The Specific Productive Role of the Stock Market
A widespread misconception is that the stock market
is somehow divorced from genuine productive activity
except insofar as it is the source of funds going directly
to corporations in exchange for newly issued stock. On
this view, the overwhelming bulk of stock market activ-
ity, which consists of the trading of already outstanding
shares, makes little or no contribution to the productive
process.
It should be realized that the ability of stockholders to
sell their shares provides a major inducement to the
purchase of those shares in the first place. If it were not
for the existence of the stock market and its continuous
trading in already issued stock, any purchaser of newly
issued stock would be faced with the prospect of not
being able to sell his stock, or of being able to do so only
with great difficulty. Such a prospect would greatly
discourage the initial purchase of stock from the issuing
corporations and would thus greatly reduce the availabil-
ity of capital to those corporations. The existence of the
stock market and its continuous trading in outstanding
shares makes it possible for the individual investor to
liquidate his investment at virtually any time, even though
the funds initially supplied to the corporation itself may
be invested in assets that have a productive life of several
decades or more and cannot be recovered from business
operations in any less time than that, and, indeed, will
most likely be permanently retained by the business
enterprise in which they have been invested.
Furthermore, it should be realized that the sale of
already issued stock can be, and very often is, the source
of funds for investment in the actual physical assets of a
business by the individual shareholders who sell their
holdings. For example, the owner of a drug store or
restaurant who owns stock in IBM or General Motors,
say, may very well decide to sell his shares, or use them
as collateral on a loan, in order to raise money to expand
his own business activities. In this way, the stock market
provides a source of funds for investment in physical
assets of business through the trading in already out-
standing shares.
The determination of the price of stock in the market
for already outstanding shares plays a major role in
deciding whether or not it is worthwhile for the present
stockholders to have their corporation issue additional
shares. Other things being equal, the higher is the price
of a share of its stock, the smaller is the percentage of the
corporation that must be given up in order to raise any
given sum of money, and thus the more likely is it that it
will be worthwhile for the present stockholders to have
the corporation sell additional stock. By the same token,
the lower is the price of its stock, the less likely is it to
be worthwhile for the present stockholders to have their
corporation sell additional shares. For example, if a
corporation has 1 million shares of stock outstanding,
and the price of its stock is $10 per share, then in order
to raise a million dollars through the sale of new stock,
it must sell an interest to outsiders that will amount to
one-eleventh of itself—i.e., 100,000 shares out of a new
total outstanding of 1.1 million shares. If the price of the
corporation’s stock were $100 per share, however, then
it could raise an additional million dollars by selling to
outsiders less than 1 percent of itself—i.e., only 10,000
shares out of a new total of 1 million shares plus 10,000
shares. By the same token, if its stock had a market value
of only $1 per share, it would have to sell 50 percent of
itself in order to raise a million dollars. On this basis, it
should be obvious that the stock market plays a decisive
role in determining whether or not a corporation will find
it worthwhile to issue new stock.
In connection with this point, it must be said that the
stock market makes it possible for firms that demonstrate
their success to obtain capital at a much faster rate than
they could if they had to rely exclusively on the reinvest-
ment of their profits. A firm’s demonstration of the ability
to earn a high rate of profit on its existing capital operates
to raise the price of its outstanding shares and thus to
make it possible and worthwhile for the firm to obtain
substantial additional capital from the sale of additional
stock. In this way, the firm can obtain control over larger
sums of capital more rapidly than would otherwise be the
case. Indeed, if it increases its equity in this way, the firm
correspondingly increases its capacity to borrow and can
thereby raise still more capital if it wishes. By these
means, successful small businesses are enabled to grow
into large businesses and play a more important role in
the economic system more rapidly than they otherwise
could. At the same time, as an important consequence,
they are enabled to challenge the existing large firms all
the more rapidly.
Finally, it must be pointed out that the existence of the
stock market serves to penalize poor management and to
offer a protection against the abuse of stockholders by
corporate managements. The effect of poor management,
or of the abuse of stockholders, is a low price of the firm’s
stock relative to the value of the firm’s assets. This
situation invites an outside takeover of the firm, the firing
of its present management, and, very often, the sale of
some or all of its assets to other firms which are capable
of putting them to better use. Apart from anything else,
the mere fact of changing circumstances, and the inabil-
ity of many corporate managements to keep pace with
the changes, repeatedly necessitates the breakup of ex-
isting corporations, as the land sites their facilities oc-
cupy and often the facilities themselves and much of their
equipment become more useful in other employments
than in their present employments.
Regrettably, in the present-day United States, this
important function of the stock market, of serving to
bring about the redeployment of the physical assets of
business firms in different hands and often for different
purposes, is threatened by government intervention de-
signed to protect incompetent managements from the
threat of outside takeovers. With the narrow-minded
perspective that is typical of opponents of the free mar-
ket, the enemies of corporate takeovers can see only that
some existing “jobs” are eliminated. They do not see the
new employment opportunities that are created in other
firms, accompanying the availability of the capital assets
that have been sold to them. They are unaware that the
very fact that the assets of a firm are worth more in being
sold off than in being retained is virtual proof that their
employment elsewhere will be more productive and thus
will contribute to a more rapid rate of capital accumula-
tion and a higher productivity of labor. They do not even
see that corporate takeovers, followed by the selling off of
assets, are a powerful remedy for previous ill-conceived
mergers, whose existence, along with all other mergers, the
enemies of capitalism never tire of denouncing.