Shareholders Versus Directors in a Corporation
Last Updated: October 17, 2023
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Zack Dean
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Sarah Ure is a Legal Writer at LawDepot. Sarah has undergraduate degrees in English and Psychology from the University of Calgary, as well as a Law degree from the University of Victoria. During her clinical terms at law school, Sarah was fortunate to help low-income clients in many different areas of law, including criminal law, family law, wills & estates, landlord & tenancy law, and environmental law. Sarah completed her articles in Toronto in 2015, then moved back to Alberta to begin her legal career. She worked with the Elizabeth Fry Society providing legal information to low-income clients, and later as a criminal defence lawyer, before being hired by LawDepot in 2019. Sarah is called to the bar in Ontario and Alberta. Sarah is a huge proponent of access to justice, and she is proud to use her legal and writing skills to create comprehensive, high-quality legal templates, available to people at a reasonable cost.
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Key Takeaways:
- Shareholders are essentially the owners of a company.
- Directors are the people who make and approve high-level decisions on the company's behalf.
- Shareholders choose a company's initial directors and then elect and re-elect directors periodically.
Table of Contents
If you've only ever heard terms like 'shareholders,' 'directors,' or 'the board' on TV and in movies, you might have a vague idea of what they are but not really know the differences between them. Characters tend to use them interchangeably to represent a room full of businesspeople in suits who aren't going to be happy about something, and it rarely goes beyond that.
However, in reality, shareholders and directors have distinct roles with key differences.
What’s the difference between shareholders and directors?
Shareholders are essentially the owners of a company, while the directors are a person or group who make and approve high-level decisions on the company's behalf.
What is a shareholder?
Ashareholder, also known as a stockholder or member, can be a person, business entity, or organization. In the case of multi-million dollar corporations, the top shareholders are often other corporations.
Because shares are units of ownership in a company, a party becomes a shareholder by purchasing shares and meeting a company's Shareholder Agreement requirements. The more shares they own, the greater the percentage of the company they own.
Having shares is valuable for a company because it encourages individuals and organizations to invest in a company without needing to make them a partner or put them on the payroll. From the shareholder's perspective, buying shares comes with the benefit of limited liability, meaning the company's debt isn't passed onto them. The only real financial risk comes from the shares losing their value and, therefore, the shareholder losing their investment.
What is a director?
Some corporations have thousands of shareholders. However, it isn't realistic for each of them to attend every meeting and make decisions. That's where directors come in. Shareholders elect directors to run the company with their best interests in mind.
Take Apple Inc. as an example. It has over 6000 shareholders, the top 10 of them being other corporations. However, only nine directors represent the shareholders and make decisions for Apple.
The directors make business and financial decisions on the shareholders’ behalves and hire the managers and corporate officers that'll run the day-to-day operations.
If the shareholders aren't happy with the job a director is doing, they can also remove a person from that role. It's important to note that a director can be a shareholder in the company as well.
Some corporations have three types of directors:
- Chairperson: This person is the head of the board of directors and is in contact with the company president. They also often make sure director meetings run smoothly.
- Inside directors: These people are usually also shareholders, officers, or upper management within the corporation.
- Independent directors: These people generally don't hold another role within the company other than a director.
A uniform rule across the U.S. is that a director must be an actual person (i.e., not another company). However, the other requirements vary from state to state. For example, a director needs to be at least 18 years old in Florida, while California doesn’t have an age requirement.
How are directors selected?
The shareholders should hold elections for appointing directors at shareholders' meetings. The initial directors are selected before the Articles of Incorporation are filed, and then future elections are usually held at an annual shareholders' meeting.
For a vote to occur, the number of shareholders present must meet the quorum specified in the Corporate Bylaws. A quorum is the minimum number of voting members that must be present at a shareholder’s meeting to conduct business. A shareholder who can’t attend the meeting can also appoint someone to vote on their behalf by proxy.
According to the Council of Institutional Investors (CII), a company can use two main voting methods for an election: majority and plurality.
A majority vote is precisely what the name implies. A nominee must receive a vote from a majority of the company's shareholders. If they don't receive a vote, they aren't elected to the board of directors. The CII says nine in 10 companies use this method.
The other method is a plurality vote, when the nominees with the most votes from the shareholders earn a position on the board. For example, if a company has five directors on its board and 15 nominees are running, the nominees with the five most votes are elected as the directors.
How are directors removed?
Many companies put procedures in their Corporate Bylaws for removing a director. Generally, a director may be removed by the other directors or through an election at a shareholders' meeting. If a director is running for re-election and doesn't receive the necessary votes, they'll need to step down from their position on the board. However, this isn't always the case, as laws vary from state to state.
In some states, like California, the court has the power to remove a director if it finds they committed fraud or abused their position of authority, or it determines the director of 'unsound mind.'
How does a shareholder stop being one?
For someone to stop being a shareholder, they need to no longer own any shares in a company. This can happen voluntarily or involuntarily.
To voluntarily give up their shares, a shareholder can sell their shares to a buyer. Some Shareholder Agreements also include a tag-along clause. This clause allows a minority shareholder to automatically sell their shares (if they choose) to a buyer purchasing a majority owner's shares. The clause protects them from third-party buyouts.
However, just like directors, shareholders can be forced to give up their position in a corporation. For an involuntary removal to occur, the board of directors needs to be presented with evidence of violating the Shareholder Agreement or Corporate Bylaws. For example, many agreements and bylaws prohibit conflicts of interest.
For shareholders who don’t own more than 25% of a company’s shares, the board then votes on their removal. If the agreement or bylaws don't specify the required number of votes to remove a shareholder, 75% in favor of removal is the default threshold. If the vote passes, the shareholder is forced to sell their shares to fellow shareholders or back to the company. It's worth noting that voting out shareholders is generally rare and more likely to occur in a private company with fewer shareholders than one that trades stock publicly.
What are a shareholder’s responsibilities?
As previously mentioned, shareholders are responsible for choosing a company's initial directors and then electing or re-electing directors periodically. However, this duty falls under shareholders’ primary responsibility to ensure a company is run and managed well.
These elections hold the directors accountable for their decisions. Although shareholders can't amend decisions already made, they can voice approval for specific actions or raise objections that will influence future decisions. If the shareholders disagree with the direction a director is taking the company, they may be able to remove the director from their position on the board.
Depending on the directors' and managers' philosophies, the shareholders sometimes need to push a company to evolve with the times. These changes can be related to products, internal tools, advertising, or even the optics surrounding environmental, social, and humanitarian issues.
Shareholders are also responsible for creating the Shareholder Agreement that outlines their rights, responsibilities, and procedures for buying, selling, or transferring shares.
What are a director’s responsibilities?
A director's responsibilities relate more to the actual running of a company than the shareholders'. At directors' meetings, they'll develop policies that guide themselves and the rest of the management. They're also responsible for appointing, compensating, and supervising the company's Chief Executive Officer (CEO) and corporate officers (i.e., president, secretary, and treasurer) who take care of the day-to-day decisions.
As the company’s fiduciary, directors determine its visions and goals with the shareholders in mind. It’s their job to ensure they’re protecting the business’ assets and providing financial oversight.
How do directors and shareholders make money from the company?
The compensation structure for directors and shareholders is also quite different from each other. Directors receive a salary for their position on the board, and the shareholders determine their compensation. Company executives serving on the board can also receive incentives in the form of equity.
Shareholders, on the other hand, don't have a salary. Shareholders’ compensation comes from their ownership of shares. They can either make money on dividends or capital appreciation.
Dividends are a portion of a company's profit distributed back to the shareholders periodically. The other option, capital gains, is when a company's share value increases after its owner purchases it. For example, if a shareholder purchases a share at $10 and the value rises to $15, they could sell it and make a $5 profit.
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