Economics of Shareholder Theory

A corporation is a legal entity. A corporation is owned by its shareholders who cannot be sued for what the corporation does. In a dispute the corporation is sued.

The corporation answers to shareholders once a year at the annual meeting. The shareholders appoint the board of directors. The board of directors hire managers that run the corporation.

Managers sometimes serve their own interests that is not always good for the shareholders. This is called the agency problem.

The board can authorize bonuses to overcome the agency problem. This helps to drive profits for managers and the shareholders.

A corporation pays taxes on earnings, and then pays dividends to shareholders from those earnings. Dividends, or earnings are taxed again in the shareholders own federal taxes. This is called double taxation.

The shareholders earn return on their investments through capital gains on the stock and through dividend payments.

The true objective of business is to make a profit in the form of retained earnings. Retained earnings are reinvested in the corporation.

So the Executive team’s goal is to increase the stock price and increase earnings.

Stakeholder theory will be discussed in the next blog.