Three economics challenges

[nibot]

(1) Popular wisdom has it that corporations are quite concerned about their stock price, that when the company is doing well, the stock price goes "up", and when the company is doing poorly, the stock price goes "down". In other words, changes in stock price are directly tied to the performance of a company. (One share in a corporation means that you own 1/N of that company, where N is the total number of shares. Dividends are periodic cash payouts to shareholders, maybe $0.50 per share per quarter.)

My question is how? Tell me one way in which the performance of a company is actually tied to the price of its stock.

The price of a share in company FOO should be exactly the expectation value of all future dividends paid by that company, and at one time this was true. At one time, people invested in corporations in order to provide the capital to perform some undertaking (say, "Buy ships and hire a crew to sail to the New World and dig up riches!") with the expectation of future rewards ("Profit from riches dug up in the new world."). But these days this is no longer true. Companies rarely issue substantial dividends any more. Microsoft recently did, but that was sufficiently suprising to be sort of the "exception that proved the rule."

Shares in a company (stock) are bought and sold willy-nilly. After the initial sale of shares to investors (for publicly traded corporations, this is the venerated IPO, or "Initial Public Offering"), the price of stock is utterly irrelevent to the company itself, since the only time the company gains capital is when the company sells shares to an initial investor. An investor selling his share to another investor does nothing for the company.

People buy stock (shares) not because they expect future dividends, but because they expect the price of the stock to go up. But I see no actual mechanism to tie the performance of a company to its stock price. In this case, "investing" in the stock market is no more than speculation, and the whole system is nothing more than a pyramid scheme. Indeed, the only reason that investing in the stock market usually pays off is because the amount invested is growing. Every year more people invest in the stock market, fuelling the pyramid scheme.

Prove me wrong.

(2) I hate chains. I mean stores like McDonalds or Blockbuster or Walmart or Borders Books And Music or Best Buy. I detest them, but I can't put my finger on exactly what about them I find so reprehensible. I dislike the homogeneity, the impersonalness, the fact that the employees are robots. Somehow Independent Businesses just seem "better". Their products are more interesting and you can see that their revenue is reinvested directly in the local community, instead of being siphoned off to an absentee owner. I want to figure out whether this is a reasonable position. Should I just embrace "chain stores"?

One of my big suspicions is that we need chain stores, because the base of potential business owners simply lacks the creativity and manpower to produce a zillion independent businesses, whereas it's relatively easy to clone an already-successful business to operate in a zillion locations. Also, I understand the economy of scale. It's certainly vastly more efficient to have the supply chain available to supply your chain business with what it needs. It also mitigates risk. When there are a zillion copies of a business, the other copies can keep a less successful copy afloat until it takes root.

Then there is another distinction (as squibb points out). Franchises, like, say, Subway, are independent business. The franchisee buys a "kit" from the motherbusiness (Subway, Inc) and starts a business using their paraphernalia. It's a recognizable copy of another business with a recognizable brand, but it's locally owned. Then there are centrally-owned businesses, like our old friend Starbucks, where every single store is owned and operated from central headquarters. Franchises seem a lot less evil than these centrally-owned businesses, but I really don't like either.

Are chains really bad? Am I irrational for hating them? I have never, and, as far as I'm concerned, I will never, patronize Starbucks. So far I'm Wal-Mart free as well. Is this reasonable?

(3) Define "wealth". How is it created? What is "inflation"?

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By the way, a good site for background info is invest-faq.com. I think the only two books I've read in this milieu are A Random Walk Down Wall Street and Steven Landsburg's The Armchair Economist. Other references appreciated.

Comments

[easwaran.livejournal.com]

I was just thinking the same thing about stock prices. How it should be worth the expected value (discounted) of future dividends. But it becomes quite speculative. One thing that actually connects the fortunes of the company with the stock is that large shareowners (say 10% or more of the stock) actually get substantial say in the running of the company, and a successful company is worth more to them, so they're more likely to buy if it does better. And when mergers, acquisitions, and spinoffs happen, appropriate amounts of stock are created, bought, or split.

As for chains, I think it largely depends on which chain you're talking about. Because the economies of scale really do allow certain benefits. For instance, the big book stores can very easily order books specially and have coffee shops included and do things like that. But maybe I just feel this way because I've never really had "local" bookstores to patronize.

Coffeeshops I tend to agree with you on, but then again, I've also never learned how to use coffeeshops (I think of them as a place to buy coffee, not a place to spend time and do work or whatever - it still seems weird to me that you can hang out in one for longer than it takes to drink your coffee).

What about things like department stores though? I imagine most people buy almost all of their clothes from chains of various sorts, though perhaps in a couple of the densest cities this is different.

Anyway, I think Berkeley fosters an extremely anti-chain view, which is overdone. Some chains (like, as I understand, In'n'Out) are generally good in their environmental, labor, and other practices, and it's easier to know these things about large chains than about every single local store. And it's also useful to know the quality and type of products sold there ahead of time, even if you're traveling outside your home area. (For instance, if you're a vegetarian looking for some place to eat.)

[janviere.livejournal.com]

I'm not an expert in any of this, so I'm probably wrong.

My impression is that stock prices are mostly used as a barometer for public confidence in the company, which will certainly affect dealings with big league investors and other corporations. Stock prices go up on good news, so it's causal, but only in the "wrong direction". So I could be wrong in general, but isn't an IPO supposed to be a way to raise lots of cash? If a company's stock price is in the gutter, it's probably difficult for them to raise any money by issuing more stock. This is probably super-important for stupid little web companies, and less so for gigantic corporations.

I don't think franchises are "better" than chain stores. I think Fast Food Nation talks a bit about franchises, and how evil some companies are to their franchisees. Which might be a motivation to be nice to the franchise owners... but really, you're still financing evil.

One of the interesting things about being here for the summer, *where there literally are no non-chain stores* (I couldn't boycott wal-mart if I wanted to), is that people actually seem invested in the chain stores. It's not so bad if the person working behind the counter is someone you went to high school with, though it's a bit sad that they'll never have a say in how the store is run. Even the farmer's market isn't that local--we asked where the produce came from and they told us it was from Georgia.

The takeover of chain stores in the bay area is particularly sad, because there are so many community-based stores who are losing the battle. If you're lucky enough to be in Berkeley, the choice between Cody's and Moe's and Border's is a no-brainer. But here... I don't think there was much of anything before the chain stores took over. Everyone's happy that a best buy is opening up nearby, because now they can get their cheap electronics locally instead of, well, probably driving to the next-closest best buy. If there was anything around originally, I'm pretty sure it died a long time ago.

I guess my point is that I'm all for boycotting chain stores, but I think it's important to understand why middle america seems to be embracing them, and why you probably would too, in the same position.

Finally something I can talk about

[ucbfumbler.livejournal.com]

Stock prices are "supposed" to be based on future earnings and/or dividend. But that model mostly fall on established companies (ie. AT&T has a huge dividend). While companies like Google and Amazon are growth (or emerging growth companies) have their prices based on supply and demand. Some companies (ie. Intel and Microsoft) don't pay dividends but are market leaders and investors expect to eventually be paid once they become established companies.

(side note, statistically speaking, emerging growth companies indexes perform the worst of all pure stock indexes.)

2) Chain stores are actually a reaction to the "personality" of small businesses. People wanted a uniform and consistent product and service wherever they go. If you were to go into an In-N-Out, you know exactly what you're going to be getting in service and food quality.

3) "Capitalism lifts all boats" (I forgot who said it). And wealth is "created" by TVM (time value of money) and preception of value. What's more valuable a gallon of water or 1 kilo of cocaine? (sorry, been playing DopeWars) If I'm in the desert the water is much more value, probably be able to trade a of diamonds or something for it from my thirsty comrades. But what's worth more in say downtown LA? I can get trucks of water for the kilo of cocaine. Money is just an easy exchange medium.

If you own a million home, are you wealthy? Yes and no and yes. Yes, because if you paid $200K for it, in theory you can access $800K from the home. The money is "created" based not on the money you put into it or the money you'll repaid the loan, but on the market value (supply and demand) of that home if you were to sell it. So you just created $800K out of nothing more than expectation. Just like most currencies are floated (based on the strength of the countries' economy). No, because you have to repay about 2X-3X your borrowed amount in interest.....BUT yes, although you're going to be paying 3-4X ($800K + 2-3X of interest) your amount over 30 years, $800K will double 3 times if you invested it in a very conservative pure bond (7%) investment. Cost = $3.2 million, Earnings = $6.4 million. So you created wealth. BTW, there are investments that have no downside risks are return 6%-10%.

Which is worst: inflation or deflation? Depends.... Inflation is the "increasing costs of doing business." Largest cost of doing business is interest rate on loans. And that is partly Feds Fund Rate, Fed Discount Rate, Require Reserves, and of course supply and demand of loans. Out of control inflation hurts growth because your money gets devalue quicker than you can spend it, so it causes people to buy more leading to more inflation (ie. money chasing after limit goods and services).

Deflation: US's Great Depression and Japan's somewhat current situation. When I was a freshmen there as a theory that most economists didn't think could happen, the "liquidity trap." Basically, interest rate would be so low that the was no room to lower them yet there was no growth. Well, that's exactly what happened in Japan. After decades of easy money, the banks in Japan had a lot of bad loans on the books (ie. businesses that shouldn't have gotten money in the first place). What's the solution? Growth. Meaning you have to create more businesses, so the banks competed to loan out more bad money....interest rate (supply and demand component) dropped to almost zero. The banks couldn't call their loans or else the write off would be so great that it would bring down the system, so they lend more money out....lowering interest rate again. As it stands right now, Japan's debt is 125% of GDP.

So what's the theme of this post....suppply and demand rules the day.

#1

[util.livejournal.com]

I'm also not an expert on this but here are my thoughts. A share of stock gives you partial ownership of the company, which is reflected in the fact that stockholders are given dividends and get to vote on what direction the company should go. So, of course, as owner you want to own something more valuable. Also, similarly to currency, a stock's having any value is dependent on the continued existence of the entity that issued it. The better a company does, the less likely it is to disappear and leave its investors with nothing.

A few why reasons a company should worry about its stock price: If the price dips too low, the company is in danger of being taken over by a competitor. That is, the lower the price is, the more economical it becomes for a competitor just to buy a controlling stake in the company. Also, the trend in the value of the company's currently issued stock gives investors a clue about what to expect for new stock issued by the company. If the company's current stock fairs poorly, the company will have trouble raising money later by selling new stock. Finally, if a company's stock gives a poor return to its major investors, they will be more likely to call for the firing of the people leading the company. And the company's leaders' concerns are the company's concerns.

[erinmack.livejournal.com]

My biggest issue with chain stores is that they make the world more homogenous. Unlike some Americans, who find this comforting, I like to know that if I go to Greybull, Wyoming -- or, hell, Sri Lanka -- I won't be able to walk into a store that looks exactly the same as one in Memphis, and get exactly the same thing.

[shamster.livejournal.com]

The most depressing part of my stay in Maryland is looking around and seeing Irvine after having flown for 5 hours across the USA. The same chains hold the same foods and books and t-shirts, and everyone is humming the same pop-music and telling me the same jokes I heard back home. I never put thought into the homogeneity until now - it's a bad thing to the same extent that comfort and convenience is a bad thing.