Know your shareholders' rights
What are shareholders' equity?
If you've just bought shares in Disney, as a partial owner of the company, does that mean you and your family can access Disneyland for free this summer? Do Anheuser-Busch contributors receive a case of beer every quarter?
These virtual privileges are highly unlikely, but they raise the question: what rights and privileges do shareholders have? While they may not be entitled to free rides and beer, many investors are unaware of their rights as stock owners. Here are several perks that come with being a contributor.
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If the company is liquidated, creditors are the first to pay their debts from the company's assets.
Bondholders are next in line to receive any proceeds from liquidation.
Ordinary shareholders are the last to pay any debts from the liquidation company's assets.
Ordinary shareholders are granted six rights: the right to vote, ownership, the right to transfer ownership, dividends, the right to examine company documents, and the right to sue for wrongful acts.
Levels of Equity
Each company has a hierarchical rights structure for the three main classes of securities issued by companies: bonds, preferred shares and common stocks. In other words, there is a selective arrangement of rights.
The priority of each security category can best be understood by looking at what happens when a company goes bankrupt. You may think that as a joint shareholder with an ownership stake in the company, you will be the first to receive a portion of the company's assets if you go bankrupt. In fact, ordinary shareholders are at the bottom of the company's food chain when the company is liquidated. During insolvency proceedings, creditors are the first to pay their outstanding debts from the company's assets.
Bondholders are the next priority followed by preferred shareholders, and finally regular shareholders. This hierarchy is determined by the so-called "absolute priority," which are the rules used in bankruptcies to determine which part of the payment will be received by the participants.
In addition to absolute priority rules, other rights for each warranty category are different. For example, a company's charter usually states that only ordinary shareholders have voting privileges, and preferred shareholders must receive dividends before ordinary shareholders. The rights of bondholders are determined differently because a bond agreement, or bond contract, represents a contract between the issuer and the bondholder. Payments and privileges received by the bondholder are subject to undertakings (principles of the contract).
Risks and rewards
Ordinary shareholders still own part of the company, and if the company can make a profit, it benefits the joint shareholders. The filter preference we described above makes sense. Shareholders take greater risk because they receive almost nothing if the company goes bankrupt, but they also have a greater chance of being rewarded by exposure to a stock price rise when the company succeeds. In contrast, blue-chip stocks generally experience less price fluctuations.
Main rights of shareholders
Voting power on key issues. Voting power includes the election of directors and proposals for fundamental changes affecting the company such as mergers or liquidations. Voting takes place at the annual meeting of the company. If the shareholder is unable to attend, he can do so by proxy and mail in their vote.
Ownership in part of the company. We previously discussed the issue of corporate liquidation where bondholders and preferred shareholders are paid first. However, when a business flourishes, ordinary shareholders own a piece of something that has value. Ordinary shareholders have a claim on a portion of the assets owned by the company. Because these assets generate profits and with profits reinvested in additional assets, shareholders see a return as the value of their shares increases as stock prices rise.
Right to transfer ownership. The right to transfer ownership means that shareholders are allowed to trade their shares on the exchange. The right to transfer ownership may seem ordinary, but the liquidity provided by exchanges is important. Liquidity – the degree to which an asset or security can be quickly bought or sold in the market without affecting the price of the asset – is one of the main factors that distinguish stocks from investment such as real estate. If the investor owns the property, it may take months to convert that investment into cash. Since stocks are highly liquid, investors can move their money elsewhere almost instantly.
Dividend entitlement. Besides claiming assets, investors also receive a claim for any dividends paid by the company in the form of dividends. The management of the company basically has two options with profits: they can be reinvested in the company (thus, one hopes to increase the total value of the company) or paid in the form of dividends. Investors have no say in the percentage of dividends to be paid - the board decides this. However, when dividends are announced, ordinary shareholders are entitled to their share.
An opportunity to inspect the books and records of the company. Shareholders have the right to examine basic documents such as the company's bylaws and minutes of board meetings. In addition, the Securities and Exchange Act of 1934 requires public companies to periodically disclose their financial statements.
Most companies produce two copies of their annual report. Version 10-K must follow the registration requirements set by the Securities and Exchange Commission (SEC).
The right to sue for wrongful acts. Suing a company usually takes the form of a shareholder class action lawsuit.
For example, Worldcom faced a firestorm of shareholder class action lawsuits in 2002 when it was discovered that the company had significantly inflated profits giving shareholders and investors a misconception of its financial health.
$1.8B
The amount paid to settle 87 securities collective cases in 2021. 7
Shareholder rights vary from state to state and state to state, so it is important that investors review local authorities and public watchdogs. However, in North America, shareholders' equity tends to be standard for buying any common stock. These rights are necessary to protect shareholders from mismanagement.
Corporate Governance
In addition to the six basic rights of ordinary shareholders, investors should conduct thorough research on the corporate governance policies of the companies in which they invest. These policies determine how the company treats and informs its shareholders.
Shareholders' Rights Plan
Despite its name, this plan differs from the standard shareholder rights set by the government (the six rights mentioned above). Shareholders' equity plans define the rights of a shareholder in a particular company. (Information can usually be accessed in the investor relations department of the company's website or by contacting the company directly.)
In most cases, these plans are designed to give the company's board of directors the ability to protect the interests of shareholders in the event that an outsider attempts to acquire the company. The company will have a shareholder equity plan that can be exercised when another person or company acquires a certain percentage of the outstanding shares to prevent a hostile acquisition.
The way the equity plan works can be illustrated by an example: Let's say Cory's Tequila notices that its competitor, Joe's Tequila Company, has bought more than 20% of its common stock. The shareholders' equity plan may then state that existing ordinary shareholders have the opportunity to purchase shares at a discount from the current market price (usually a 10% to 20% discount).
This maneuver is sometimes referred to as the "poisonous pill". By being able to buy more shares at a lower price, investors get instant profits and, more importantly, dilute the shares owned by a competitor whose attempt at acquisition is now becoming more difficult and expensive. There are many technologies like this that companies can put in place to defend themselves against hostile takeover.
Sometimes there are few extras
Although free beer may be a little out of reach, there are companies that offer shareholders a bit of extras. Holders of at least 100 Carnival shares (CCL) receive room discounts when traveling on Carnival Cruises flights. 8 So do the shareholders of the Royal Caribbean Cruises (RCL). 9 investors in Intercontinental Hotels Group (IHG) can increase savings by booking hotel stays at discounted rates. 10 In the meantime, owners of at least 100 Ford (F) shares for six months can receive a discount on a new car.
Before buying ownership of a company, investors should conduct thorough research on its corporate governance policies. These policies define how the company treats and informs its shareholders.
The Bottom Line
The purchase of shares, which represents a claim to ownership in a company, provides certain rights. While regular shareholders may be the last to be paid when it comes to liquidation, this is offset by other opportunities such as a rise in the share price. Knowing your rights is an essential part of being a conscious investor. Although the SEC and other regulatory bodies try to impose a certain degree of shareholder rights, knowledgeable investors who fully understand their rights are less likely to take risks.