We should perhaps start by looking at the historical background of shares. Joint stock companies are not recent phenomena. According to the Guinness Book of Records, the oldest company in the world is the Faversham Oyster Fishery Co. which has been in existence since before 1198. The second oldest is probably Stora Kopparbergs, a Swedish Company which celebrated its 700th anniversary in 1988. However, the modem limited liability and joint stock companies (this is the legal name for the typical public company whose shares we can buy on the stock exchange) have their origin in 18th century England. At that time, there was a tremendous amount of interest in trading overseas with the newly ‘discovered’ parts of the world. In those days, trading was a high risk activity. It cost a lot of money to outfit a ship, hire the men and set off for the Spice Island or wherever. The journey may take several years and there was little certainty that the ship would ever return. Even the richest of people at that time were reluctant to invest a large part of their fortune in such ventures even though the profit, if the ship were to return, would be extremely high. This was the origin If the idea of joint stock companies. The cost of the venture could be offered to a large number of people, each of whom only had a small were in the total cost. If the ship did not return, the loss of the individual would be small. In this way, an 18th Century ship’s voyage is similar to today’s publicly listed company, that is, both are high risk Ventures and that we spread our risk by investing in several different ships or companies. There are several other similarities and differences and it is very important that we understand them.
The similarities between a ship ’3 voyage and a listed company
Separation of Power between Management and Shareholders. This type of joint venture had one very important feature which is still applicable to most listed companies of today. The ownership of the venture is totally Separated from the ‘management’ of the venture (so to speak). Once the investors had paid up, they no longer had any control at all of the ship or its voyage. This was left totally to the captain. This principle still applies to present-day companies. The typical small investors have no effective control over the companies they invest in. In a sense they are very much like the 18th century investors. They pay their money and hope for the best or leave it in the hands of God. Since the 18th Century investors had no control over how the voyages were managed, investors in those days looked for captains with successful records to entrust their money in. Thus good captains would attract many investors. In the present-day situation, do you not think that the same principle should apply since you have no real control over the way the companies are run? Should not the shares of successful and well-run companies be selling at higher PER than unproven new companies?
Most readers will give an emphatic ‘Yes!’ to my question. But what is reality today? The truth is that most well-managed blue chips are selling at a PER which is well below that of newly taken over, untried companies. Surely, something is very wrong with the thinking of the local investors.
Principle of a Fair Share for All. The second similarity between a ship’s voyage and a joint stock company is the principle that every share holder is supposed to get a share of the benefits in proportion to his initial investment. As we shall see later, this principle has since become much abused.Differences between a ship’s voyage and a public company
The Number of Shares in Companies NOT Restricted. There is one major difference between investing in a ship’s voyage and buying a share in a modern company. A ship’s voyage is an entity on its own. The profit or loss the investors will get is based on that one voyage alone. At the end of the journey, all the assets of that ship would be sold and the proceeds divided among the original shareholders according to their holdings.
But a modern joint-stock company is very different. The percentage ownership in the company of a pre-existing investor can be reduced considerably by the creation of new shares for one purpose or another. Since the principle of a fair share for all applies to all shares irrespective of when the shares were created, the latecomers have just as much right to the benefits as those who have been there right from the start. The problem is compounded by the fact that the management of the company can usually create shares for their own benefit. A tremendous dependence on the integrity of the management is therefore created. If the management is avaricious and dishonest, they can create virtually as many new shares as they like. It is almost as if sometime during a ship’s return voyage (when all the hardships had been overcome), there was a possibility that pirates will force themselves upon the ship and demand a share of the profit even though they were not one of the original investors.
Life of Joint Stock Companies NOT Limited to One Journey. Unlike a ship, the life of a company is not limited to one ‘voyage’ alone. At the end of a ship’s voyage, all the assets are sold and divided for all shareholders to see. The shareholders therefore had confidence that what was rightly theirs would go to them. Since a modern company’s assets only get to be divided among the shareholders if the company is liquidated, the shareholders’ ownership of the company are seldom divided. The company in effect holds their assets in trust for them. This is why when a manager or director of a company misappropriates the money of the company, he is said to have committed a ‘criminal breach of trust’ (CBT for short). What the shareholder gets is usually dividend which is very much dependent on the wishes of the management of the company over which he has no control whatsoever. More often than not, the amount they get is very small because the management prefers to keep the money in the company under their control.
Think carefully of the similarities and differences between an 18th century ship’s voyage and a modern listed company. It is hoped that the major implications with regards to buying shares in a company can be discerned. These points will be discussed in greater depth in later chapters.