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BOOK VALUE VERSUS MARKET VALUE

We discussed the distinction between book and market value earlier, but it bears repeating.

Book value is a backward-looking measure. It tells us how much capital the firm has raised from shareholders in the past. It does not measure the value that investors place on those shares today. The market value of the firm is forward-looking; it depends on the future dividends that shareholders expect to receive.

Heinz`s common equity has a book value of $1,803 million. With 358 million shares outstanding, this translates to a book value of $1,803/358 = $5.04 per share. But in April 1999 Heinz shares were priced at about $49 each. So the total market value of the common stock was 358 million shares АГАз $49 per share = $17.5 billion, nearly 10 times the book value.

Market value is usually greater than book value. This is partly because inflation has driven the value of many assets above what they originally cost. Also, firms raise capital to invest in projects with present values that exceed initial cost. These positive-NPV projects made the shareholders better off. So we would expect the market value of the firm to be higher than the amount of money put up by the shareholders. However, sometimes projects do go awry and companies fall on hard times. In this case, market value can fall below book value.

DIVIDENDS

Shareholders hope to receive a series of dividends on their investment. However, the company is not obliged to pay any dividend and the decision is up to the board of directors. Because dividends are discretionary, they are not considered to be a business expense. Therefore, companies are not allowed to deduct dividend payments when they calculate their taxable income.

STOCKHOLDERS` RIGHTS

Stockholders have the ultimate control of the company`s affairs. Occasionally companies need shareholder approval before they can take certain actions. For example, they need approval to increase the authorized capital or to merge with another company.

On most other matters, shareholder control boils down to the right to vote on appointments to the board of directors.

The board usually consists of the company`s top management as well as outside directors, who are not employed by the firm. In principle, the board is elected as an agent of the shareholders. It appoints and oversees the management of the firm and meets to vote on such matters as new share issues. Most of the time the board will go along with the management, but in crisis situations it can be very independent. For example, when the management of RJR Nabisco announced that it wanted to take over the company, the outside directors stepped in to make sure that the company was sold to the highest bidder.

VOTING PROCEDURES

In most companies stockholders elect directors by a system of majority voting. In this case each director is voted on separately and stockholders can cast one vote for each share they own. In some companies directors are elected by cumulative voting. The directors are then voted on jointly and the stockholders can, if they choose, cast all their votes for just one candidate. For example, suppose there are five directors to be elected and you own 100 shares. You therefore have a total of 5 АГАз 100 = 500 votes. Under majority voting you can cast a maximum of 100 votes for any one candidate. With a cumulative voting system you can cast all 500 votes for your favorite candidate. Cumulative voting makes it easier for a minority group of the stockholders to elect a director to represent their interests. That is why minority groups devote so much effort to campaigning for cumulative voting.

On many issues a simple majority of the votes cast is enough to carry the day, but there are some decisions that require a БІАААмsupermajorityБІАААн of, say, 75 percent of those eligible to vote. For example, a supermajority vote is sometimes needed to approve a merger. This requirement makes it difficult for the firm to be taken over and therefore helps to protect the incumbent management.

Shareholders can either vote in person or appoint a proxy to vote. The issues on which they are asked to vote are rarely contested, particularly in the case of large, publicly traded firms. Occasionally, however, there are proxy contests in which outsiders compete with the firm`s existing management and directors for control of the corporation. But the odds are stacked against the outsiders, for the insiders can get the firm to pay all the costs of presenting their case and obtaining votes.

PROXY CONTEST Takeover attempt in which outsiders compete with management for shareholders` votes.

MAJORITY VOTING Voting system in which each director is voted on separately.

CUMULATIVE VOTING Voting system in which all the votes one shareholder is allowed to cast can be cast for one candidate for the board of directors.