This section is from the book "Business Finance", by William Henry Lough. Also available from Amazon: Business Finance, A Practical Study of Financial Management in Private Business Concerns.
Writing in the American Economic Review, Mr. Mulvey, Assistant Secretary of State, Ottawa, Canada, first discusses the four methods named below of tiring out the minority stockholders and leading them to sell at an abnormally low price:
1. Piling up huge undistributed surplus.
2. Making a contract with a subsidiary company which permits the subsidiary to take most of the profits.
3. Paying out profits in the form of exorbitant salaries.
4. Selling out the profitable features of the enterprise to a new company which is promoted by the majority.
Mr. Mulvey then points out that all these abuses may be controlled by the charter or by-laws, and says:
Salaries may be limited, the dealings with subsidiary companies for the purpose of withholding profits may be regulated, methods of accounting may be devised whereby dividends may not be withheld. A sale of the undertaking may be prohibited, except with unanimous consent. The shareholder has a contract with the company which is made up of the statutes, charter, and articles or by-laws. These may be framed so that exactions or overbearing methods of the majority may be eliminated.
The objection to charter or by-law provisions placing limitations on the operations of the company, as Mr. Mulvey suggests, is found in the fact that such restrictions sometimes seriously hamper the action of the company. Provisions entirely harmless at the time they are adopted may be outgrown or conditions may so change as to make their operation injurious. Another objection to the charter or by-law provision as a protection of the minority is found in the fact that these may be omitted or amended if a sufficient vote can be secured, and the protecting provisions be thus swept aside.
Among the charter or by-law provisions for protecting minority stockholders most commonly employed may be enumerated the following:
Cumulative voting, whereby in elections for directors each stockholder may cast the whole number of his votes for one candidate or distribute them among two or more candidates as he may prefer. When this is done the minority stockholders - if they hold any material amount of stock - may always secure representation on the board of directors and thus protect their interests.
Classification of stock, each class of stock being given the right to elect one or more directors, thus insuring its representation on the board.
Regular audits. These may be prescribed by charter or by-laws. They may be annual, quarterly, or held at irregular intervals, and serve both as a check on the management and a verification of their accounts.