Shareholders can legitimately sue corporations for not acting in the best interest of the shareholder. But why is the legal system involved in this? Shouldn’t the solution be for the shareholder to sell their shares if they deem the corporation isn’t acting in their interest? Is there a simple explanation on how this came to be?
Uh… I meant to place this in General Questions but on second thought a debate on this would be interesting.
When you buy shares of a company, you are literally buying a piece of the company.
When shareholders sue, it’s not because the company isn’t acting in the interest of the shareholder. They sue because the board of directors isn’t acting in the interest of the company itself, which they have a legal obligation to do.
I guess because selling shares is not an adequate remedy in many instances. If I own 25% of a company (let’s say it’s worth $1 million), the the Board and Management screw it up and the shares are now worth $400,000, selling the shares doesn’t really help me. Obviously, the price can go up and down without malfeasance at the top levels, but if I can establish an actionable breach of their duty towards the shareholders, why shouldn’t I be able to sue them in court and recover what I lost?
Is suing the company a great remedy, though? If you win, and prove that the company has damaged shareholders, then the company should pay off all the shareholders that it damaged, right? But it pays them out of its assets, which the shareholders already have a claim to, and which will reduce the value of their shares by that amount.
I don’t know. I think there are law firms that do nothing else, so perhaps it’s a lucrative pursuit. Maybe it’s covered by insurance. Maybe the company has plenty of other assets. If I lost $1 million because Bill Gates violated some duty, Microsoft could pay me what I lost without effecting the share price. I’m far from an expert on these matters, but I would assume that if people are bringing these lawsuits, they’ve thought it through and think it will benefit them.
But didn’t all the other shareholders lose as well? And won’t they also sue and win and get paid? That will certainly affect the share price.
It’s a common misconception about the market. Warren Buffett has an analogy where you own a working farm, and you’re doing pretty well, but every day your neighbors are shouting offers for your farm. Some are good, some are bad, but at the end of the day what they say is irrelevant if you want to own a farm.
Nowadays, everyone sees shareholders as in it for a quick buck - and many are, rather than people that are invested in a business they want to own - which many are.
If I actually want to own a chunk of Twitter, selling my shares to Elon doesn’t do me much good. He’s offering more than some people think they’re worth, but that’s short-sighted. After all, the value’s doubled in the last 5 years, so odds are good I’ll make that just hanging on to them.
I believe that what effectively happens is that only the people who (1) owned shares during the alleged malfeasance and (2) don’t own shares any more are filing the suits.
So, for example a $1m cap stock goes down by ~20% after some bad action comes to light, and 50% of shares sell. The previous owners of those shares sue for the $100k they lost, they win, and the company pays them. So previous shareholders who held effectively lose 25%, and the new shareholders, who bought from the older shareholders, lose 5% as well. Doesn’t seem like a great stride toward justice.
My question wasn’t about whether it is right to sue or not, but why is it illegal for directors to not act in the best interest of the company? As far as I know, this isn’t a breach of contract type deal, this is just a part of US (or maybe just Delaware?) corporate law.
Correct. It’s a principal called duty of care.
My lay understanding is that it can be difficult to prove, but is based on something called the business judgement rule.
I think the simple explanation is that corporations are entirely “creatures of statute”. They are an artificial entity, created by the law, and the relationship of a shareholder to a corporation is entirely regulated by law. Why shouldn’t a shareholder be able to go to law to enforce their legal rights under the law governing the corporation, just like with other laws?
Plus, if the actions of the corporation have damaged the economic interests of a shareholder, how would selling the shares help?
Suppose a corporation with three shareholders, with equal shares. Although the profits are supposed to be shared equally under their corporate charter, suppose A and B decide to split all the profits amongst themselves, and give nothing to C. At the shareholders meeting, A and B vote to distribute everything to themselves, and the motion passes, with two-thirds of the shares voting in favour (A and B), and one-third opposed (C).
How does selling their shares help C? They need to go to court on an action for minority shareholder oppression, to get their share of the profits.
Corporations are creatures of law, and operate under a charter which is a form of contract. The shareholders, the board of directors, and the government are parties to that contract.
The board of directors have a fiduciary duty to the shareholders, specified in the corporate charter. Just like any other provision of any other contract, the legal system is there to resolve disputes.
~Max
Yep
What does fiduciary mean?
Fiduciary duty requires board members to stay objective, unselfish, responsible, honest, trustworthy, and efficient. Board members, as stewards of public trust, must always act for the good of the organization, rather than for the benefit of themselves. They need to exercise reasonable care in all decision making, without placing the organization under unnecessary risk.
I’ll try this again in a different way: Why should corporations have a legally-enforced fiduciary duty to the shareholders? What is this intended to prevent from happening?
Lots of bad things could happen. As one example, they could sell a million dollar asset to themselves for $5. If someone is a fiduciary, their obligations have to be legally enforced or they don’t really exist. What’s the objection to imposing duties on board members and senior management?
The “corporation” is simply a bunch of legal agreements. What you’re actually asking about is the Board of Directors, which are elected by shareholders and charged with representing the interests of the shareholders in setting policy and guidance to corporate management.
Let’s use a familiar example. You hire a real estate agent to help sell your house. That agent has a legal responsibility to present any offer to buy to you. They have a responsibility to disclose whether they have a relationship with the buyer. They have a responsibility to separate the money that changes hands from their personal money. Not doing those things is not acting in your best interest, and the law provides remedies if the real estate agent violates their responsibilities.
All contracts are legally enforced. If a shareholder’s rights are violated / if a director shirks his fiduciary duty, the shareholder asks a judge to enforce his rights. Just like if you write up a divorce contract, and it is violated, you go to a judge to enforce your rights under the contract.
~Max
Are shareholders suing corporations for money or to force them to act in a certain way? Change the board of directors, make them sell more stock or stop them from selling more, make then issue a dividend, etc?
Shareholder suits come in two types. They can sue in their own right, for things like, I’m not being paid my dividend and I have a right to be paid. They’re not letting me vote for the board of directors. They’re not letting me review the company accounts, but section 3 paragraph b says I have that right. etc. Shareholders get the damages in this case, after their lawyers take a cut.
The other type is when a shareholder files a derivative lawsuit, meaning they file against the CEO or whoever on behalf of the corporation. I think you have to get either the board, or so many shareholders to sign off on it (not a lawyer, don’t quote me). This is for things like, he’s embezzling money, he’s selling out to our competitor, he’s violating the law, he’s generally not meeting his fiduciary duties, etc. All harm the corporation. So the corporation gets the damages after the (shareholders’) lawyers take their cut.
~Max