idea stock market reform: I commenda you

["Ronald Calitri" <calitrir@xxxxxxxxxxxxx>]

Your idea is A way to stabilize the middle of the term structure.
    The commenda was a Venetian trade investment institution 1200 - c.1400,
and similar to the structure you suggest. Generally, wealthy investors would
enter partnership for a determinate term. Not all were business savvy, so
operations were conducted by a subset, often just one - commendatore. The
voyage done, or the term expired, the association would be liquidated. My
impression is that the end of the system was caused by a combination of
too-frequent uncertainties and losses, the need for too-close supervision,
and the parallel developments of a true bond market that made more sense for
non-speculative investment, and of a mercant-banking industry to
professionally intermediate speculative endeavors.
    A similar set of concerns has prevented a large number of fixed-term
stock investments in the present. I have heard of these at the informal
markets. Perhaps someone with knowledge of the turn-around industry would
know more. Also, in the current environment, investors expect returns in
both dividend and principal value streams. The tax system is now the
principal constraint. After tax returns to changes in principal value are
greater than those to dividends. So rather more depends on what you are
talking about than just inventing a clever financial engineering instrument
to fill in medium-term volatility.
    Now to a theoretical issue. With fixed coupons the market is
theoretically structured as you suggest, with less price volatility from
interest rates at shorter maturities. This is due to the convention that all
interest rates into the future change identically. My guess is that the
"rational" perpetual investor does not change its opinion about all rates
from just one valuation. Or, if the vector of all returns is reset, it is
through a more complicated process. Empirically, there are cases where
I(t1) can go up and I(t2) may be expected to go down, etc. And, with
short-term instruments, any shock to the present return in a series may be
expected to carry easily into the next two, so all I(t>t) in the formula
will change. The result is the perpetual complaint of stocks owners - long
term instruments should be less volatile. Why can't they be more like
consols.

This analysis underlies the first problem you have seen. That is:

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


The benefits to investors of rises in principal are not lost. You are
proposing an innovation in the type of new issues vendors. Just because it
has been tried already, does not mean anything, they all have.

>
>(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.


Two theories are at issue: 1) - in your favor, all innovations at a specific
time may be expected to have a determinate duration. There is nothing really
long-term in the life of capitals in business these days.
2) Unfortunately, what this translates into theoretically for the individual
investment "chunk" being talked about is that it must be an "innovation,"
requiring really good knowledge on the part of the investor to make any
assumptions about anticipated returns.
3) Unfortunately, what you have done is complementary with the proposed
short duration employment contract at industry. It may be used as rewards in
a kind of "labor commenda." At least we should leave most of the anyway
possibly doomed employees the illusion that the stocks they are getting are
wealth.
To continue:
>
>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.
What will is GSTO - gross short-term overvaluation
, and this
>again, should also remove the primary reason for the biggest panics and

>crashes.

Unless Disney buys Ford
There will be a small panic, like now.
>
>I have by this given what could be called a *robustness argument* for the
VB
>proposal.

The VB market is a good idea, but you need to develop how it will change the
new issues market.
>
>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.

So will this
>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.

Yes, it is a VERY good idea for small or risky businesses either where the
knowledge of investors makes a difference, or an indefinite payback for a
capital infusion is not a desired component of the investment.
>
>The above is an *efficiency* argument for the VB proposal.

Good luck.
>
>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.

How about making it industrially frequency specific, Say, daily in the
newspaper and TV businesses. Tree farmers could use it as a price hedge in
the paper industry. The dividend on ABC could be talked about on CBS. PBS
could be the perpetuity. Or, alternatively, in the next wave, it could
become an option, expiring on inauguration day.

No, seriously, If there is a place for VBs, it is among the medium sized
businesses struggling to resist merger-mania and in labor arrangements. Such
forms there are more likely to be large blocks and so less not more
volatile.

Chiao,
Ronald Calitri