Opinion

Edward Hadas

Economists overvalue stock markets

Edward Hadas
Oct 31, 2013 13:07 UTC

Is it possible to construct portfolios which perform better than the overall stock market? Two of the three recipients of the latest Nobel prize in economics have tried to answer that question. Roughly speaking, Eugene Fama said that all efforts are in vain, while Robert Shiller said that they are not.

These nearly contradictory views are typical of an intense but inconclusive argument stretching back four decades. Market researchers have produced a mountain of studies, but they rarely consider the macroeconomic, ethical and social meaning of equity investing. That’s a shame. If more attention were paid to these issues, everyone could calm down.

Start with the economics. For the economy as a whole, changes in individual stock prices are basically irrelevant. The companies receive no cash when existing shares trade hands, whatever the price. The trading shareholders may have gains and losses, but they cancel each other out. The net economic effect of frenetic stock markets is zero.

The share price does matter when new shares are issued, but that happens rarely. While promising young companies can use cash to expand, and troubled older ones need cash to survive, in normal times companies generate all the cash they can invest profitably from operations, so they don’t need or want to raise new capital. It’s perfectly reasonable that over the last seven years, the value of newly issued shares was only about 10 percent higher for listed U.S. companies than the value of repurchased old shares, according to data from Thomson Reuters Datastream and Factset.

The main economic influence of share price moves is indirect, and basically negative. Top managers spend too much time watching the stock market. They hope for bonuses which are often based on share prices and they fret about being taken over. Both concerns lead them to follow the advice of stock market investors, outsiders who rarely have much insight into long-term strategic issues. Although activist investors can occasionally clarify their thinking, managers would usually be well advised to ignore the market price and rely instead on their superior knowledge as insiders.

A call for radical financial reform

Edward Hadas
Oct 9, 2013 14:56 UTC

The governments of developed countries have the power to rescue economies from defective finance. There is a radical solution. It would be relatively easy and at least as fair as the current slow generation-long recovery from the 2008 financial collapse.

I have been suggesting massive “start from scratch” financial reform for several years. The response is usually a mix of incredulity (it’s too hard to do) and indignation (it would be unjust). A thought experiment might help deal with those objections. Pretend that the current situation – excessive debts and deficits, unprecedented and risky monetary policy, overly powerful banks, slow GDP growth and unacceptably high levels of unemployment – was the result of a recent war.

Under those tragic circumstances, it would not be strange to say that the prevailing financial order was a relic from a lost period. Perhaps the arrangements were effective and fair back then, leaders would say, but the old promises, practices and privileges are now helping the few, hurting the many and holding the economy back. So finance needs to be reconstructed.

Elop and the neo-feudal revolution

Edward Hadas
Oct 2, 2013 15:17 UTC

I have nothing against Stephen Elop. The former and future Microsoft executive seems to have done a pretty good job running Nokia. It’s a little awkward that he was offered $7.3 million to move from Microsoft to the Finnish phone-maker and stands to receive $25.4 million to rejoin the his former employer. But the tech industry often has a slightly incestuous feeling, and there were plausible strategic arguments for both moves. Elop did what almost any senior American executive would have done – negotiated and renegotiated favourable contracts.

However, Elop’s packages are part of an outrageous system of executive remuneration. It features pointlessly complex arrangements – base salary, cash bonus, a small collection of share plans plus substantial payments for coming and going. The deals are rigged in the executive’s favour; Elop obtained highly attractive last minute alterations just before the sale of the phone business. And the numbers are all unjustly large, by any relevant standard.

The announcement of Elop’s terms was understandably met with widespread disgust. The same response is typical whenever executive pay comes up.

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