common stock

Equity without priority for dividends or in bankruptcy.

cumulative voting

A procedure in which a shareholder may cast all votes for one member of the board of directors.

3The golden rule: Whosoever has the gold makes the rules.

4By minority participation, we mean participation by shareholders with relatively small amounts of stock.

Ross et al.: Fundamentals I III. Valuation of Future I 8. Stock Valuation I I © The McGraw-Hill of Corporate Finance, Sixth Cash Flows Companies, 2002

Edition, Alternate Edition

254 PART THREE Valuation of Future Cash Flows straight voting

A procedure in which a shareholder may cast all votes for each member of the board of directors.

is that Jones can't divide 320 votes among four candidates in such a way as to give all of them more than 80 votes, so Smith will finish fourth at worst.

In general, if there are N directors up for election, then 1/(N + 1) percent of the stock plus one share will guarantee you a seat. In our current example, this is 1/(4 + 1) = 20%. So the more seats that are up for election at one time, the easier (and cheaper) it is to win one.

With straight voting, the directors are elected one at a time. Each time, Smith can cast 20 votes and Jones can cast 80. As a consequence, Jones will elect all of the candidates. The only way to guarantee a seat is to own 50 percent plus one share. This also guarantees that you will win every seat, so it's really all or nothing.

Buying the Election

Stock in JRJ Corporation sells for $20 per share and features cumulative voting. There are 10,000 shares outstanding. If three directors are up for election, how much does it cost to ensure yourself a seat on the board?

The question here is how many shares of stock it will take to get a seat. The answer is 2,501, so the cost is 2,501 x $20 = $50,020. Why 2,501? Because there is no way the remaining 7,499 votes can be divided among three people to give all of them more than 2,501 votes. For example, suppose two people receive 2,502 votes and the first two seats. A third person can receive at most 10,000 - 2,502 - 2,502 - 2,501 = 2,495, so the third seat is yours.

As we've illustrated, straight voting can "freeze out" minority shareholders; that is the reason many states have mandatory cumulative voting. In states where cumulative voting is mandatory, devices have been worked out to minimize its impact.

One such device is to stagger the voting for the board of directors. With staggered elections, only a fraction of the directorships are up for election at a particular time. Thus, if only two directors are up for election at any one time, it will take 1/(2 + 1) = 33.33% of the stock plus one share to guarantee a seat. Overall, staggering has two basic effects:

1. Staggering makes it more difficult for a minority to elect a director when there is cumulative voting because there are fewer directors to be elected at one time.

2. Staggering makes takeover attempts less likely to be successful because it makes it more difficult to vote in a majority of new directors.

We should note that staggering may serve a beneficial purpose. It provides "institutional memory," that is, continuity on the board of directors. This may be important for corporations with significant long-range plans and projects.


A grant of authority by a shareholder allowing another individual to vote his/her shares.

Proxy Voting A proxy is the grant of authority by a shareholder to someone else to vote his/her shares. For convenience, much of the voting in large public corporations is actually done by proxy.

As we have seen, with straight voting, each share of stock has one vote. The owner of 10,000 shares has 10,000 votes. Large companies have hundreds of thousands or even millions of shareholders. Shareholders can come to the annual meeting and vote in person, or they can transfer their right to vote to another party.

Obviously, management always tries to get as many proxies as possible transferred to it. However, if shareholders are not satisfied with management, an "outside" group of shareholders can try to obtain votes via proxy. They can vote by proxy in an attempt to

Ross et al.: Fundamentals of Corporate Finance, Sixth Edition, Alternate Edition

III. Valuation of Future Cash Flows

S. Stock Valuation

© The McGraw-Hill Companies, 2002

CHAPTER 8 Stock Valuation

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