Re: An idea for stock market reform

[Trond Andresen <trond.andresen@xxxxxxxxxxx>]

Thanks to all you guys who have commented om my "voting bond" idea.
I will reply to most of the comments in chronological order.

At 15:00 17/12/98 -0800, Peter Dorman wrote:

>....
>My biggest concern is that "temp-shares" would exacerbate the problem of
>short time horizons that plagues market-driven corporate ownership
>regimes.  If my share liquidates at face value on day X, changes in its
>value will depend entirely on projected dividends prior to X.  To the
>extent that corporate decisions will be made to drive up share prices
>(eg stock options to top managers, market for corporate control, etc.),
>short-termism intensifies.

But how can a VB be driven much up in value when the market knows that more
VBs may at any time be issued from the same firm? And when the market also
knows that they will be redeemed (only) at *nominal* value at maturity? What
sort of speculative maneuvers can entice the market to over-buy VBs to the
extent that the price rises grossly above nominal level?
Anyway, I am not sure about this. My questions are not rhetorical, but
rooted in a wish to find mechanism(s) for gross overvaluation in a VB
market, *if there are any*. It is very neccessary to play the devil's
advocate when discussing such reform ideas.

>I don't know whether this is a good thing or a bad thing, but
>temp-shares coexisting in the market with different dates of maturity
>would vastly complicate proxy battles, M&A's, and the like.

In a computer-mediated environment, any player of a reasonable size will
have access to excellent overviews of the situation at any time, also in a
VB type market.

>Finally, the biggest practical problem would be that equity would lose
>much of its attraction, since capital gains would be modest and
>front-loaded over each share's life cycle.

Yes, capital gains will be modest. You can't have it both ways. If one
agrees that gross long-term overvaluation is a serious problem and something
that should be curbed, then this means a drastic reduction in the
posssibility for significant capital gains. But the only attraction of
equity should be a higher dividend than what can be had from gvt. bonds or
bank saving, as Peter suggests himself:

>....It would be possible to
>market voting bonds only if dividends were increased to be competitive
>with interest rates, but this would place heightened pressure on firms'
>cash flow.  It would also increase the importance of external relative
>to internal finance (with dimished retained earnings).

But no, it would not place heightened pressure on firms' cash flow, because
for the average VB that is repaid, a similar amount is issued. Of course a
given firm is not *guaranteed* that a money flow for newly-issued VBs will
completely compensate for matured VBs, but that is one point of the proposal
- to allow the market to shift its preferences. But on the average, new VBs
will be bought and thus compensate for maturing ones. Remeber that agents
will have to do something with the extrta (compared to today's situation)
money they get on their hands when VBs mature. Thus the pressure on firms'
cash flows should not be greater than today.

>Firms, of course, are free to arrange the equivalents under current
>conditions by issuing shares (or buying back and reissuing shares) via
>contracts specifying mandatory repurchase at fixed prices and dates.

In theory, yes. But I think such a reform must be mandatory. There are to
many vested interests in upholding today's type of market.

Now to jackodonnell <jackodonnell@xxxxxxxx>, who addresses a transitory
scenario where today's type of stocks co-exist with a VB system. This of
course raises difficulties, which Jack describes. A general remedy, I think,
 is that a VB reform must assume that it starts with all existing equity
being converted to VBs, at market price. Then one can take it from there.

At 19:22 17/12/98 -0500, Gregory P. Nowell wrote:

>In some ways this isn't new.  Bond holders have long
>thought they should have a veto of leveraged buyouts
>(which can turn highly rated corporate bonds to trash).

This problem should be eliminated in a pure VB system, since
bondholders have voting rights.

>But there are bonds that don't expire, just like
>stocks.  British consols, for one.

Consols, stocks - any *perpetuity* is IMO bad for an economy. If net
financial assets in the main are perpetuities or are very long-term, this is
cet.par. conducive to debt-asset-polarization, which I have demonstrated
earlier here on PKT, see footnote.

At 22:09 17/12/98 -0500, "Colander, David" <colander@xxxxxxxxxxxxxxxxxxxxx>
wrote:

>I too congratulate Trand on his creativity.

Thanks, Divud ;-)

>...I think thinking about
>modifying capital market institutions is an important policy issue.  I think
>Peter's comments about problems however make it highly unlikely, and it is
>unclear how it would be legislated.

Well, is the likeliness of such a reform being implented related to the
objective weaknesses of the proposal, or simply that the guys in power
prefer today's casino type of stock market anyway? Isn't it simply a
question of who has the raw economic and political power, not who has the
best proposals?

>I've been thinking along somewhat different lines--although with some of the
>same ends as Trand had.  My thought was to have a limit on how much a share
>can increase in a year--say 20%.  After that the firm will have to issue new
>shares to all who want in at that price. That would mean that when a firm
>becomes "hot" it will have an enormous infusion of cash.  It would also mean
>that the value of insider information would be less.

We share the same intention. But off the cuff: Wouldn't this reform scheme
be easier to sabotage/circumvent than a pure VB market?

>There are probably as many or more problems with this as there are with
>Trand's but I would like to hear them.

Me too. I have read the ensuing exchanges between David C. and Gary D. with
interest, but have no comments to them at this stage.

At 11:55 18/12/98 -0500, Paul Davidson wrote:

>Trond and David's concerns has to do with volatility in financial markets.
>Trond's bond would not necessarily solve the problem.  There have been
>periods when price fluctuations in bond markets clearly were much larger
>than in equity markets-- e.g., during the early Volker years.

But to use that argument, you have first to assess to what degree
fluctuations in historical (or today's) bond markets were/are due to factors
such as central bank interest rate changes and/or reflections of stock
market fluctuations. If you are able to prove that a VB market will be
*inherently* just as volatile, even when abstracting from these factors,
then the proposal is flawed. But to do that one has to make a systemic, not
anecdotic, argument for volatility in a VB market -- and remember, this is a
market where stocks are no more a factor.

>The question is how to stabilize the movement of financial assets whether
>they be stocks, bonds, foreign exchange, etc.  (What Trond and David forget
>is that in an open economy even if you restrict the domestic price of
>securities to plus or minus 20 %, the exchange rate permits wider
>fluctations in the value of these stocks in terms of another currency.)

One has to start somewhere. Cet. par., my conjecture is that a VB system
will be more robust (strongly reduced propensity towards gross long-term
overvaluation w/ panics and crashes) and more efficient (channeling mony
where the collective mind of participators thinks it is best allocated),
even in an open economy.

The 20% proposal is David C's, not mine, so I leave the defense of that to him.

I have earlier argued that the dynamics of stock or bonds or forex markets
have different systemic characteristics, and must be therefore be treated
separately, so I will stick with the stock (or VB) market for the time being.

Concerning "volatility", we have discussed this earlier on this list. I
think - as stated earlier -  that day-to-day or even month-to-month
fluctuations are no big problem (except tying up an outrageously large part
of the workforce in outrageously overpaid and parasitic activity). It is
gross long-term overvaluation that is truly dangerous, when P/E ratios
approach the double of historical averages like today.

Paul says:

>The crux of my argument in the debate paper is that the interpretation of
>the role that financial markets play in the economy depends on the theory
>one, implicitly or explicitly, relies on.
>
>There are two alternative theories (1) the classical efficient market
>theory and (2) Keynes's liquidity theory of financial markets.  The first
>theory logically leads to a laissez-faire policy for otherwise policy
>prevents efficiency (with asymetric information the only policy is
>transparency so information becomes close to costless to obtain). Keynes's
>theory, on the other hand, logically leads to the argument that
>transparency wouldn't do it and that there is a role for government in
>developing an institution to stabilize the financial market prices.

If we stick to stock markets, I can't remember seeing that Paul has proposed
a gvt. institution to stabilize prices. I know that he has proposed a strong
global "market maker" to discourage *currency speculation* and thus reduce
volatility. But does this mean that Paul also proposes a gvt. institution
for the *stock market*, that shall be so big that it can stabilize the stock
market by buying and selling (or at least maintaining a credible threat of
doing so, which has the same effect) against volatile trends? If not, what
exactly is Paul's proposal for regulating the stock market?


Trond Andresen

**************************************************

Footnote: The danger of perpetuities
==========================

If a certain share of a capitalist's expenditure is on the condition that it
shall yield a future stream of dividends, and these in the next round are
not spent but financially reinvested in the same proportion, etc., then
simple maths indicate that for certain parameter values the aggregate of all
financial assets (mirrored by corresponding debts) will grow exponentially.
(In the following we consider stocks on a par with bonds, i.e. as implying
a permanent claim to a future income stream):

Let -

aggregate net non-money financal assets (debt)   = A(t) [$]
initial aggregate assets at t = 0 is       A(0) = A0
average interest (dividend) rate   = i  [% / year]
the propensity to save out of financial income   = s  [  ]
average loan repayment rate (incl. perpetuities)   = d  [% / year]

Then accumulation will occur following the simplest
possible linear homogeneous differential equation there is:

dA/dt = ( -d + s (i +d) ) A(t)                                        (1)

or, with the net asset growth factor defined as

g = -d + s (i +d) ,                                                       (2)

dA/dt = g A(t)                                                            (3)

which has the solution

A(t) = A0 exp(gt)                                                      (4)

A(t) will grow, and we have asset/debt polarization, if g > 0.
In other words, this can be avoided with g <= 0.
This condition  may be reformulated in three equivalent ways,

            s <=  d / (i+d)                                              (5)

or        (1-s) >=  i / (i+d)                                          (6)

or         is <=  (1-s) d                                               (7)

For low nominal interest rates, savings rates, short average repayment time
(= 1/d) on loans - the system will not experience growing debt burdens.

Note especially, following (7), that a relative decrease in d (which means
more long-term debt/perpetuities) on the average) has a stronger impact
towards polarizaton than a corresponding increase in the interest rate.