An idea for stock market reform

[Trond Andresen <trond.andresen@xxxxxxxxxxx>]

I am in this mesage going to air an idea for reform of stock markets. The reform
consists in changing the character of stocks from perpetuities (financial
claims that never mature) to "stocks that are repaid", i.e. to what we could
perhaps call "voting bonds" (form now on, "VBs" - not to be confused with
the excellent Australian beer with the same abbreviation.. ;-)  ).

Before explaining the (hopeful) advantages of this proposal, first a
description of what a VB is:

A new or existing firm in need of fresh venture capital issues VBs instead
of stock. VBs give dividends just as stocks do, and the dividend rate is
decided each year just as with stocks, by those holding the firm's equity
(i.e. its VBs). But after a predetermined amount of years, the VB matures,
and then have to paid back at its nominal value, just as a bond. If there
already are existing VBs that were issued at some earlier time, and the firm
wants to float new ones (this will be the typical case), the voting power of
already existing bonds are reduced correspondingly, so that after an
additional float, every VB, old and new, has a voting power proportional to
its nominal value. (As a possible modification to compensate for inflation,
new VBs may be assigned a slightly lower voting power, so that inflation
since the last float is compensated for. Any such modification is no big
technical feat.)

Whenever a firm floats new VBs, the new and reduced voting power of all
earlier and still non-matured VBs are calculated and published. All this is
a breeze in a computer-assisted market environment. Note that there is a nice
built-in balancing mechanism here: Whether to float additional VBs is
decided by the current owners, i.e. those who hold a majority of existing
VBs. Thus they have an incentive to hold back, before floating new (and
additional) VBs.

So far on technicalities. What is the point of this proposal?

Its main purposes are twofold:

(1) to remove the phenomenon of gross long-term overvaluation (GLTO), with
ensuing panics and crashes that have serious effects on the real economy.

(2) to enable the stock (now: VB) market do what the textbooks say it is
supposed to do, channel fresh cash into activities that the population of
market participants thinks have a future.

To point (1) first:
In a VB market the participants know that if demand for a given firm's VBs
drives the price upwards, the firm may very well decide to float additional
VBs. In fact, the firm very probably *has* to do that sooner or later, at
the least to redeem earlier floated VBs when they mature. So this will
happen. This knowledge in the market is a strong incentive aginst buying
existing VBs far above nominal value. Thus GLTO will not accur, and this
again, should also remove the primary reason for the biggest panics and
crashes.

I have by this given what could be called a *robustness argument* for the VB
proposal.

Now to point (2) above:
Today only a puny part of stock market buying is fresh cash drawn in for new
venture. Most of it is a game of musical chairs in already existing stocks.
Since VBs, however, are paid back when they mature, firms have to renew
their equity continually (as already stated). This should enable the market
to do what it is supposed to do: In an optimal way channel money to those
ventures that are the most promising, based on the collective
wisdom/knowledge of the aggregate of market participants.

The above is an *efficiency* argument for the VB proposal.

I have by now discussed the character of VBs and why they should do the
trick for making the stock market both more robust and more efficient. I
invite list participants to help in imagining how a hypothetical market in
VBs would behave, and to criticise and/or suggest modification to the
proposal.

Trond Andresen