The profits of a solvent going corporation, whether current profits or those reinvested in the business, are owned absolutely by the owners of the corporation and are subject to their disposition and control, except where the law imposes restrictions. Oftentimes, the stockholders themselves impose restrictions by incorporating restrictive provisions in the charter or by-laws of the corporation. Of course, the same power which made them has power to remove them, though the exercise of the amending power is usually more difficult than the original expression of that power in enacting rules. The nature of a corporation is such, however, that many acts and privileges which are per se rights of the stockholders must in their exercise be delegated to others. Thus, while the right of ownership and control of the profits of a corporation is inherent in its proprietorship, the control is indirect—through the medium of a board of directors subject to periodic review and election by the owners. This board, during the period of its incumbency, acts for the stockholders and, during the prosecution of its duties, if performed in good faith, with sound judgment, and without fraudulent intent, is free from interference.
Shareholders’ Rights as to Profits
Shareholders’ rights in regard to sharing in the profits are therefore dependent upon the action of their elected board of directors. As soon as that board authorizes a dividend, however, its control over the portion of the profits so appropriated ceases except as to the routine of payment of the dividend. The right which the stockholder thereafter possesses is of the same nature as the claim of an outside creditor, and in the event of dissolution the assets of the corporation must be applied to the liquidation of this claim equally with all other unsecured claims. Thus, a claim for dividends must be met before the determination of the net assets with which the ownership of capital stock is liquidated.
Directors’ Control over Profits
As stated above with regard to profits generally, the directors have entire control of the declaration of dividends, except where limitation is specifically imposed by the state or by the owners as expressed in charter or by-laws. The following expression of directors’ power over profits and dividends, contained in the English Companies (Consolidation) Act of 1908 is typical of most laws covering the question: “The directors may, before recommending any dividend, set aside out of the profits of the company such sums as they think proper as a reserve or reserves which shall, at the discretion of the directors, be applicable for meeting contingencies, or for equalizing dividends, or for any other purpose to which the profits of the company may be properly applied, and pending such application may, at the like discretion, either be employed in the business of the company or be invested in such investments (other than shares of the company) as the directors may from time to time think fit.”
Provisos as to Declaration of Dividends
Specific provision may be made in the by-laws covering the declaration of dividends. Thus, the directors may there be ordered to set aside for specific purposes a certain amount of the profits earned and to declare dividends only from any residue. This may represent a permanent policy but usually only temporary; that is, periodic reservation of profits may continue until a definitely named reserve (or surplus) has been created, after which all profits become free for such disposition as the directors may see fit to make. A somewhat different policy is occasionally prescribed by which the directors are ordered to pay out of each period’s profits dividends of a named amount, after which any residue shall be carried to a reserve (or surplus). The objection to this latter policy, as ordered in the by-laws, is that it ties the hands of the directors to the division of profits among the owners regardless of the exigencies of new situations, as they arise, bringing very different conditions from those under which the policy was originally ordered.
The power of the directors as to declaration of dividends extends not only to common stock but also to preferred. No dividends, common or preferred, can be declared except from profits. Legal inhibition of the payment of dividends out of capital is one of the chief points of difference between the corporate and other forms of business organization.
As stated in a preceding section, regulatory bodies and commissions sometimes impose rules compelling corporations over which they have authority to set aside to surplus some portion of the profits before the declaration of any dividend.
Stockholders’ Rights to Dividends