What Is the Relationship Between a Corporation & Its Shareholders?
Private corporations offer shares of the company for sale to investors to generate funding. This brings a new player into the business, the shareholders. The relationship between a privately held corporation and its shareholders depends upon the corporate charter, shareholder agreements and shareholder provisions. However, most shareholders have common rights and a standard relationship to the corporation that they partially own.
The corporation as a whole has a duty to the well-being of the shareholders, as the shareholders are considered owners of the corporation. Typically, directors of the corporation are elected by the shareholders. The corporation is run for the benefit of the shareholders, who delegate their authority to directors and managers. The corporation is obligated to act in the best financial interest of the shareholders, but this is sometimes constrained by legal concerns or by other stakeholders such as consumers, employees and the general public.
Although the shareholders are the legal owners of the corporation, they have limited avenues to make decisions. Shareholder meetings offer an opportunity for the shareholders to review and vote on pertinent issues, but many decisions made by management are arbitrary and can’t be compared to other businesses in the industry. Information is often clouded for shareholders of privately held corporations because accounting doesn't have to follow rigid federal regulations that apply to publicly held companies. Chief executive officer pay, for example, is not restricted. Unlike public corporations, privately held companies do not have as many disclosure rules. Shareholders -- often family members, angel investors and those close to the owners -- are not as concerned with the day-to-day operations or accounting procedures as they are with profits.
Although the corporation is obligated to its shareholders, this can become murky legal territory. Corporations are defined as legal persons, and upper management is primarily obligated to act in the corporation’s best interest as it is defined in its charter. Primary shareholders in private companies often are upper management as well. So while the company has the goal of maximizing profits and shareholder values, the board of directors can take its own initiatives. This is usually not an issue at private firms, except when the board of directors takes actions that harm the other shareholders’ value in the short term, with a view to long-term gain.
Shareholders of privately held corporations can vote out directors if they can garner a majority. The shareholders own the corporation, while the managers control and direct it. However, this does not take account of the power that shareholders derive from ownership and voting rights. Although shareholders who don’t hold management positions do not have any rights to directly formulate corporate policy, they do have the right to elect or refuse to re-elect directors to run the corporation. They are free to organize and choose directors from their own ranks, meaning that while outside shareholders as a group may not have the right to formulate policy, they can exercise decisive control over how policy is made and carried out.