How Companies Work: Corporate Finance Basics
Who Controls a Company? Boards and Shareholders
How corporate governance balances power between shareholders, the board of directors and managers, and why it matters.
A large company may have millions of shareholders, but none of them runs it day to day. Managers do. Corporate governance is the system of rules and practices that decides how companies are directed and controlled, and how managers are held accountable to owners.
The board of directors
Shareholders elect a board of directors to oversee the company on their behalf. The board hires and can fire the chief executive, approves major decisions like mergers, sets executive pay, and oversees the accuracy of financial reports.
Many governance codes call for independent directors: board members with no close ties to the company’s management, who can challenge the executives more freely. In India, the Companies Act of 2013 requires listed companies to have at least one third of their board made up of independent directors.
Shareholders’ powers
Shareholders usually vote on electing directors, major changes like mergers, and in many countries on executive pay. Large investors, such as pension funds and index fund managers, have growing influence, and some shareholders, called activist investors, buy stakes specifically to push for changes.
Why governance matters
Governance addresses the principal-agent problem at the heart of the modern company: shareholders own it, but managers control it. Weak governance can let managers pursue their own interests, such as excessive pay or empire-building, at shareholders’ expense. Research has linked stronger governance to better company performance, though cause and effect are hard to untangle.
Some companies, especially technology firms, issue two classes of shares. The founders hold shares with many votes each, while public investors buy shares with one vote or none. This lets founders keep control even with a small share of ownership. Supporters say it lets founders pursue long-term plans without pressure from short-term investors. Critics say it removes a key check on management.
Stakeholders
A long-running debate asks whose interests a company should serve. One view, associated with Milton Friedman, holds that a company’s responsibility is to its shareholders, within the law. Another view says companies should balance the interests of all stakeholders, including employees, customers, suppliers and communities. Laws and norms differ across countries.
Shareholders rarely make business decisions. They elect directors who oversee managers. Their power is real but indirect, exercised mainly through votes and by buying or selling shares.
- Corporate governance governs how companies are directed and how managers are held accountable.
- Shareholders elect a board of directors, which oversees and can replace the chief executive.
- Independent directors and shareholder votes help check management.
- Debate continues over whether companies should serve shareholders or a wider group of stakeholders.
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