Running a Business

by Rob Landley

Austin, TX (June 24, 1998) -- With Cisco Systems now in the portfolio, at a cost of $1985.95 (with our $7.95 commission included), we are finally fully invested. Can you imagine what our portfolio would look like if we'd been able to get started, as planned, with all of our selections on January 1st? We'd be crushing the market. C'est la vie. We'll have to wait just a little longer!

Today, I'd like to get back to corporate structuring and governance, hopefully rendered Foolishly. Yesterday, I gave a rough explanation of why the founders of a company might want to operate their business as a Corporation. Today, I'm going to give a brief overview of the mechanics of running a corporation. Much of this material is also available in the Cash-King Step #8, so I'll be brief. (Aside: Let me restate that if you're a regular reader of this column and you haven't gone through the 11 Steps to Cash-King Investing, we have high hopes that you'll take the 30 minutes to do so. Heck, we even re-read it!)

Ok, corporations and how they're run can be quite confusing at times. They have several completely separate levels of control -- from shareholders, to board members, to corporate officers, to management, to the workers (whose control is currently very pronounced at GM). Why are there so many levels? Well, because there are so many different functions to a growing corporation. Consider America Online. The company has gone from a hundred employees to over 7,000 employees just in the 1990s. That sort of growth demands organizational discipline and hierarchy.

Let's walk through the different levels.

We'll start with the stockholders, or owners of the corporation, who are in charge of corporations in about the same way that the American public runs the Federal Government -- in other words, not very actively. Once in awhile, the stock owners who actually take the time to vote (Fools should!) elect a group of people to oversee the company. Often, though, stock owners just want the company's management to do everything well and to reap the benefits.

Most of this corporate voting takes place at something called the Annual Meeting, which all companies are legally required to hold once a year. Public companies have to allow anybody who owns a voting share in the company to attend. And even if there is just one vote that year, the shareholders will have it. It's the election of the members of the Board of Directors for the coming twelve months.

Most stock out there is voting stock. A share of stock is a legal document, like the deed to a piece of land, and each share gives its owner one vote in the running of the company. There is something called "preferred stock" which is generally non-voting shares with a high dividend. For the most part, it's just debt with a fancy name that can be weaseled off to another portion of the balance sheet.

Holders of preferred stock have no say in running the company unless they also own voting stock. (P.S. Preferred stock that is convertible into normal voting stock generally means that some investor really had the company over a barrel at one point. I consider convertible preferreds a bad thing. But I digress.)

With normal stock, you get one vote per share. A million shares gives you a million votes and a big voice in running the company -- particularly if it has less than two million shares... you'd be the majority shareholder. Very large holdings relative to the total number of shares usually translates into a position on the Board of Directors (mentioned below).

So, at the big annual meeting, the shareholders who show up (or mail in their votes) elect the Board of Directors, including a Chairman of the Board (no, not Frank Sinatra) to preside over the meetings. These board members don't actually have to be major stockholders, although they often are. Since companies can own stock in other companies, a number of board members may be representatives from other companies.

Being on the Board of Directors of a company is a very part-time job, though often an intense one. Corporate boards usually only meet a few times a year and they often include our society's wealthiest -- so it's not like any fishing trips to Aruba get canceled. That said, serving on a board demands thorough research of the industry, critical thought about the business, and smart planning for the future. As the Internet takes center stage in the financial world, I have no doubt that corporate boards will come under greater scrutiny in the 21st century.

The board's job is to set broad policy for the company, as in "We're going to make cars," "Let's go deeply into debt and buy another company," "Why don't we issue ourselves an enormous dividend?," "How much should we pay Ginger Spice to promote our deodorant?" etc. Okay, maybe not the last one.

The board can also pass bylaws, or even amend the Articles of Incorporation, which is the legal document that defines what the corporation allows itself to do. But these days, most corporate charters tell the company to "make money... and more of it" and leave it at that. Other than that, the Board of Directors' main jobs are 1) to appoint officers who will actually run the daily operations, 2) to tell them what to do, and 3) to get out of their way and let them do it.

You've probably heard of most of the officers that get appointed by the board: the Chief Executive Officer (CEO), the Chief Financial Officer (CFO), the Chief Information Officer (CIO). These are the people who hire others to manage the company. The managers in turn help hire the employees who carry out the work at the company. The corporate officers set the day-to-day policy for managers and employees, aiming to meet and exceed the stated objectives coming from the Board of Directors.

An individual can be both a board member and an officer of the company. Occasionally, you'll see a CEO that is also Chairman of the Board -- as is the case with a Cash-King company like Coca-Cola. Our CEO there in Atlanta is Douglas Ivester. He's also our Chairman of the Board.

Generally, if the founder of a company or an individual who owns a majority stake in a company wants to be the top dog, they'll name themselves Chairman, and then as Chairman they'll appoint themselves CEO. This is partially because the position of CEO pays a salary, while the position of Chairman generally doesn't.

Thus someone like Michael Dell, Bill Gates, or Warren Buffett, who doesn't want to have to pay dividends or sell any of their stock, appoints themselves to the CEO position. They'll be responsible for the daily operations and they'll get paid a salary.

On the one hand, a one person Chairman/CEO combination usually means the individual shareholders have less control of the company. On the other hand, it means that the largest shareholder is running the company personally, and is going to care an awful lot about increasing the value of the company and its stock. As a shareholder in such a company, you just want to be sure that your Chairman/CEO isn't an oaf and/or hasn't lost her marbles.

So, the employees work for the managers who report to the officers who report to the CEO, who -- along with a handful of officers -- reports to the Board of Directors once or a few times each year. If the stock price tanks for an extended period (a few years), the larger shareholders will probably propose to elect new members to the Board of Directors. Then dominoes start falling. The new board will appoint new corporate officers who will, in turn, clean out some or all of the old management.

And now you know how and why that all works. If you ever cared. (I hope so!)

Tomorrow I'm going to talk about why a company elects to have its shares publicly traded like baseball cards, and what the actual mechanisms are that allow for that trading.

Oh, and 'twixt now and tomorrow, you might enjoy the public duel on the Fool mainpage over our C-K holding, Pfizer. Click here to read it: Fools Duel over Pfizer.

Until then...

- Rob Landley

06/24/98 Close

Stock  Change    Bid 
 AXP   +2 3/4   108.63 
 CHV   -  1/16  84.00 
 CSCO  +  7/8   87.75 
 KO    +1 11/16 84.25 
 GPS   +2 3/8   61.50 
 EK    +1 3/16  68.38 
 XON   +  7/8   72.50 
 GM    -  3/16  67.81 
 INTC  +2 1/8   77.38 
 MSFT  +4 1/4   104.94 
 PFE   -  1/4   109.88 
 TROW  +  1/2   35.50 
                  Day   Month    Year  History 
         C-K      +1.87%   6.05%  12.16%  12.16% 
         S&P:     +1.20%   3.86%  13.14%  13.14% 
         NASDAQ:  +1.80%   5.56%  13.60%  13.60% 
 Cash-King Stocks 
     Rec'd    #  Security     In At       Now    Change 
     2/3/98   24 Microsoft     78.27    104.94    34.07% 
     2/3/98   22 Pfizer        82.30    109.88    33.51% 
    2/27/98   27 Coca-Cola     69.11     84.25    21.91% 
     5/1/98   37 Gap Inc.      51.09     61.50    20.38% 
     2/6/98   56 T. Rowe Pr    33.67     35.50     5.43% 
    5/26/98   18 American E   104.07    108.63     4.38% 
    6/23/98   23 Cisco Syst    86.35     87.75     1.63% 
    2/13/98   22 Intel         84.67     77.38    -8.62% 
 Foolish Four Stocks 
     Rec'd    #  Security     In At     Value    Change 
    3/12/98   20 Exxon         64.34     72.50    12.69% 
    3/12/98   20 Eastman Ko    63.15     68.38     8.28% 
    3/12/98   15 Chevron       83.34     84.00     0.79% 
    3/12/98   17 General Mo    72.41     67.81    -6.34% 
 Cash-King Stocks 
     Rec'd    #  Security     In At     Value    Change 
    5/26/98   18 American E  1873.20   1955.25    $82.05 
     2/3/98   24 Microsoft   1878.45   2518.50   $640.05 
     2/3/98   22 Pfizer      1810.58   2417.25   $606.67 
    2/27/98   27 Coca-Cola   1865.89   2274.75   $408.86 
     5/1/98   37 Gap Inc.    1890.33   2275.50   $385.17 
     2/6/98   56 T. Rowe Pr  1885.70   1988.00   $102.30 
    6/23/98   23 Cisco Syst  1985.95   2018.25    $32.30 
    2/13/98   22 Intel       1862.83   1702.25  -$160.58 
 Foolish Four Stocks 
     Rec'd    #  Security     In At     Value    Change 
    3/12/98   15 Chevron     1250.14   1260.00     $9.86 
    3/12/98   20 Exxon       1286.70   1450.00   $163.30 
    3/12/98   20 Eastman Ko  1262.95   1367.50   $104.55 
    3/12/98   17 General Mo  1230.89   1152.81   -$78.08 
                               CASH     $51.68 
                              TOTAL  $22431.74 
 *The year for the S&P and Nasdaq will be as of 02/03/98