Know Your Shareholder Rights (2024)

What Are Shareholder Rights?

If you just bought stock in Disney, as a part-owner of the company, does that mean you and the family can hit Disneyland for free this summer? Do Anheuser-Buschshareholders receive a case of beer each quarter?

These hypothetical perks are highly unlikely, but they do raise a question: What rights and privileges do shareholders have?

What Happens When Public Companies Go Bankrupt

Every company has a hierarchical structure of rightsforthe three main classes of securities that they issue: bonds, preferred stock, and common stock. In other words, there’s a pecking order of rights.

The priority of each class of security is best understood by looking at what happens when a company goes bankrupt. You may think that having an ownership stake in the company means you would be first in line to receive a portion of the company’s assets if it went bankrupt. In reality, common shareholdersare at the bottom of the food chain when a company liquidates.

During insolvency proceedings, secured creditors are the first to have their outstanding debts paid from the company’s assets. Unsecured creditors, such as banks, suppliers, and bondholders, are the next priority followed by preferred shareholders and, finally, the common shareholders. This hierarchy is determined by what’s called“absolute priority,” the rules used in bankruptcies to decide which portion of the payment will be received by which participants.

In addition to the rules of absolute priority, other rights differ foreach class of security. For example, a company’s charter typically states that only the common stockholders have voting privileges and preferred stockholders must receive dividends before common stockholders. The rights of bondholders are determined differently because a bond agreement, or indenture, represents a contract between the issuer and the bondholder. The payments and privileges the bondholder receives are governed by the indenture (tenets of the contract).

Risks and Rewards

Common shareholders are still part owners of the business, and if the business can turn a profit, common shareholders benefit. The liquidation preference we described above makes logical sense. Shareholders take on greater risk as they receive next to nothing if the firm goes bankrupt, but they also have a greater reward potential through exposure to share price appreciation when the company succeeds. In contrast, preferred stocks generally experience less price fluctuation.

Common Shareholders' Main Rights

1. Voting power on major issues.Voting power includes electing directors and proposals for fundamental changes affecting the company such as mergers or liquidation. Voting takes place at the company’s annual meeting. If the shareholder cannot attend, they can do so by proxy and mail in their vote.
2. Ownership in a portion of the company.When a business thrives, common shareholders own a piece of something that has value. Usually, the better a company performs and the brighter its outlook, the higher its valuation rises and the price that each share of ownership fetches. So, if you own a stake in a company that keeps growing profits, your slice of ownership should grow in value and be worth more than what you initially paid.
3. The right to transfer ownership.The right to transfer ownership means shareholders are allowed to trade their stock on an exchange. The right to transfer ownership might seem mundane, but the liquidity provided by stock exchanges is important. Liquidity—the degree to which anassetorsecuritycan be quickly bought or sold in the market without affecting its price—is one of the key factors that differentiates stocks from an investment such as real estate. If an investor owns the property, it can take months to convert that investment into cash. Because stocks are so liquid, investors can move their money into other places almost instantaneously.
4. Entitlement to dividends.Capital appreciation isn't the only way common shareholders make money. They also may receive periodic cash payments from the company they're invested in. Management of a company essentially has two options with profits: they can be reinvested back into the firm or paid out in the form of a dividend. Investors do not have a say as to what percentage of profits should be paid out—the board of directors decides this. However, whenever dividends are declared, common shareholders are entitled to receive their share.
5. Opportunity to inspect corporate books and records.Shareholders have the right to examine basic documents such as company bylaws and minutes of board meetings. In addition, the Securities and Exchange Act of 1934 requires public companies to periodically disclose their financials. Two of the most important documents are theannual reportand the Form10-K.
6. The right to sue for wrongful acts. Suing a company typically takes the form of a shareholder class-action lawsuit. For example, WorldCom faced a firestorm of shareholder class-action suits in 2002 when it was discovered that the company had grossly overstated earnings and given shareholders and investors an erroneous view of its financial health.

Shareholder rights can vary from state to state and country to country, so it is important that investors check with local authorities and public watchdog groups. In North America, however, shareholders' rights tend to be standard for the purchase of any common stock. These rights are crucial for the protection of shareholders from poor management.

Corporate Governance

In addition to the six basic rights of common shareholders, investors should thoroughly research the corporate governance policies of the companies they invest in. These policies determine how a company treats and informs its shareholders.

Shareholder Rights Plan

This plan differs from the standard shareholder rights mentioned above. Shareholder rights plans outline the rights of a shareholder in a specific corporation. The information isusually accessible in the investor relations section of a company's website or by contacting the company directly.

In most cases, these plans are designed to give the company’s board of directors the power to protect shareholder interests in the event of an attempt by an outsider to acquire the company. A company will have a shareholder rights plan that can be exercised when another person or firm acquires a certain percentage of outstanding shares to prevent a hostile takeover.

The way a shareholder rights plan works can be demonstrated via an example: Say that Cory’s Tequila Company notices that its competitor, Joe’s Tequila Company, has purchased more than 20% of its common shares. A shareholder rights plan might then stipulate that existing common shareholders have the opportunity to buy new shares at a discount to the current market price (usually a 10% to 20% discount).

This maneuver is sometimes referred to as a “flip-in poison pill.”By being able to purchase more shares at a lower price, investors receive instant profits and, more importantly, they dilute the shares held by the competitor, which makes its takeover attempt more difficult and expensive. There are numerous techniques like this that companies can put into place to defend themselves against a hostile takeover.

Sometimes There Are Little Extras

Although free beer may be a little far-fetched, there are companies that offer shareholders little extras.

For example, holders of at least 100 shares of Carnival can apply for onboard credits to spend when traveling on Carnival Cruises. Shareholders of Royal Caribbean Cruises also get similar special treatment. Investors in Intercontinental Hotels Group who hold their shares in certified form in their sole name, meanwhile, can book hotel stays for discounted prices.

The Bottom Line

Buying a stock, which represents an ownership claim in a company, provides certain rights. While common shareholders might be the last to be paid when it comes to liquidation, this is balanced by other opportunities such as share-price appreciation. Knowing your rights is an essential part of being an informed investor. Although the SEC and other regulatory bodies attempt to enforce a certain degree of shareholder rights, well-informed investors who fully understand their rights are less susceptible to risks.