Berkeley Program in Law and Economics

Common shareholders are not the only important residual claimants on a firm's income. Instead, other claimants, including employees,

creditors, preferred shareholders, option holders, suppliers, customers, and the government (as tax collector) also often gain substatially when

the firm does well, and suffer when the firm does badly. The conventional contractarian explanation for why only common shareholders vote - that

they are the firm's principal residual claimants - thus fails to fit the facts.

I propose a refraiming of the question - why do only common shareholders vote - as several related questions. In a world where common

shareholders, employees, creditors, preferred shareholders, and others are all important residual claimants, why do common shareholders

receive voting control rights, some creditors receive default-based and nonpayment-based control rights, other creditors receive only

nonpayment-based control rights, preferred shareholders receive weak, situation-limited voting rights, and employees, suppliers, customers,

and the government receive no formal control rights (unless they happen to also own common shares)?

In answering these interrelated questions, the emphasis shifts from explaining why residual claimants receive control rights to explaining why

they often do not. Why are residual interests so much more widely distributed than formal control rights? Why do employees, suppliers,

customers, and the government receive no formal control rights even though they are often major residual claimants? Why do preferred

shareholders receive voting rights that are almost uselessly weak? Why do trade creditors receive only nonpayment rights while banks receive

stronger default rights, when standard contractarian theory - in which formal control flows from residual interest - would predict the opposite

outcome? The article sketches some possible approaches to answering these questions.