Accounting For Canadians For Dummies by John A. Tracy

Author:John A. Tracy
Language: eng
Format: epub
Publisher: Wiley
Published: 2011-12-06T05:00:00+00:00

Now consider this: The main purpose of issuing additional shares is to deliberately dilute the market value per share. For example, a publicly owned corporation doubles its number of shares by issuing a two-for-one stock split. Each shareholder gets one new share for each share currently owned, without investing any additional money in the business. As you would expect, the market value of the stock drops in half — which is exactly the purpose of the split, because the lower share price is better for stock market trading (according to conventional wisdom).

Recognizing conflicts between shareholders and managers

Shareholders (including managers who own shares in the business) are primarily concerned with the business’s profit performance; the dividends they receive and the value of their shares depend on it. Managers’ jobs depend on living up to the business’s profit goals. But although shareholders and managers have the common goal of optimizing profit, they have certain inherent conflicts of interest:

The more money that managers make in wages and benefits, the less shareholders see in bottom-line net income. Shareholders obviously want the best managers for the job, but they don’t want to pay any more than they have to. In many corporations, top-level managers, for all practical purposes, set their own salaries and compensation packages.

A public business corporation establishes a compensation committee consisting of outside directors that sets the salaries, incentive bonuses, and other forms of compensation of the top-level executives of the organization. An outside director is one who has no management position in the business and who, therefore, should be more objective and should not be beholden to the business’s chief executive. This is good in theory, but it doesn’t work out all that well in practice — mainly because the top-level executive of a large public business typically has the dominant voice in selecting the persons to serve on its board of directors. Being a director of a large public corporation is a prestigious position, to say nothing of the annual fees that are fairly substantial at most corporations.

The question of who should control the business — managers, who are hired for their competence and are intimately familiar with the business, or shareholders, who may have no experience relevant to running this business but whose money makes the business tick — can be tough to answer.

In ideal situations, the two sides respect each other’s contributions to the business and use this tension constructively. Of course, the real world is far from ideal, and in some companies, managers control the board of directors rather than the other way around.

As an investor, be aware of these issues and how they affect the return on your investment in a business. If you don’t like the way your business is run, you can sell your shares and invest your money elsewhere. (However, if the business is privately owned, possibly no ready market exists for its shares, which puts you between a rock and a hard place.)

Partnerships

Suppose you’re starting a new business with one or more other owners, but you don’t want it to be a corporation.

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