A:

The average shareholder, who is typically not involved in the day-to-day operations of the company, relies on several parties to protect and further his or her interests. These parties include the company's employees, its executives and its board of directors. However, each one of these parties has its own interests, which may conflict with those of the shareholder.

The board of directors is elected by the shareholders of a corporation to oversee and govern management and to make corporate decisions on their behalf. As a result, the board is directly responsible for protecting and managing shareholders' interests in the company.

For a board of directors to be truly effective, it needs to be objective and proactive in its policies and dealings with management. This helps to ensure that management is generating shareholder value. A more objective board of directors, or one that is separate from a company's management, is more likely to promote or protect the interests of the company's shareholders. For example, a board of directors made up entirely or primarily of management would clearly be hampered by conflicts of interest, and the preservation of shareholder value might not be a priority.

Another factor that has an impact on the effectiveness of a board of directors is compensation. Adequately compensating board members for their work is one way to ensure that they will make every effort to promote and protect investor interests. The members of a board of directors are paid in cash and/or stock. Likewise, management and employees also need to be aligned with investors and this can be achieved through the compensation that both groups receive. This may include making both parties owners (investors) in the company. When management and employees are also shareholders, they will be motivated to protect shareholder interests as their own. This helps to protect a company from mismanagement and weak employee productivity. Also, a bonus targeting system can be used in which employees and managers receive bonuses when certain goals are met. Such strategies help to align the interests of employees and management with those of investors.

If these groups are not aligned with the interests of investors, major problems can arise and destroy shareholder value. Although the average shareholder does not have control over the board of directors or the day-to-day operations of the company, the ultimate responsibility for the protection of shareholder value lies with each individual investor. The investor is ultimately responsible for reviewing corporate policy and governance as well as for the compensation of managers. Investors who feel that a company does not show an adequate level of commitment to shareholders can always sell their investment.

For additional reading, see Governance Pays, The Basics Of Corporate Structure and Knowing Your Rights As A Shareholder.

RELATED FAQS
  1. How do modern companies assess business risk?

    Before a business can assess or mitigate business risk, it must first identify probable or likely risks to its bottom line. ... Read Full Answer >>
  2. Why has emphasis on corporate governance grown in the 21st century?

    Corporate governance refers to operational practices, management protocols, and other governing rules or principles by which ... Read Full Answer >>
  3. What impact did the Sarbanes-Oxley Act have on corporate governance in the United ...

    After a prolonged period of corporate scandals involving large public companies from 2000 to 2002, the Sarbanes-Oxley Act ... Read Full Answer >>
  4. Why should investors research the C-suite executives of a company?

    C-suite executives are essential for creating and enacting overall firm strategy and are therefore an important aspect of ... Read Full Answer >>
  5. What is the difference between a direct and an indirect distribution channel?

    A direct distribution channel is organized and managed by the firm itself. An indirect distribution channel relies on intermediaries ... Read Full Answer >>
  6. How can an investor determine a company's annual return from looking at its financial ...

    The funds in a share premium account cannot be used for a company's general expenses. These funds are restricted in terms ... Read Full Answer >>
Related Articles
  1. Economics

    What Does Vesting Mean?

    Vesting is the process of accruing non-forfeitable rights.
  2. Economics

    What's a Conglomerate?

    A conglomerate is a corporation that’s comprised of several different independent businesses.
  3. Investing Basics

    Breaking Down Optimal Capital Structure

    An optimal capital structure shows the best balance of debt to equity a company can have in order to minimize its cost of capital.
  4. Economics

    Explaining Interest

    Interest is the price charged to borrow money, and is typically expressed as a percentage of the principal, or the amount loaned.
  5. Investing Basics

    What is Convertible Preferred Stock?

    Convertible preferred stock is preferred stock that can be converted into common stock as of a predetermined date at a specified ratio.
  6. Term

    What is a Preemptive Right?

    A preemptive right allows select shareholders to buy newly issued shares in their corporation before the general public.
  7. Economics

    Explaining the Balanced Scorecard

    A balanced scorecard is a metric that measures a business’ performance.
  8. Investing Basics

    What is a Public Company?

    A public company has sold stock to the public through an initial public offering (IPO) and that stock is currently traded on a public stock exchange.
  9. Economics

    What Does Human Resources Do?

    Human resources (HR) is the department within a company that handles all matters relating to employment.
  10. Professionals

    8 Justifications For Sky-high CEO Salaries

    Why are CEO salaries so astronomically high? There may be more to the story than you think.
RELATED TERMS
  1. Sticky Wage Theory

    An economic hypothesis theorizing that pay of employees tends ...
  2. Earnings Before Interest & Tax - EBIT

    An indicator of a company's profitability, calculated as revenue ...
  3. Record Date

    The cut-off date established by a company in order to determine ...
  4. Corporate Social Responsibility

    Corporate initiative to assess and take responsibility for the ...
  5. Corporate Culture

    The beliefs and behaviors that determine how a company's employees ...
  6. Dividend Payout Ratio

    The percentage of earnings paid to shareholders in dividends. ...

You May Also Like

Trading Center
×

You are using adblocking software

Want access to all of Investopedia? Add us to your “whitelist”
so you'll never miss a feature!