Official and Actual Proprietary Rights of Shareholders

 

Alina SZEWC-ROGALSKA

 

Foreword

 

In the recent years there has been an increased amount of interest in shareholders’ proprietary control of enterprises among scholars, experts and proprietors. This issue is especially relevant due to the crisis of trust which followed after the collapse of Enron and other financial scandals. Moreover, it is also connected with the rise in the number of minority shareholders, who often have limited possibilities to exercise their proprietary rights through control.

Profusion of different forms of ownership and an increasingly complex proprietary structure of enterprises sometimes pose difficulties in unequivocally indicating individuals and groups who have the biggest influence on the way these enterprises are managed and who benefit the most, financially and otherwise.

Thus, the aim of this article is an attempt in demonstrating the official and actual proprietary rights of shareholders.

 

1. The essence of ownership and economic power in enterprises

 

            Proprietary rights or proprietary entitlements are relations formed between goods (subjects of ownership) and certain individuals or groups, for example shareholders (proprietors). The extent of proprietary rights is determined by the following entitlements of the owner:

-         to actually exercise control over goods,

-         to obtain all benefits produced by goods (for example in a form of income),

-         to manage a subject of ownership, i.e. directly or indirectly participate in making relevant decisions concerning its use.

The owner is able to transfer all or any part of their proprietary rights to other people on the basis of mutually agreed conditions. Ownership can be considered from many perspectives, especially legal and economic. From legal perspective, the proprietor is the official owner of a certain subject in accordance with laws in force in a given country. On the other hand, from economic perspective, the proprietor is the actual owner i.e. the one gaining most benefits and exercising most power when managing a given subject of ownership [13]. In the economic sense, ownership is in most cases perceived as a set of proprietor’s effectively exercised rights in relation to a given subject, without limiting these rights to those stated in any constitution or code [5].

In order to explain the nature of actual proprietary entitlements it is necessary to refer to concepts regarding economic power in an enterprise. Power can be understood as residual rights of control of key resources. Being in charge, which means having the residual rights of control, provides the best incentive to make certain investments and to protect them. Exercising power might also imply privileged access to valuable resources within an organisation and an ability to work with different people [8].

In case of the enterprises whose production is especially dependent on capital goods, the legal proprietor might have a lot of actual power. The ownership of these assets might be a source of power in itself and both power and ownership can be transferred through a transaction. On the other hand, in case of the enterprises which rely on the human capital in their production process, significant power might not lie in the hands of legal proprietors. More control over human capital and thus more power can be gained through adequately designed motivational systems. Moreover, internal mechanisms of control of access to the key resources can also be employed in gaining more of that particular type of power [9].

Outside investors who finance enterprises, gain proprietary entitlements to their assets. Nonetheless, they usually lack specialist knowledge to manage them, which makes it virtually impossible to exercise effective control resulting from their proprietary rights. Consequently, this situation makes investors transfer a large proportion of their rights of control over the assets stemming from the ownership itself, onto the managers they employ, who specialise in managing companies.

In practice, it is impossible to write a comprehensive agreement outlining all the actions of managers in every possible situation. The right to make decisions in cases not included in agreements usually lies with adequately trained managers. This, in turn, means that managers have a lot of residual rights of control and enjoy relative freedom in allocating the capital of outside investors [3].

The relation formed between the owners (shareholders) and the managers is defined as an agency relationship. According to the agency theory this relationship occurs when one party is dependent on the actions of the other. The parties involved are the principal and the agent. The principal employs the agent to provide services on their behalf and delegates part of their rights to make decisions. In the agency relationship prosperity and wealth of the principal (principals) depends on the decisions made and actions undertaken by the agent (agents). The basic problem lies in the fact that the interests of the principal might not be entirely satisfied due to differences between their aims and their agents’ aims and due to information asymmetry between them. The agent, being directly involved, has the information unavailable to the principal, who, in turn, cannot perfectly and without any costs, monitor the agent’s actions and information [2].

As J. Miroński notes [6]: “Principal’s power focuses on making decisions about possibilities of using tools of control and systems of encouragement. On the other hand, the agent’s power defines an area of their freedom and a degree to which they can concentrate on their own gain irrespectively of the principal’s interests or at their expense.” The principals and agents might constantly take actions in order to reduce their dependency and increase the dependency of the other party.

The principal as well as the agent have potential access to many sources of power. Sources of power can be divided into two categories: positional and personal.

Positional sources of power include:

·                    official position in the structure of an enterprise (here workers-agents are at a disadvantage)

·                    unofficial position in the network of mutual dependency within the company

·                    flexibility and importance of the performed tasks

·                    direct and evident influence on the other people’s work within the organisation

Personal sources of power are:

·                    professionalism (agents’ domain)

·                    interpersonal attractiveness

·                    professional commitment

·                    sanctioned behaviour

The use of official and unofficial influence, especially by the principals, has a significant effect on the functioning of an agency relationship. It is of utmost importance that using the power should be well balanced. Inappropriate way of using influence tools might lead to the agents’ frustration and opposition. The second condition of successfully exercising the power within an agency relationship is for the principals to seek approval for their own opinions, ideas and planned decisions. That is why, apart from using influencing techniques, it is necessary to form coalitions and seek new members that could join one’s interest group.

 

2.         Exercising control by different groups of shareholders

 

            Shareholders of the companies do not form homogenous elite. They differ in their expectations, attitudes, activity, their interest in influencing the decisions made by the company and in their participation in the ownership of the company’s capital. They can be split into groups of direct investors and portfolio investors. Portfolio investors are interested in obtaining income either through dividends or by trading stock on the secondary market. Above all, they strive to maximise their profits from their stock portfolio through adequate planning of its structure. They are not interested in influencing the company’s decisions. On the other hand, direct investors strive to obtain income as well as enough shares to exercise some control. They try to influence the company’s decisions through their control shares [10].

            The potential of such actions depends on the relation between the level of the controlling block integrity and the level of the stock distribution. The level of the controlling block integrity is determined by the number of shareholders, whose shares collectively form the controlling block. However, the level of the stock dispersal depends on the number of portfolio investors. Shareholders’ potential for influencing the decisions made within the company increases in the situation when the stock dispersal level is increasing and, at the same time, the number of shareholders in charge of the controlling block is decreasing [10].

            Due to the relevance of the votes possessed in relation to the actual power, five types of corporate governance can be distinguished (Table 1).

 

Table 1

Types of corporate governance

 

Type of governance

Characteristics

Private governance

One person or one family has more than 80% of votes during the general meeting.

Majority governance

One person or one family has more than 80% of votes during the general meeting.

Minority governance

One person or group has minority shares but due to the significant dispersal of the other votes, they are enough to obtain a dominating position.

Using the law to gain advantage

The ultimate power in the company is gained through the use of special issues, accumulating powers of attorney,  or cascade companies, etc.

Full managerial control

The power of managers comes from their access to information, as no group of shareholders have enough votes to make any decisions against the board, even when the board has very few shares or none at all.

Source: Author’s own interpretation on the basis of [4].

 

            In case of the high stock dispersal, the shareholders who have only few shares are not able to control the managers‘decisions through voting during the general meeting. Their share of stock is relatively small compared to the resources they would have to employ in order to take part in monitoring. Moreover, the expectation that someone else will take initiative to control the company in practice means that shareholders are passive. Thus managers are primarily concerned with their own interests compromising those of the shareholders. This type of agency conflict is typical for Anglo-Saxon countries where the outsider system of control is prevalent [7].

            On the other hand, another type of an agency conflict occurs when the ownership is concentrated. In such a situation, the relationship between the majority shareholder (working together with a loyal manager) and minority shareholder is somewhat problematic. The majority shareholder enjoys better access to information and has an ability to appoint people for the key positions in the corporation, which facilitates personal gain through control [1]. This imbalance threatens the position of the minority shareholders, especially since the division between the ownership and control is said to have grown due to the majority shareholders using law to their advantage through Class A (voting) shares, for example. Because of their privileged position in the company they can enjoy benefits disproportionably greater then those which would stem from their proprietary rights alone [7, 11]. The agency conflict described above is typical in the countries where the insider model of corporate governance is prevalent. In those countries, ownership lies in the hands of the majority shareholders or groups of investors.

            As mentioned above, majority shareholders may use Class A shares to their advantage. It may consolidate their position in the company at the expense of minority shareholders. The use of Class A (voting) and Class B (non-voting) shares causes discrepancies between the intensity of shareholders‘ financial relation with the company and the number of votes on general meeting.  The intensity of the shareholders financial relation with the company depends on their share in the company’s share capital. What depends on the intensity of this relation are a number of proprietary entitlements including participation in the shareholders general meetings and taking part in the work of the supervisory board [14].

            P. Tamowicz and M. Dzierżanowski [12] underline that the outsider system is characterised by „ownership without control“, which means that minority shareholders have more proprietary entitlements then they can actually use in exercising control over managers‘ and majority shareholders‘ actions. On the other hand, the insider system is described as „control without ownership“, which means one can exercise more control then one is entitled to solely on the basis of ownership. This situation can be described in the following way. The ordinary shareholders who usually participate in the shareholder’s general meetings are the ones who have more than 5% of votes. The other shareholders are dispersed and not interested in exercising their right to vote. For example, if there is only one shareholder who admitted having shares that entitle them to more than 5% of votes during the general meeting, it means that they can exercise complete control over the company (regardless of the amount of shares they have, i.e. if they have 10% or 75% of votes)

 

Conclusions

 

            The above attempt of analysing investors’ proprietary rights and their actual participation in exercising control over the enterprises, leads to the following statements and conclusions:

 

Key words

ownership, control, shareholders

 

Bibliography

1.         GROSSMAN S. J., HART O. D.: One Share - One Vote and Market for Corporate Control, “Journal of Financial Economics” 1988, no. 20, pages 175-202. ISSN 0304-405X

2.         JENSEN M. C., MECKLING W. H., Theory of the Firm: Managerial Behavior, Agency Costs and Ownership Structure, “Journal of Financial Economics” 1976, no 3, pages 305-360. ISSN 0304-405X

3.         KULTYS J.: Natura firmy, problemy agencji i nadzór korporacyjny, [w:] A. WOJTYNA (red.), Instytucjonalne problemy transformacji gospodarki w świetle teorii agencji, AE w Krakowie, Kraków 2005, pages 22-63. ISBN 83-7252-259-6.

4.         MACHACZKA J., MISIOŁEK K.: Federalizm a nadzór korporacyjny, [w:] S. RUDOLF (red.), Ekonomiczne i społeczne problemy nadzoru korporacyjnego, Wyd. Uniwersytetu Łódzkiego, Łódź 2004, pages 57-70. ISBN 83-7171-732-6

5.         MILEWSKI R. (red.): Podstawy ekonomii, PWN, Warszawa 2003, page 23. ISBN 83-01-13010-5

6.         MIROŃSKI J.: Relacja agencji w teorii przedsiębiorstwa, „Gospodarka Narodowa” 2005, nr 4, pages 1-16. ISSN 0867-0005

7.         POPŁAWSKI W.: Akcjonariusze mniejszościowi i ich pozycja na rynku kapitałowym, „Organizacja i Kierowanie” 2003, nr 1, pages 59-75. ISSN 0137-5466

8.         RAJAN R. G., ZINGALES L.: Power in a Theory of the Firm, „Quarterly Journal of Economics” 1998, no 113, pages 387-432. ISSN 0033-5533.

9.         RAJAN R. G., ZINGALES L.: The Influence of the Financial Revolution on the Nature of Firms, „American Economic Review” 2001, no 91, pages 206-211. ISSN 0002-8282.

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11.       SZEWC-ROGALSKA A.: Nierówności z pozycji interesów akcjonariuszy mniejszościowych, „Gospodarka Narodowa” 2006, nr 10, pages 49-60. ISSN 0867-0005

12.       TAMOWICZ P., DZIERŻANOWSKI M.: Własność i kontrola polskich korporacji. Ewolucja struktur własnościowo-kontrolnych,  seria:  Transformacja Gospodarki, IBnGR, Gdańsk 2002, nr 110 (raport z badań)

13.       TITTENBRUN J.: Ekonomiczny sens prywatyzacji, Spór o wyższość własności prywatnej nad publiczną. Wyd. Fundacji Humaniora, Poznań 1995, page 25. ISBN 83-7112-182-2

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Summary

 

            The aim of this article is an attempt in demonstrating the official and actual proprietary rights of shareholders. Minority shareholders’ official rights of control which stem from proprietary rights bear little relation to their actual right of control. Dominating shareholders and strong managers may in reality gain more benefits than they are entitled to, based on their proprietary entitlements alone.

 

Author’s address:

 

Dr Alina Szewc-Rogalska  [PhD]

Uniwersytet Rzeszowski [Rzeszów University]

Wydział Ekonomii [Faculty of Economics]

ul. Plac Ofiar Getta 5

35-002 Rzeszów

Polska

Tel.: +48 17 872 20 96

E-mail: aszewc@univ.rzeszow.pl