Many people think of shareholders as owners of the corporations in which they invest, but this perception bears little resemblance to the truth. In the most basic sense, the relationship between a corporation and its shareholders is for each to profit from the activities of the other. This mutually beneficial relationship is essential to the modern market economy, and creates enormous wealth for those who have the means to participate in it.
Corporations issue stock to acquire funding. Investors buy the stock, providing the funding, with the expectation of eventually profiting from their purchase. An “initial public offering” happens when a corporation issues stock for the first time; generally, the process is called “underwriting.” Usually, it involves a third-party, such as an investment bank, which raises capital from investors on behalf of the corporation so that the corporation need not expend the effort directly. When corporations raise money this way, they can expand their business considerably. Shareholders in the primary market thus provide corporations — particularly young corporations — with a key means of growth.
The vast majority of shareholders in a corporation trade their stock on the secondary market, which does not directly involve the company at all. Instead, the investors trade shares with each other. The most familiar stock markets, such as the New York Stock Exchange, cover this secondary market. Corporations benefit from this activity in numerous ways, primarily when the value of the stock rises. For example, a higher stock price permits a corporation to issue new stock for more money. Also, the key figures in the corporation — founders, executives and major shareholders — personally benefit from a higher stock price even when the corporation itself does not. Like any business, large corporations exist to profit the people who control them.
Shareholders control numerous powers over a corporation through their investment. They often have the right to buy more stock, or sell it. They are entitled to a dividend if the company declares one, relative to the value of their investment. And they have a voice in who sits on the board of directors, although this usually only matters to major shareholders. However, shareholders are not actually “owners” of a corporation, and do not have any direct claim on the corporation’s profits and assets. Also, only those shareholders in the primary market are true investors in the corporation.
Both corporations and shareholders benefit from their relationship, when the business does well. Corporations can raise money, enrich their leaders, and build wealth through no direct effort of their own thanks to perceptions on the secondary market. Shareholders can buy stock at a lower price and sell it at a higher price, turning a profit, and they can exert limited control over the company to boost those profits by advising what course they should like the corporation to take. They can also build their wealth by holding stock and not selling it, enabling them to build more wealth in other ways, such as by getting loans backed by their stock holdings and using the loans to make more investments or grow their own businesses.
Josh Fredman is a freelance pen-for-hire and Web developer living in Seattle. He attended the University of Washington, studying engineering, and worked in logistics, health care and newspapers before deciding to go to work for himself.