Shareholders and Investment (AQA A-Level Business): Revision Notes
Shareholders and Investment
What are shareholders?
Shareholders are the owners of a limited company. Anyone can be a shareholder – individuals, other companies, or institutions like pension funds. You become a shareholder by owning at least one share in a company.
When shareholders invest in a company, they provide ordinary share capital. This is money that becomes a permanent part of the business. Importantly, the company never has to pay this money back to the shareholders. If shareholders want their money back, they must sell their shares to someone else through the Stock Exchange – they cannot sell them back to the company.
Share capital is a permanent investment in the business. Unlike loans or mortgages that must be repaid, share capital remains with the company indefinitely. This provides businesses with stable, long-term funding that doesn't create repayment obligations.
Private individuals can invest in publicly traded companies, becoming part-owners alongside many other shareholders. However, individual investors typically own only a small fraction of shares in any single business. The largest shareholders are usually financial institutions such as pension funds and insurance companies, which invest huge sums on behalf of their clients.
The role and rights of shareholders
Shareholders play an important governance role in limited companies. They have certain rights that allow them to influence how the business is run:
- Attending the Annual General Meeting (AGM): Major decisions affecting shareholders must be approved at this meeting, which is called by the directors
- Voting on key decisions: Shareholders vote on important matters that impact the business
- Holding directors accountable: They ensure directors don't exceed their powers or act inappropriately
The main role of shareholders is to attend the AGM, discuss items on the agenda, and make sure the directors are running the company properly. Some decisions can only be made by shareholders themselves, such as removing directors or changing the company's name.
Why do investors buy shares?
There are two main reasons why individuals and institutions choose to invest in shares:
Income from dividends
A dividend is a payment made to shareholders from the company's profits. It represents a share of the after-tax profit distributed according to how many shares each person holds.
The board of directors decides how much dividend to pay. This amount, known as the dividend, can vary from year to year. Investors hope that their returns will increase over time as the company becomes more profitable. The more shares you own, the larger your dividend payment will be.
Worked Example: Calculating Dividend Income
Imagine you own 500 shares in a company. The board of directors declares a dividend of £0.50 per share for the year.
Your dividend payment would be:
If you owned 1,000 shares instead, you would receive:
This demonstrates how larger shareholdings generate proportionally larger dividend income.
Capital growth
Shareholders also hope that the value of their shares will increase over time. This is called capital growth. If the share price rises, shareholders can sell their shares for more than they originally paid, making a profit on their investment.
Worked Example: Capital Growth
Suppose you purchased 200 shares at £2.00 each:
- Initial investment:
Two years later, the share price has risen to £3.00 per share:
- Current value:
Your capital growth would be: profit
This represents a return on your original investment through capital growth alone (excluding any dividends received).
How share prices are determined
The price of an individual share is determined by market forces – the relationship between supply and demand:
- If demand is greater than supply, the share price will increase
- If there are more sellers than buyers, the share price will fall
This works just like any other market. Share prices fluctuate constantly based on how many people want to buy versus how many want to sell.
Common Misconception About Selling Shares
Students often mistakenly believe that when a shareholder sells their shares, they sell them back to the company. This is not true.
Shares are sold through the Stock Exchange to a new shareholder who wishes to buy them. This process works in the same way as buying and selling used cars – you sell to another individual buyer, not back to the manufacturer. The company itself is not involved in these share transactions between investors.
Factors that influence share price changes
Both dividend levels and share prices can fluctuate significantly. It's crucial to recognise that these values can go down as well as up. Several factors can cause these fluctuations:
Company performance
If a company's performance is worse than expected, share prices typically fall. Conversely, if profits are higher than expected, share values will increase.
Real-World Example: Seasonal Performance Impact
Consider a major retailer during the Christmas shopping season. Christmas is traditionally a period of very high sales and profits for retail businesses.
Scenario 1 - Poor Performance: If the retailer reports disappointing Christmas sales figures, shareholders may lose confidence in the company's ability to generate profits. This causes many shareholders to want to sell their shares, increasing supply. With more sellers than buyers, the share price will decline.
Scenario 2 - Strong Performance: If Christmas sales exceed expectations, investor confidence grows. More people want to buy shares in what appears to be a successful company, increasing demand. With more buyers than sellers, the share price will rise.
The market reacts quickly to performance news, causing immediate price movements based on investor expectations and confidence.
Key Points to Remember:
- Shareholders are the legal owners of limited companies and can be individuals, companies, or institutions
- Share capital is permanent – companies don't repay it; shareholders must sell their shares through the Stock Exchange to get their money back
- Two main investment motives:
- Income through dividends (share of after-tax profits)
- Capital growth through rising share prices
- Dividends are a share of after-tax profits distributed according to the number of shares held
- Share prices fluctuate based on market forces (supply and demand) and are heavily influenced by company performance
- Shares are sold to other investors through the Stock Exchange, not back to the company
Exam Tip
When assessing legal structure decisions, always consider the specific circumstances of the business – its objectives, size, the products or services offered, and the risks involved. There's no one-size-fits-all answer.