBCA and many state statutes exclude shares traded on a recognized securities exchange (e.g., the New York Stock Exchange)

Shareholder Rights of Inspection Corporate managers resist shareholders’ inspecting corporate books and records, but most state corporation statutes specifically grant shareholders inspection rights MBCA grants shareholders an absolute right of inspection of the shareholder list and the articles, bylaws, and minutes of shareholder meetings within the past three years

Distributions to Shareholders Shareholders may receive distributions of the corporation’s assets, generally in the form of cash or property dividends Declared by the board of directors and paid on the date set by the directors Once declared, dividends are debts of the corporation and shareholders may sue to force payment of the dividends Preferred shares generally have a set dividend rate stated in the articles of incorporation Dodge v. Ford Motor Co.: court ordered payment of a dividend to common shareholders The court found that Henry Ford had the wrong motives for causing Ford Motor Company to refuse to pay a dividend.

Share Dividends & Share Splits A corporation may distribute additional shares of the corporation to shareholders instead of a cash or property dividend Share dividend: each shareholder receives specified percentage of shares Declared by the board, but revocable Share split: shareholders receive specified number of shares in exchange for each share they currently own A reverse share split is possible if shareholder action amends the articles to effect the action which decreases the number of shares of a class. The purpose of a reverse share split is usually to increase the market price of the shares.

Share Repurchases A corporation may also distribute assets by repurchasing shares from its shareholders: Right of redemption (or a call) is a right of the corporation to force an involuntary sale by a shareholder at a fixed price Must be allowed by articles of incorporation Open-market repurchase is when a corporation purchases shares from any shareholder willing to sell

Shareholder Lawsuits A shareholder has the right to sue in his own name to prevent or redress a breach of the shareholder’s contract One or more shareholders may bring a derivative action for the benefit of the corporation if the directors failed to pursue a corporate cause of action Derivative action rules: Person bringing suit must be a current shareholder who also held shares at time the alleged wrong occurred Shareholder must first demand that board of directors bring the suit If board refuses, shareholder cannot bring derivative action since business judgment rule insulates the board’s decision Shareholder may still sue directors!

Shareholder Litigation Committee Boards may create a shareholder litigation committee (SLC) whose purpose is to decide whether to sue if a shareholder makes a demand to file suit MBCA has adopted the Zapata rule to determine board acts in good faith with regard to shareholder litigation MBCA has adopted the Zapata rule: If majority of directors not independent (i.e., an interest in the derivative suit), corporation has burden to prove directors made the decision to dismiss the action in good faith and dismissal serves the best interests of the corporation If majority of directors are independent, the shareholders bringing the derivative action have burden to prove bad faith or no reasonable investigation

Dissolution of Corporations Voluntary dissolution: corporation must file articles of dissolution with secretary of state Involuntary dissolution: without consent of corporation by judicial or administrative action of the secretary of state Administrative dissolution requires that the secretary of state give written notice to the corporation of the grounds for dissolution

Winding Up & Termination Dissolved corporation continues to exist for the sole purpose of winding up, the orderly collection and disposal (liquidation) of assets and distribution of the proceeds from the sale of assets After completing the winding up process, the corporation’s existence terminates

Thought Question Is it ethical for a Shareholders Litigation Committee to recommend dismissing an action against officers who, like some in the Adelphia, Tyco, and Enron scandals, either looted the corporation or caused it to overstate earnings or understate liabilities? Opportunity to discuss ethics in corporate management.