How Corporations Work – Part 2

To understand an corporations, we have to understand how they are organized. Within an organization, there are usually three entities:

 

Shareholders

 

Shareholders are individuals who actually own stock in the company. If I own a single stock of Alphabet, then that makes me a shareholder of Alphabet. Corporations can have as many or as little shareholders as they want, depending on how much shares a corporation has, and how many each shareholder has.

 

As a shareholder, you would likely want two things to happen. First, you’d want your shares to increase in value. If you bought a share for 20 dollars, you’d likely want for that share to grow to greater than 20 dollars in the future, so you can sell it off for a profit. Second, you would likely want a steady stream of dividends. Dividends are recurring cash payments given to shareholders. Of course, you could be ok with only one of these things happening. If you believe that Microsoft stock was going to grow extensively, you may be willing to give up short-term dividends because you value stock appreciation. Microsoft shareholders did not receive dividends for decades after Microsoft’s IPO, but shareholders tended to be ok with that, due to increasing share prices. On the other hand, you could hold on to a stock such as Coca-Cola, which is known for its steady dividends, and be less concerned about the fluctuation in Coca-Cola’s prices.

 

As an official owner of a company, shareholders would want to make sure that the company is taking actions that will ensure profit. However, most corporations have thousands upon thousands of shareholders. Coordinating decisions from all these shareholders on how company strategy should be implemented, who to hire, etc. is very difficult. This becomes especially hard if there is a lack of expertise by the shareholder. If I own a share from a pharmaceutical company, there are certain decisions I would not want to make, due to my lack of experience in pharmaceuticals. However, I would have power in deciding who gets to make these decisions. This is why a Board of Directors exists.

 

Board of Directors

 

The Board of Directors is a board of around 7 or so members (more or less). These people are meant to represent shareholders, and become a part of the Board of Directors by election by the shareholders. Usually, shareholders have a one share-one vote policy, so shareholders who have more shares in the company have more sway in deciding who the Board of Directors should consist of.

 

The Board of Directors has certain powers. These include how dividend distribution to shareholders, hiring decisions of senior executives, and executive compensation. Obviously, because directors can be added or removed by shareholders, it is in the Board’s best interest to make decisions that satisfy the requests of the shareholders.

Within the Board of Directors is a particularly special decision deemed “Chairman of the Board”. This position has the most power among the Board, typically has the highest stake in the company, has the most voting power, and makes major general decisions involving the company. Sometimes, the chairman and the CEO are the same person, which brings us to employees.

 

Employees

 

Employees are individuals responsible for the day-to-day operations. Generally, most of us have a good idea who employees are. The janitor on an office floor is an employee, as well as the researcher in a pharmaceutical lab, or an analyst in a hedge fund. These individuals all make up the employees section of a company, and they are responsible for keeping the company a money making machine.

 

The higher up we go in a employee org chart, the closer we reach “C-level employees”, or “Chief (blank) Officer). These are the employees with most power, and typically are in charge of a certain division of the company. Examples include COO (Chief Operations Officer), CTO (Chief Technology Officer), CMO (Chief Marketing Officer), and so on. The individual who makes the most decisions hower, is the CEO (Chief Executive Officer).

 

We sometimes imagine the CEO to be the most powerful person in a company, but ultimately, the CEO is an employee, and must answer to the Board of Directors. However, it is typically true that the CEO is the most powerful employee in the company, and is in charge of the day-to-day management of the company and making corporate decisions. The CEO must also act as a bridge between the Board of Directors, and the employees.

 

Fundamentally, this is how most modern corporations operate. Understanding this structure should make one realize that upper management isn’t as powerful as we imagine them to be, nor are shareholders, or the Board of Directors. It is the interwoven system of incentives that drives corporate action.

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