Susan Watson: Small shareholders' rights of control are mostly illusory

The Government is quite right to view the sale of shares in SOEs as no more than a divestment of some of its investments, says Susan Watson. Photo / Sarah Ivey.

A few years back a property syndication investment company ran a television advertisement where an old man sat outside an office building and pointed out to his wife that he owned that window up there, the one on the fourth storey three along.

The joke was of course that the man felt he owned a piece of the building. The reality was that he had an investment interest in a property syndication company.

Small investors in listed companies who think they own the assets or business of the companies in any meaningful way may not see the joke. The truth is, a company owns its assets and business.

When investors acquire a small number of shares in a company listed on the stock exchange, they are acquiring a bundle of rights that entitles them to certain things from the company.

The most significant of those rights for most people is to receive a dividend, a share of the profits of the company, and the right to sell their shares at a laterdate.

What holders of small parcels of shares do not acquire is any real ability to control decision-making by the company. In a modern large company, decision-making rights sit with management.

The significance of separation of ownership (in the shareholders) and control (in the management) as companies grew and the shareholding became more dispersed was actually recognised more than 80 years ago, and the problem this caused for shareholding investors some 40 years later.

Companies are now conceived as a nexus of contracts - organisations surrounded by a web of interests including shareholders, creditors and employees but extending out to other constituencies such as suppliers, customers and the wider public.

The debate now centres on whether it is the shareholders as a body or the board that sits at the centre of that nexus. That, in turn, influences the debate about whether shareholders should be empowered or whether the board and management should be left alone to get on with their jobs.

No one seriously argues that small shareholders in large listed companies have any real control rights.

Even the apparent rights held by shareholders are more illusory than real - shareholders can vote on the appointment of directors but directors decide who will be on the ballot, shareholders can share pro rata in the dividends of the company but the directors decide how much of the profits of the company will be paid out as a dividend, and so on.

Holding shares is therefore an emaciated form of ownership.

Just as the old man looking up at the building doesn't really own any piece of the building, a shareholder only really owns the rights attached to the shares, not really in any meaningful way the company itself or its assets.

A purchase of shares in a large listed company such as the privatised state companies is the purchase of an investment. Because companies are such an ideal vehicle for aggregating capital and human resources, shares generally have proven to be good investments over time.

In terms of time spent and where expertise sits, it is rational to leave the running of that business to the board and management - there is plenty of evidence to show that the model generally works well.

What if shareholders seek decision-making rights, though?

The only way that shareholders can gain control over a company is by acquiring enough shares to control the appointment of board directors and to be able to pass company resolutions. For both that requires more than 50 per cent of the shares in the company being voted in favour. So what has all of this got to do with the partial privatisation of the state companies?

The Government has sold 49 per cent of Mighty River Power shares and intends, at least at this stage, to sell only minority interests in the other state-owned companies on the block.

That is very different from earlier privatisations where 100 per cent of the shares in the companies were sold; in other words, not just investment rights but control rights were transferred from the public to the private sector.

In this round, control and decision-making rights will remain with the Government as the majority 51 per cent shareholder.

The Government is quite right to view the sale of the shares as no more than a divestment of some of its investments (energy generation and retail companies) so that it can invest in other assets (new infrastructure and, more controversially, patching up existing infrastructure).

Mixed ownership offers another advantage.

The sharemarket acts as a barometer measuring the perceived health of listed companies.

The market - and others such as the press, financial analysts and investment banks - monitors management.

Share price is a good indication of how investors view management decisions.

The management of Solid Energy might not have been able to go ahead with expansion plans, had they been subject to the scrutiny of the market.

For a partially listed company, the market is a monitor for all investors, including for the majority stake held and controlled by the Government or, more correctly the public's share, our share.

Susan Watson is Professor in law at the University of Auckland School of Law.