1. McGraw-Hill/Irwin
Copyright © 2013 by The McGraw-Hill Companies, Inc. All rights reserved.

2. 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

3. Shareholders’ Rights and Liabilities44 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)

4. 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

5. 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

6. 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.

7. 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

8. 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

9. 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

10. 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

11. 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

12. 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)

13. 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

14. 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.

15. 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.

16. 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

17. 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!

18. 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

19. 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

20. 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

21. 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.