In the good old days, the equity section of the balance sheet was called “Owners’ Equity.” Today, most companies call it “Shareholders’ Equity” or just “Equity.” What is this section all about, and what does it tell us about accounting as a social practice?
Accounting gives special status to the company’s financial obligation to its shareholders, by separating it out and giving it the name equity. Obligations to everyone else are called liabilities.
Liabilities are limited in size. Once a liability has been paid in full, the creditor in question ceases to be a creditor. They may continue to have some other relationship with the company - for example, they might be workers who were owed a week’s wages, or a bank that provided a loan alongside other financial services - but once they are paid, the “creditor” part of their relationship is over. The workers go back to being workers, the bank goes back to being a place where the company does its banking.
Equity, however, is a permanent and unlimited obligation. Unless a shareholder actually sells their shares back to the company, no amount paid to them by the company can ever change their status as shareholders. No matter how successful the company becomes, the obligation to the shareholders never reaches a limit. Creditors don’t enjoy this kind of upside.
A share of what's left
In the end, however, the shareholders only share what’s left after the creditors are paid. Even if something is left for them, they may never get their hands on the money, because the company is free to hang onto it and reinvest it. The best the shareholders might do is sell their shares to someone else, hopefully at a profit.
Shareholders don’t have any other rights and privileges, unless you include voting at the Annual General Meeting. This isn’t much of a privilege unless you own a large percentage of the shares. Corporations are not democracies. It’s not one person, one vote. It’s one share, one vote. If you only own a few shares, you don’t have much say at the AGM.
So let’s be clear. Shareholders in a modern public company only own a claim on the equity. They do not in any practical sense own the company.
Anyone who doubts this is free to buy one share of Apple, walk into its offices at 1 Infinite Loop, Cupertino, CA, and try to act like an owner. Go ahead! Order the staff around. Drop into the CFO’s office and demand to see the books. You will soon be picking yourself up from the sidewalk.
So who are the owners of a company?
In a small company, like a bakery or a coffee shop, the shareholders often work at the company. They may have founded the business, and they often still run it by providing management and much of the labour. This is the kind of situation we usually have in mind when we talk about the owners of a company. It’s a nostalgic image.
Most large and medium-sized companies, like banks and phone companies and mining companies, are not run by the majority shareholders. True, senior managers like the CEO often own shares, but they aren’t the majority owners. Consider Apple again. Apple CEO Tim Cook is the company’s second largest individual shareholder. He owns over a million shares. This sounds like a lot, but there are four institutional investors that each own over 100 million shares, led by the Vanguard Group at almost 330 million shares. At Apple, as with practically all large corporations, the shares are mainly owned by institutions like pension funds, mutual funds, and insurance companies. All Apple’s employees together, including Cook, own approximately 0% of the shares. Zero per cent.
So the institutional investors own the company, right? Well, consider the 330 million shares owned by Vanguard Group. These amount to just 6.02% of all Apple shares. This means that even the biggest shareholder at Apple doesn’t own enough shares to have significant influence over the company. Significant influence in a public company is usually considered to start at somewhere around 20% of the shares.
My point is that no one owns Apple. There are no majority shareholders. In fact, in Canada, the UK, and the US, it is quite rare for a publicly traded company to have a shareholder with more than 25% of the shares. Corporate shareholding, for all the angst generated by stock markets and for all the political pressure put on government leaders to keep the stock market from crashing, is not a system of ownership. It is a system for diversifying the risk of investors by allowing them to purchase small bits of many companies. Or, looked at from a different perspective, it is a system for diffusing shareholder power.
As a result of the thin distribution of corporate shares over vast numbers of shareholders, corporate managers have become largely autonomous, with far more power to run the company than any shareholder.
Disagree? Consider the Board of Directors. The directors of a corporation is supposed to provide guidance and oversight to senior corporate managers, in order to safeguard the interests of the shareholders. However, almost all directors of large corporations in the Western world are part of an elite dominated by white men. Don’t take my word for it. Download any ten annual reports from the websites of large corporations and look at the pictures of the board members. They look an awful lot like me.
This problem of narrow (i.e., white male) representation on major corporate boards is compounded by the fact that many corporate directors are also managers of other corporations. Look at Apple one more time. Its largest individual shareholder, slightly ahead of Tim Cook, is the Chairman of the Board, Arthur Levinson. (Apple uses the term “Chairman.” Enough said.)
Who is Arthur Levinson? Can he protect the shareholders from the power wielded by Tim Cook and the other senior Apple executives? Levinson, in his day job, is the CEO of Calico, another technology company. Calico is looking for ways to dramatically extend the human life span. This sounds nice, but I suppose it depends which humans.
Calico is owned by Alphabet, the parent company of Google. Now think about that. A Google employee chairs the board of Apple. This means that the senior managers of major tech companies are governing each other. It’s like me leaving the exam room and telling my students to invigilate themselves – which sounds ruder than it is.
The all-too-convenient arrangement of senior executives of public companies serving on each other’s boards exemplifies what passes for corporate governance in major public companies. They are called public companies, but the general public has no direct influence and the shareholders, who provide a veneer of democracy, have almost no influence either. Oversight of senior management is supposed to be provided by the Board of Directors, but many board members are senior managers themselves elsewhere, and therefore have a personal interest in making sure these senior managers enjoy autonomy and lucrative compensation.
The notion of accountability when it comes to senior managers is therefore paper thin. When accounting produces financial statements that, by virtue of a special section called “Shareholders’ Equity,” reinforce the illusion of shareholder power, it helps prop up this managerial elite. It creates the impression that the shareholders have political power over the company when they don’t.
All shareholders own is a claim on the residual portion of the company’s wealth. And as it turns out, actually getting one’s hands on this wealth can be difficult. We’ll see this clearly next time, when we examine Apple’s balance sheet.