During a recent roundtable, I was startled when a participant brought me a recent Financial Times (Nov. 10, 2015) article, titled “Shareholders think they own the company – they are wrong,” subtitle elaborating “So whose is the business? No one’s, just like the river Thames.” Eh?
If this article appeared in a negligible media, I would not have bothered wasting a minute on it. But that Financial Times, that many consider the best international newspaper – which in many respects it is (perhaps together with the Wall Street Journal), published it, presumably passing some editorial control, requires a response, participants told me. After all, the issue the article raises is not matter of opinion and freedom of speech, but just knowing the facts. And important ones – since discussing how to regulate and tax corporations are daily front page news.
Here is what the gentleman is writing (will leave interested readers to look up his name and co-ordinates on the FT site): “Ownership is not a simple concept … If I own an object I can use it, or not use it, sell it, rent it, give to others, throw it away and appeal to the police if a thief misappropriates. And I must accept responsibility for its misuse and admit the right of my creditors to take a lien on it. But shares give holders no right of possession and no right of use. If shareholders go to the company premises, they will more likely than not be turned away.”
Indeed, ownership is not a simple concept, and never was. It is a shorthand term for a bundle of rights and obligations. When you buy a house, what do you “own”? You have the right to make certain changes, but not others. You may not allowed to paint your house in pink in certain neighborhoods; not allowed to cut trees in your yard (without municipal approval); not allowed to build another floor (to keep uniformity of landscape – see center Paris); not allowed to rent using parts of the house for a grocery store or other business; not allowed to block views of neighbors or build a tower in your garden that put shadow on the neighbor’s etc.
Briefly owning a house is a complex maze of contracts with many covenants, rights and obligations – as is every notion of “ownership.”Shares in corporations are no exceptions. To start with, corporations are a maze of complex contracts between parties, their precise details depending on their relative negotiating powers when drafted. Shareholders have certain rights; creditors have others; employees have others, and obligations too; customers have rights, and so do governments and the courts. Shareholders have rights to sell their shares, use them as collateral etc., although these rights too are subject to governments’ rules. Governments have the right to close stock markets, as they did in the US during the last decade, and as China did recently. So shareholders are not always able to exercise even the right to sell. And this right is also limited by insider trading rules and others. But governments are expected to impose these rules on rare occasions, so we can forget about them for this discussion of the “general, not the exceptions.
What is the essential right that a share confers on its holder? Some shares have voting rights and others not: so voting to oust an incompetent board and management is not the essential feature of a share: Google has voting and non-voting shares; many family businesses have similar structures for centuries.The essential right of a “share” is: The right to appreciation. Of course.
As straightforward as owning a “share” meaning “right to appreciation” appears to me, and the facts leave no doubt that this is indeed its only interpretation, and not a novel one, I was surprised to read in the Financial Times article, that this view required repeated confirmation by the courts, some relatively recently. In England, the article notes, the Court of Appeal declared in 1948 that “shareholders are not, in the eyes of the law, part owners of the company.” And in 2003, the House of Lords reaffirmed this ruling.
Yet it has long been the practice, for example, to value real estate for the minerals that may be present – may be – beneath land (in countries adopting the English, not the French tradition. In the latter, real estate property excludes anything that is beneath the land. You struck oil? Coal? Gold? Tough luck. The government has the rights to it – which obviously diminishes entrepreneurial ventures to explore, but that is another story). How will you value selling the mineral rights?
The deal is valued based on the royalties paid for each: If such royalty amounts to $3 for a ton of coal, it would be multiplied by estimated extractable amount, using carefully contracted underground methods (controlling for pollution rights). Say, 500,000 tons, would value the right at $1,5 mm. That is also the value of the “right to appreciation” of the real estate due to expectations for finding that amount of coal beneath the surface. Assume no other uses for the real estate; this number reflects the value of “owning” this piece of real estate: the right to appreciation due to expected mineral rights. As this has been standard business for centuries, it is incomprehensible why economists, politicians, legal scholars would have problems relying on this practice to extrapolate the notion of “ownership” as a maze of rights and obligations to “corporations.”
After all, a corporation is a “financing device,” characterized by a statement of capital contributions defined by formal claims against the company’s income and use of capital – but not participation in the firm’s production. The corporation issues “shares” in exchange for the investment and the shareholders have the rights of appreciation for discoveries of mineral, intellectual rights, “execution” rights, the latter not being patentable. Some people are allowed to sell their shares immediately after purchasing them, others not (the law implying fear of fly-by-night operators fooling buyers who may not do their proper due diligence. Whether such “paternalistic” or – to be politically correct – “maternalistic” — restrictions are warranted is another issue for another occasion).
The appreciation from “execution right” can come from many angles: innovative marketing; advertising; lower production costs achieved, among others, by better management of teams; a management and board imposing controls to both encourage trials, but also stop internal funding and correct mistakes faster etc. There are many options to lead to appreciation, and the shareholders have no say in any of these: after doing their due diligence when they bought the share, they have no say in how the company is managed. If they are displeased with the Board and management, but gave up their voting rights, their only option is to sell the shares – voting with their pockets. If many are displeased, and see no more appreciation in the stock price, the latter will drop – and the company will have a tougher time accessing credit. If the shareholders kept voting rights, but have tiny percent of shares, and are unable to fire the board and the management – private equity firms, specialized in friendly and hostile takeovers can come to the rescue and buy such shares.
So the Financial Times piece gets it all wrong as it rushes to the conclusions that “It makes little sense even to ask who owns shares in a company.” Tell that to Mr. Icahn or other so-called “activist” funds. Then the article concludes: “So who does own a company? The answer is that no one does, any more than anyone owns the river Thames, the National Gallery, the streets of London, or the air we breathe.” Oh, well. Perhaps the Thames would not have become that polluted until few years ago as to kill all the fish, if the rights were better defined and the parties polluting induced to negotiate with fishermen, or if the use of the streets of London were better priced and regulated, pricing the rights to drive during certain hours and not others (to avoid congestion and pollution – as finally done few years ago).
Which brings us to the role of governments: They are one of the parties impacting rights to appreciation, as they have the rights to tax, regulate and create institutions impacting rates of appreciation – or even expecting appreciation. Indeed, the piece gets one thing kind of right when in the last two sentences it says: “As Charles Handy has written, when we look at the modern corporation, “the myth of ownership gets in the way.” Clear thinking about business would be easier if we stopped using the word.”
Indeed. Looking at companies as a maze of contracts and bundle of rights draws immediate attention – or should – not to rivers, museums and city streets, but to financing – because that is what a company is – a “financing device”; to deep, democratized capital markets, so the parties can have negotiating powers; to reliable courts; to reliable governments having firm rules and proceedings. All these conditions are needed to give operational meaning to the word “rights.”
The next step then is to look at rivers, lakes, the air, the streets, the highways, museums and opera houses – and see if the difference in their “performance” or lack of, is not that that one should not talk about “ownership,” but to ask what rights and what type of institutions may be required for these resources not “owned” by anyone, to become so, with rights explicitly defined and then priced. Who still recalls that opera houses in their Italian glory days of Bellini, Donizetti and Rossini were privately owned – La Scala and St Carlo in Naples included — and managed by a previous arms dealer (who also invented the cappuccino), making enough money to also commission R&D (new operas and ballets, that is) — by having casinos attached where rouge et noir were the most popular games?
Today the US prohibits the right to make such combination. But, who knows – if Mr. Trump is elected (though at present the betting markets do not suggest that outcome), he would legalize betting in the US and put his name above another Manhattan complex, the permanently financially stressed Lincoln Center. Just as movie theaters would not be financially viable without soft drinks and popcorn, neither can opera houses be viable without having the rights to have Monte-Carlo-type casinos attached. I am not holding my breath. But this is another example how looking at institutions, private or public, in terms of what rights they have paves ways to finding solutions to their sustainable financing.
Last, but not least, looking at corporations from the perspective of corporations being a bundle of contracts and “ownership” referring to bundle of rights, gives the proper angle to reconsider what it means to “tax” corporations – indeed you cannot tax “myths” – implying that legal entities upon which taxes are imposed have nothing to do with who is paying that tax. This topic too is for another occasion.
Reuven Brenner holds the Repap Chair at McGill University’s Desautels Faculty of Management. The article draws on his last books, Force of Finance and World of Chance.
The opinions expressed in this column are the author’s own and do not necessarily reflect the view of Asia Times.
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