I have a question about what would happen if the relationship between investors and companies that issue stock changed. But first, let me state how I see the relationship between companies and their employees, and companies and their investors here in the US.
Oh, and I have a favor to ask. If I’m wrong about anything, please tell me why. Thanks.
Companies and employees. Here’s how I think the relationship is usually viewed:
An employer and employee make an agreement with each other about exchanging money for work. Other than what’s in the contract (if you have one) and following the law, the company doesn’t owe you anything. If they aren’t fully supporting you and advancing you along your career path then too bad. It’s not their responsibility and if you aren’t happy you can quit and get another job.
Companies and investors. Here’s how I think the relationship is usually viewed:
A company and investor make an agreement with each other about exchanging money for profits. The investor is someone with disposable income who wants to make more disposable income*. That makes them a god. If the company doesn’t fully support you and do everything they can to give you maximum return on your investment then the company is in the wrong. Legally they have to do whatever it takes, within the law, to give you a maximum return on your investment. If they don’t you can sue them.
Now for the question. What would happen if the company-investor relationship was like the company-employee relationship? In other words, companies wouldn’t be legally obligated to give investors the maximum return on their investments? They could if they wanted to, but they wouldn’t legally be obligated to.
*I’m aware that things like pension funds or 401Ks and so on have stocks in them also.
It is an incredibly poor idea. In the ideal of the employer-employee relationship, both sides are paying as they go: the employer gives the employee a paycheque every fortnight, and the employee gives the employer X hours of labour every fortnight. If one side or the other wants to end the relationship, all that remains is to tidy up the loose ends.
This is not true of the investor-business relationship. Here, the investor has already kept his side of the bargain (by giving them money in exchange for a share of the business), and is waiting for the business to keep theirs (by paying divedends as rent on that money). Your hypothethical would mean that the company would have the right to take the money you offer for a share of their profits, then turn around and say “I’ve got mine, so you can go to hell.”
If so, companies wouldn’t even get created. Or to be more precise, only small companies started and funded by families would exist.
Your scenario takes away the very reason for the investor to put his money at risk.
The founders of google.com got a $100,000 check from an early investor. Why would that investor part with that money if there’s no incentive for a profitable return? You can’t take away the psychological motivation for strangers to fund non-family companies and still expect companies to even exist at all.
What would it be like if you paid for a McDonald’s hamburger but they weren’t required to give the hamburger? Would McDonald’s continue to exist? Why would the investor (the customer) give up $2.00 for a hamburger if there’s no certainty or expectation that he will get back a hamburger?
Companies need investors. If a company treated their investors like shit they wouldn’t invest in the company any more and the company would have screwed itself over, right?
I’m assuming that If companies need investors then they’ll do everything then can to make them happy without a law forcing them to right? (I’m asking sincerely. I know my position probably is a bit naive, but I’m still curious.)
Companies are already free to offer only a limited return on investment, e.g. by issuing bonds that pay a stated percentage. Many companies do this; there is a lively market for corporate bonds. However those companies also issue stock, because there is a market for that too.
There is no reason in principle why an enterprise can’t be funded entirely with loan capital, with the proprietors contributing labour and enterprise, but no capital. But it’s not a common model, except for very small enterprises. Companies that need more capital than the manager/owners can provide need to offer something in return.
Or, to turn your question around, if the profits of an enterprise are not distributed to stockholders, who does get them? And why should someone who has contributed no capital receive the profits in preference to people who have? And, if that’s the deal offered, why would anyone contribute capital to such an enterprise, if they have the alternative of contributing it to an enterprise which will distribute profits?
A company that acted in such a fashion would only sabotage their ability to draw future investors. They’ve still got the money they got off the first bunch. And if they don’t need more investment to expand (either they’re relying on the savings from no longer paying dividends, or the company is just a Madoff-style scheme to get a pool of money to embezzle), it’s not going to screw them over.
Your idea provides no benefits whatsoever. All it does is legalise a scam.
OK, since you are asking, here is the Straight Dope…
There are, generally speaking, two ways that investors put money into a company.
The first is to buy bonds. A bond is a loan to the company; the company agrees to pay back the loan at a fixed rate of interest for a fixed period. The company is legally obligated to pay that money; if it defaults, the company is dissolved and any remaining assets are given to the bondholders (in fact, the bondholders will usually agree to something less dramatic in an attempt to get some money back, but that is up to them–if they insist, the company is gone).
The second way is to buy stock. The stockholders own the company, hire the management, and the management runs the company according to the best interests of the stockholders. If the stockholders are not satisfied, the managers are fired. Management has no legal obligation to return any money to the stockholders whatsoever, and in fact the number of companies that do return money to the stockholders directly is shrinking. If the stockholders direct management to pursue a course different than maximizing profits, management is duty-bound to follow that course (or they will be fired).
Now, it appears to you that the stockholders have very little power over management, but that is not true–it is just that in most companies, stockholder power is incredibly diffuse, and the only thing that the stockholders can agree on is to maximize the profits. However, legally, the stockholders have the authority to decide what the company does.
It’s true that the officers and directors of a company owe a fiduciary duty to the investors, the stockholders. But that’s not the same thing as saying they must “…do everything they can to give you maximum return on your investment.” It means they must not act against your financial interests. But a company can decide, for example, to contribute to charity, in the interests of making the world a better place, being a good corporate citizen, or whatever other altruistic goal moves the board of directors, and not breach their fiduciary duty to their shareholders.
In fact, a moment’s thought would make this clear: you know, or should know, that right now many companies donate to charity or sponsor charitable causes. If it were true that they could be sued for not doing “…everything they can to give you maximum return on your investment…” then how do you imagine such corporate charity could exist?
You all seem to be ignoring the basic misunderstanding in the OP. The investor’s relationship with a company is not merely contractual – it’s ownership. The company management is hired by the investors, and can be fired by the investors. An individual investor’s ability to exert this power is diluted by the existence of other investors, and blunted by the existence of an elected board of directors whose makeup can be strongly influenced – or even determined – by the company management, but investors can and do seize the reins directly when the management gets too independent.
ETA: Arrgh; I went away from the window without posting this, and Reno slipped in with the Dope.
No no no, profits are distributed to stockholders.
I’m just thinking about situations where shareholders pressure a company to increase profits and so the companies either consider layoffs or doing something that they consider unethical (but legal). I’m just wondering how things would change if companies weren’t under legal obligation to do those things to satisfy shareholders.
I’m assuming that there would still be laws against fraud so it seems that having the investors give money only for the company not to return any profit would be fraud.
Besides what Bricker said, there is a huge problem with the assumption in the OP, that is that anyone can tell what maximizes profits, and when they should be maximized for. The management of a company makes lots of decisions - how can you prove that the decision made, though it did not maximize profits, wasn’t a reasonable attempt to do so? Do you maximize profits for this quarter or over the next five years? Doe making gambles on siubprime mortgages which maximizes profits in 2007 but leads to gigantic losses in 2008 legal or not?
And obviously companies are not legally obligated to return a profit - most startups have business plans showing losses for the first few years. Nor must they return profits to the owners - most Silicon Valley companies invest profits, not return them in the form of dividends.
Shareholder value doesn’t have to mean maximum profits.
If the shareholders collectively value the idea of running a company as a barely-break-even operation, they are free to do so.
The shareholders could even deliberately vote to run it at a loss. (However, the IRS might take a closer look to make sure it wasn’t being used as a tax dodge or a money laundering scheme.)