Shareholder Primacy

Bad and Not so Bad Arguments for Shareholder Primacy

In the Introduction of the article of the author Lynn A. Stout pointed out the two arguments in regard to shareholder primacy that were made by Adolph A. Berle and Merrick Dodd.

Adolph A. Berle argued for “Shareholder Primacy” in that he believed that the corporation exists only to make money for its shareholders.

Merrick Dodd argued against it his view was “the business corporation as an economic institution which has a social service as well as a profit making function”.

Although both men have argued over this the result of what the interest of the business lie in still remains unsolved.

No one can be sure if the firm exists to increase shareholders wealth or to serve the interests of the stakeholders of the business. Yet there has been no more research has been done after the debate to solve the argument.

Therefore from this I can interpret that the argument is whether the interest in the business lies in the interest of the shareholders or stakeholders.

So then the author Lynn A. Stout goes on to list the arguments for and against these theories –

1. The Shareholder Ownership Argument for Shareholder Primacy.

In this argument the Author considers the most common argument which is that the Business “belongs” to its shareholders in that its main purpose to increase shareholder wealth. While shareholders do not own all of the business the do own a stake in it so for this their rights as “the owners” are quite limited this is where the Agency theory takes effect while shareholders are seen as the owners they do not manage the day to day running of the business that managers do. Shareholders do not receive a salary or wage like managers but rather receive a dividend which only can be received if the directors declare one. So my interpretation is that shareholders no not have any right of control over the firm’s assets. Then Lynn A. Stout goes on to talk about Fischer Black and Myron Scholes famous paper which looks at the options theory from this I can presume that its theory is that is the company is in debt the debtholders have the right to the companies cash where as the shareholders don’t.

So the theory behind the whole argument is that while the shareholders are involved in the Business they simply do not own the business.

2. The Residual Claimants Argument for Shareholder Primacy.

The second Argument the Author considers the fact that while the shareholders do not own the business they do have a stake in it meaning they have a claim to it. It then looks in to the theory behind this argument in the work of Frank Easterbrook and Daniel Fischel who conclude that the business is a contract between its Shareholders and Stakeholders, which again suggests Agency theory to me that while the Shareholders invest their money in the business the Managers run it to provide a service or good that its customers buy which inturn makes the profit for its shareholders. Therefore one can conclude that Stakeholders are entitled to fixed payments e.g. Wages and Salaries while Shareholders are entitled to receive dividends after the fixed payments have been made.

The Argument points out that Shareholders are infact the “Residual Claimants” as they took the risk to invest their capital in the business in return for a dividend. So therefore the theory that the interest in the business is to increase shareholder wealth is some what correct but the theory that they own the business and are entitled to everything it earns is incorrect.

Then it is pointed out that the only time the Shareholders are the Residual Claimants is when the business is actually in bankruptcy and that Shareholders will only received a dividend when two conditions are met theses are –

• The business must be doing well enough financially to permit the directors to declare a dividend.

• The directors must actually decide to declare a dividend.

These two points I believe to mean that if the business id financial stable then the directors can decide to pay out a dividend or to plough more money back into the business. More often when a businesses balance sheet or earnings statement permits they often choose not to pay it out. This is mainly because if the business boosts stock prices then this inturn increases share prices which keeps the shareholders happy. So therefore I can interpret from this that it’s either small dividend