There is a widespread perception that owning shares (common equity) means you own a part of a business. This all sounds very attractive: “Look at me. I invest and own businesses”. However, technically, what common share holders own is simply voting power at the annual shareholder meetings. Effectively speaking, then, reality is not nearly as impressive. If, for example, you own $50,000 worth of UPS shares and you decide to walk into one of their parking lots and take a ride in one of their delivery trucks because, as you claim, you pretty much own that $50,000 truck, you will probably get arrested. In reality then, you don’t really own part the company. You own the shares which gives you a right to vote at the meetings.

Now presume that the business is not paying any dividends, then what common shareholders are paying for are simply those voting rights.

What are such voting rights worth?

Well, for major shareholders, that is, who could be said to have some “political power” at the meetings meaning being able to direct the actions of the company (and actually borrow/take the truck), this may have a lot of value. Conversely, minor shareholders are seldom that organized and mostly they have little power and only get to vote on whatever choices are handed to them in the proxy statements.

This is similar to how real elections are held for governments.

From this we derive that the value of the company is more than zero because those who want a controlling interest in the company are willing to pay for them.

Another common legend is that shareholders have claim on earnings. Same thing! While the claim is there theoretically, small shareholders have little or no direct control over earnings. The goal of management is not necessarily to maximize shareholder profit. It may just as easily be to maximize their use of corporate jets, pension programs, golden parachutes, etc. Management and workers (and government) may certainly arrange matters so that the company is productive yet shareholders end up with no payout. In particular, since managements are often awarded with stock options, a popular strategy is share buy backs regardless of whether the shares are trading at a good price or not.

So essentially, if you like to attend the annual shareholder meetings and get your free cup of coffee while exercising your voting right as a corporate citizen, being an equity holder may be a good deal for you. If you don’t care for that, you are simply holding a certificate that just give you that right. This certificate is valued simply for what it would be worth to some other guy (pursuing a controlling interest) and it may not necessarily be connected to any form of intrinsic value of the company and it could easily be connected to the hype of the stock market.

As they say: “Money talks, b … walks.” (but sometimes it walks quite far) … (and sometimes, then, it falls over a cliff.)

It may be well to compare it to owning a rental unit. Now, imagine you buy a rental unit with the following difference. Specifically, for this particular house, the tenant does not pay rent! Instead he takes all the money he would have paid in rent and possibly even some of his own and uses to upgrade the house. Maybe he paints the walls or installs new counter tops. This presumably increases the value of the house. Of course you can sleep well knowing that your tenant has an MHA, a master of home improvement administration, yay! To give himself incentives he sells off part of your house by issuing options on shares to himself. After a while you find you only own 98% of the house. He can do that. Sometimes, just to reward himself for a particular nice plumbing job, he gives himself a bonus and spends it on a vacation.
Also, maybe he decides to spend some of the no-longer-rent money on a car for the garage he can drive around in. You don’t really control this beyond being able to sell the house. Your hope is that someday you can sell the house for more than you paid for it due to these improvements. In return you give up control and income.

So yes, sure you own the house. And yes, it is likely that the house will be improved and grow more valuable. However, you have neither control, nor do you see any rent money.

Would you buy a rental unit under those conditions?

Originally posted 2010-04-29 01:06:36.