Stock Market Functions (SMF)
Opinion columnists and online critics sometimes assert that the stock market serves "no socially useful function" or that it represents something only a little more elevated than a huge government-endorsed gambling casino. Participants, however, claim that it serves a vital function by bringing together industry and capital, that it represents the very heart of constructive capitalism. Both views deserve critical examination.
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The Utility of Speculation
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Critics of the stock market, particularly liberal critics, often concentrate their objections on stock speculation -- the often risky, short-term trading of stocks for profit, usually without regard to underlying valuations. The 2007 stock-market meltdown resulted in considerable degree from the speculative buying and selling of derivative equities. In some instances, individuals and funds with no actual investment in the underlying securities made highly leveraged bets, objectively indistinguishable from ordinary gambling, on their future value. On the other hand, some conservative and libertarian market commentators justify speculation as helping to establish fairly valued markets, to identify future short supplies or surpluses and to encourage the velocity of money, which even liberal Keynesian economists will concede creates wealth. Speculation remains, and will likely remain, a controversial subject.
Industry and Capital
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The stock market, like markets generally, provides a place where those who have something to sell can meet those who wish to buy. Underlying this transaction, the seller receives capital necessary for the conduct of business. When a private company goes public, it receives, by means of the initial stock market offering, substantial amounts, sometimes even billions, of capital. This capital pays off the initial private investors who took the relatively high risk of underwriting a startup company. This, in turn, gives them the capital to repeat the process. The company retains substantial capital, which allows it to develop and improve products and to expand its selling and distribution capacities.
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The Reward for Initiative and Innovation
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The initial offering almost always provides substantial money flows to those who started the company, another important aspect of the initial offering. The prospect of a future reward inspires young entrepreneurs to invest high-risk money and substantial amounts, sometimes years, of time to bring their ideas to market.
After the Initial Offering
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Once the stock becomes regularly traded in the marketplace, its price constitutes what amounts to an instantly updated referendum on management. The stock price gives the stockholders of a public company an efficient mechanism for holding management accountable. If the stock falls in price, the company's board, usually at the urging of large stockholders, such as pension funds, will replace the CEO, and perhaps other senior executives, with another executive with a better track record.
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References
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