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What are the Different Types of Shareholder Protection?

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  • Written By: Kate Presto
  • Edited By: Angela B.
  • Last Modified Date: 31 August 2016
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Governments and stock exchanges enact shareholder protections to prevent corporations from using shareholders' money inappropriately. These laws are designed to check the actions of management by making them more responsible to shareholders. The most prominent forms of shareholder protection are the right to sell their stock, vote on important company decisions, select members of the board of directors, and sue when management has acted against shareholders. Shareholder protection laws are a hotly debated topic in corporate governance, and the debate has empowered shareholders and strengthened their forms of protection. Overall, shareholder protection laws are weak but improving, and institutional investors — often the largest equity holders — are the most effective shareholder group in influencing management.

The most basic shareholder protection is the right to buy and sell stock. Corporations are therefore required to help in that process. They must give shareholders regular, detailed disclosures on financial results, operations, and major events that can assist shareholders in their selling or purchasing decisions.

The second protection is shareholder voting rights. Shareholders attending the annual shareholders' meeting may vote on important corporate matters; those not attending may vote by completing a proxy prior to the meeting. The most important vote is to approve new members of the board. Other issues shareholders vote on include executive compensation, mergers, and changes in critical business.

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Annual shareholder meetings are an important way for shareholders to voice their concerns. Shareholders can also propose non-binding resolutions and, if the issue has enough support, all shareholders can vote for or against the resolution. An increasing trend is for companies to adopt approved non-binding resolutions.

A final shareholder protection is the right to sue management. When shareholders believe management has grossly underperformed, they can sue the individual manager and/or the company. This comes into play when shareholders believe they suffer an economic consequence from that underperformance.

Institutional investors often enjoy greater rights and protections than individual investors. The institutions include mutual, pension, and hedge funds. These investors have more capital than the typical individual investor and, thus, can invest more. Their investment is greater, so institutional investors are able to influence management and see policies enacted in their favor.

The U.S. Congress passed the Shareholders' Protection Act in 2010. The act was in response to a court ruling that interpreted the First Amendment right on freedom of speech to include corporate political donations. Many American citizens were outraged by the court ruling, so Congress took action. The law limits maximum total political contributions to $50,000 US Dollars. A corporation wishing to spend more must receive approval from a majority of the shareholder ownership via a vote.

Several weaknesses in shareholder protection laws render them only mildly useful. Shareholders do have the right to vote on important company decisions but, in many companies, the shareholders' decision is non-binding. Sometimes shareholders are allowed to choose the candidates for open board positions. More often, management or the board selects the candidates. In the case of mismanagement, shareholders face a significant financial burden in pursuing a lawsuit, so the common recommendation for shareholders who don't agree with management is to sell their stock and divest from the company.

Shareholder protection laws are important in numerous countries. Securities laws are an indication of how business-friendly and economically developed a country is, and shareholder protections are an important part of securities law. In addition, corporate governance is a prominent international business trend, of which shareholder protection is an important component. Many countries base their laws on American laws but include variations for their own market. Cultural, political, and socio-economical differences spur variations in shareholder rights and protections.

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