Choosing a Business Form 239aspects of the corporate form have been designed specifically for the purpose
of splitting off individual aspects of control and allocating them differently.
Stockholders
At its simplest, a corporation is controlled by its stockholders. Yet, except in
those states which have specific (but rarely used) close corporation statutes
governing corporations with very few stakeholders, the decision-making func-
tion of stockholders is exercised only derivatively. Under most corporate
statutes, a stockholder vote is required only with respect to four basic types of
decisions: an amendment to the charter, a sale of the company, a dissolution
of the company, and an election of the board of directors.
Charter amendments may sound significant, until one remembers what
information is normally included in the charter. A name change, a change in
purpose (given the broad purpose of clauses now generally employed), and an
increase in authorized shares (given the large amounts of stock normally left
on the shelf ) are neither frequent nor usually significant decisions. Certainly, a
sale of the company is significant, but it normally can occur only after the rec-
ommendation of the board and will happen only once, if at all. The same can
be said of the decision to dissolve. It is the board of directors that makes all the
long-term policy decisions for the corporation. Thus, the right to elect the
board is significant but indirectly so. Day-to-day operation of the corporation’s
business is accomplished by its officers, who are normally elected by the board,
not the stockholders.
Even given the relative unimportance of voting power for stockholders,
the corporation provides many opportunities to differentiate voting power
from other aspects of control and allocate it differently. Assume Bruce and
Erika (our hotel developers) were willing to give Michael a larger piece of the
equity of their operation to ref lect his contribution of the land but wished to
divide their voting rights equally. They could authorize a class of nonvoting
common stock and issue, for example, 1,000 shares of voting stock to each of
themselves and an additional 1,000 shares of nonvoting stock to Michael. As a
result, each would have one-third of the voting control, but Michael would have
one-half of the equity interest.
Alternatively, Michael could be issued a block of preferred stock repre-
senting the value of the land. This would guarantee him a fair return on his
investment before any dividends could be declared to the three of them as
holders of the common stock. As a holder of preferred stock, Michael would
also receive a liquidation preference upon dissolution or sale of the business, in
the amount of the value of his investment, but any additional value created by
the efforts of the group would be ref lected in the increasing value of the com-
mon shares.
The previous information illustrates how one can separate and allocate
decision-making control differently from that of the equity in the business, as
well as from the distribution of profits. Distribution of cash f low can, of