Most people seem to feel they intuitively know what stock is. However, the real features of stock and their affect on the creation and maintenance of companies and economies is rarely if ever critically analyzed. This article will take the unusual approach of asking “what is a stock?”
One of the most unusual things about a stock is who can issue them. Strangely a stock can only be issued by a company. An individual cannot issue stock, although legally a corporation is technically a “person.” Corporations obtained the rights of a person by using laws that were designed to fully emancipate ex-slaves (the equal protection clause of the 14th Amendment). Corporations are very explicit that they are persons. However, if a real person wants to borrow or raise money they must take out a loan, which must be paid back by certain dates or the collateral for the loan can be confiscated and many fees applied. Why a corporation can issue a financial instrument (called a stock) that never has to be paid back, while an individual cannot is not clear. What is clear is that corporations have superior rights to access capital over individuals. There are many justifications that are often provided, but no good reasons. One of the justifications is that companies need capital to grow. However, as with most things the important details are left out of this statement. Questions like..
- Which companies will end up growing?
- How the financing system is setup will have an impact on the the structure of an economy?
- Why are companies the focus of a society?
- What type of companies will obtain capital?
More Money for The Creation of Monopolies
The statement regarding the fact that companies need money to grow leaves out the fact that the stock market overwhelmingly caters to larger companies. Thus large companies receive more capital than smaller companies. Small generally companies cannot list themselves and issue stock except under very unusual circumstances such as during the tech boom of the late 1990′s. Companies on the smaller side but which are still substantial can issue stock but do so at a disadvantage. Another piece of information that is left out is that it his horribly expensive to raise money through the stock market because the investment bankers, which underwrite the issue, are themselves monopolies and ask for and get large feeds.
What this means is that larger companies raise capital to purchase the smaller companies. With the earnings of the smaller companies they can then attract more capital and so on. This is actually a business model of a number of companies including General Electric. The results of this are higher concentrated power and economic control over assets that would not ordinarily be concentrated except for the particularities of our financing system.
Most of what Jack Welsh did was simply take advantage of the fact that investors would pay more for the earnings of GE than for a smaller company. If a acquired firm had a P/E ratio of 10, if GE acquired it, and the earnings stream, those earnings would be valued at a P/E of 15. This of course promoted the acquisition of companies by GE, which increased its monopoly power.
Stock has some other features that are curious:
- Stock holders are the last to be paid in the event of a bankruptcy. The corporation is not required buy the stock back from the stock holder, or ever pay the stock holder back in any way. The primary, and for those stocks without dividends, the main lure of a stock is the ability to sell it to someone else at a later date. Corporations are not required to issue dividends although some do. In previous decades dividend payment was much more common, but in the modern era investors have tended toward purchasing stocks for appreciation rather than for dividends.
- It is often stated that stocks provide voting rights. This is true, however, only the largest institutional investors can exercise these rights to make a course change in a company. Corporations use many techniques to minimize the effect of voting rights including making the voting topics unintelligible in their descriptions in the proxy statements sent in the mail.
- The accounting statements which are used as guidelines to stock valuation are subject to interpretation making it very difficult to say with any certainty what a company’s earnings were in any one year. Therefore a company reporting a price/earnings ratio of 10, in most cases has a real price/earnings ratio much higher than that. There is actually a large component of fraud that goes along with most of the accounting documentation, which supports earnings statements. The earnings issued by companies have moved away from GAAP (the official legal standard, which is already quite lenient) towards “pro-forma” earnings, which removes many expenses from the earnings in order to mislead investors.
Implications
The reason to invest in stock is because other people do and the marketability of something is due to the perception of its value. For stocks this perception changes through time. During some periods of time investors are willing to pay high p/e ratios for stocks, during other times they prefer to pay a lower multiple. However, of all the people who own stocks, very few understand what they are, and how they reconfigure the structure of companies to the benefit of very specific interests. Another factor is that few understand that typically only the well to do obtain the “average” performance which is so often quoted. This is called the yield disparity.
http://counterecon.com/2008/01/11/yield-disparity/
Business schools and investment media focus a great deal on stocks, but they are careful to not ask the important question of “what it is.” They are also careful not to discuss what the system of US equities does to the business world and what individuals and what types of corporations the system gives preference to. These two effects of stock markets is simply assumed to be positive. In fact we are told that stocks are essential to a capitalist system.
We don’t mean to be deliberately snobbish, but these people on the MSNBC show Fast Money are corrupt, irresponsible and let us just say not the deepest thinkers. They are promoting large sections of the population to get involved in a market, which none of them understand the basis for. They seem to live from minute to minute and speak as if they have a cocaine addiction. People like this, those that propose fast money is a good thing, are overwhelmingly confident and are essentially corrupt are always in great number, at the decline of various civilizations. Its hard to see how these people are actually working for a living, which is strange, because I am constantly told by conservatives how important hard work is.
Alternatives?
Unknown to the majority of the population is that stocks are unnecessary to support, maintain or develop a capitalist system. The vast majority of capital in America is not raised externally, but from internal business operations. The reasons for the existence of stock is to provide off balance sheet compensation to executives. Stock options are still not expensed to the the company that gives them, and without stock, there is no way the present discrepancy between executive compensation and the average worker could continue. Conservatives argue that “the market” determines compensation. This is untrue. All we have to do is make stock options illegal and see how executive compensation will drop like a stone. Stock is what drives executive compensation.
Conclusion
Due to their power concentrating characteristics, their tendency to promote insider trading and corruption, and the focus they bring on short term goals, stocks can be observed to be counter productive for the development of stable companies and economies. An economic system which does not allow equities is more equitable and less corrupt than a society that does allow for equities. Furthermore stocks are not a necessary accouterment for capitalism. Generally the term capitalism is imbued with properties that are not within its definition by institutions and individuals that seek to benefit themselves. Capitalism only means that production is performed by private rather than government entities. An economy without a stock market is no more or less capitalistic than an economy without one.
Venice was somehow able to maintain a highly dynamic trading city state for hundreds of years (Venice as a government lasted for roughly 1000 years, but was not at its zenith for all 1000), all without a stock market. Conservatives would like to say that abolishing the US stock market would be socialist, except, the problem with that is it does not square with history. The investment and trading in certificates, rather than commodities (which goes back to antiquity) is a relatively new phenomena and given the frequent financial crisises imposed by them, greatly invalidates their supposed necessity.
We like to propose all the feasible options here at CounterEcon. While this post proposes that stocks are essentially a very low cost way for companies to raise money (and not pay it back). What is interesting is that they do not seem to be actually raising all that much money with stocks. While this might seem illogical, stocks may have begun to transfer from low cost capital to primarily unaccounted for executive compensation. See the excerpt from the excellent Dollars and Sense website.
“The process of financialization has not made finance more effective at fulfilling what conventional economic theory views as its core function. Corporations are not turning to the stock market as a source of finance for their investments, and their borrowing in the bond markets is often not for the purpose of productive investment either. Since the 1980s, corporations have actually spent more money buying back their own stock than they have taken in by selling newly issued stock. The granting of stock options to top executives gives them a direct incentive to have the corporation buy back its own shares—often using borrowed money to do so—in order to hike up the share price and allow them to turn a profit on the sale of their personal shares. More broadly, instead of fostering investment, financialization reorients managerial incentives toward chasing short-term returns through financial trading and speculation so as to generate ballooning earnings, lest their companies face falling stock prices and the threat of hostile takeover.”
http://www.dollarsandsense.org/archives/2008/1108vasudevan.html