value, profit, and debt

[spoonless]

Yesterday I went for a walk, and I started thinking about the concept of "profit" and realized that there is still something about it that I can't quite put my finger on that I don't understand. And it also made me think about a lot of interesting related issues about value and debt. I think some of this may be stuff that economists still argue about, and form different schools of thought over, and have written whole books about, so maybe it is ok that I don't understand it. On the other hand, maybe it is just basic knowledge and someone who knew more could fill me in.

I think part of what got me thinking about this was that I have a Roth IRA that I started in 2000, which is mostly composed of "safe" index funds but had one "risky" small cap stock in it, TIVO. Since I've had barely enough income to survive for most of grad school, I haven't even been able to contribute anything to it since 2002, and I haven't bothered to buy or sell anything in my portfolio since then either. For most of the past decade, TIVO has hovered between $5/share and $8/share, although I bought it in 2000 as it was taking a nose dive all the way down from $30/share during the dotcom bubble. At the time, it was not clear that the downward movement of technology stocks was due to a bubble bursting, and its price had already cut in half from $30 down to $15 so I bought 120 shares of it at around $15 (unfortunately, being 10 years ago I did not keep good enough records and do not know for sure what the actual price was). By the end of 2001 I had pretty much realized that I was stuck with having lost 2/3rds of my investment, and it didn't look like it would recover any time soon. But I figured maybe in the long term TIVO still had a chance of being a great product and getting into every home, so eventually it might recover. So I held on to it, and year after year it did nothing but oscillate between $5 and $8 occasionally going a bit higher or lower but not much change. Suddenly, a few weeks ago, it shot up to $17/share with the expected release of TIVO Premiere. So I thought about it for a bit, and put in a few stop-market sells over the course of a few days, to lock in my profits, and it still didn't fall down or go up much, and then just decided to sell it all. So I ended up making a profit after all, although for a 10 year period the rate of return I got was not very impressive... the equivalent of a little over 1% per year (13% overall) which is not as good as I could have done if it had put it in a CD or something with a fixed rate of return. Then again, everything else in my portfolio has done better, so my overall rate of return on my Roth IRA for the decade looks decent.

I'm not sure if it was thinking about this or about all of the financial shuffling I've been doing lately with the debt I'm trying to pay off (spread across 4 separate accounts--between that and the 3 different bank accounts I have open, I have been doing an incredible amount of moving money around from one place to another within the past few months).

But anyway, what I started wondering was two related things... where does the idea of "value" originate from when applied to stocks, and is it right to say there is "value" in the "profit" that is made by for-profit endeavors? If there is value in the profit that's made by for-profit endeavors, then that would seem to imply that non-profit endeavors that are just "breaking even" lack that value. Although if they are accomplishing the same thing, then in what sense can the non-profits be missing value? I think another part of me thinking about this may have been spawned by arguments on sifter lately about public versus private schools, where public schools are essentially non-profit, and 80% of private schools are religious so they are mostly non-profit, but the other 20% of private schools are secular, for-profit, and have much higher tuitions.

Usually when you buy something, like a skateboard, you get some kind of utility out of it, it has some value to you. Maybe that value is just that you enjoy riding around on it, or maybe it is that it helps get you to school or work on time. Or you could be buying a service, like a haircut or a car wash, but the point is you still derive some kind of value from making the purchase. Then there is money, which is somewhat special in that it doesn't have any immediate value to the person holding it, except that they know they can trade it in for something that does. The value there comes from the expectation that other people will do things for you or give you things if you pass the money on to them. But then there's stocks. What value do you get when you buy a stock? Surely if people purchase them, they have some value to the purchaser, but what is it? Exploring that thought, it seems clear that nobody who purchases a stock expects to get any kind of value out of it like the value they would from a skateboard. At best, if you had enough of it, for some stocks it might give you some weak voting rights in decisions the company makes, but for most stock transactions even that is not true. You don't get anything of value except that you expect that at some later point, you may be able to sell it to somebody else for more than you bought it. So is it like a collector's item, like antiques or coins or baseball cards? Where people buy them, hold onto them for a while, and know they can sell them for more later? Sort of, but that also seems different. At least with the collector's items, they have some sentimental value to somebody, somewhere. Most of the people collecting them may just be doing it to make a profit, but the fact that people are willing to pay more for them seems tied to the value at least some people place on owning them. Is there anyone that actually gets that kind of value from owning a stock, or does all of the value literally come from the expectation that it will have more value in the future? And if the value today comes from the expectation that the value tomorrow will be greater, but the value tomorrow comes from the expectation that the value the day after tomorrow will be even greater, then where does this process end and isn't there some kind of "origin" for the value rather than just an infinite nest of expectations? Is it really turtles all the way down, or is there some place we can trace this perceived value as coming from?

Looking at it from the other side, what is the difference between a for-profit and a non-profit? Every company has various expenses, and then they have income. A lot of the expenses are compensating the employees (including the management) for value they've added to the company through their labor and time. But if the income they receive from whatever product they are selling exceeds the value of the time and effort everyone put in to producing the product (plus whatever other expenses the company had, like rent, electricity, raw materials, etc.)... then we say justifiably that they "made a profit". For a non-profit, presumably the expenses match the income and they "break even". But for a for-profit, there are two questions relating to the profit: 1.) where did it come from?, and 2.) where does it go to after that? Let's put the first question off for now and look at the second question. They've already paid everyone including the management, so the profit must somehow go to the shareholders, which is where stocks come in.

Perhaps the difficulty in understanding "where the value comes from" in stocks stems from the language of buying and selling that we typically use to describe trading stocks. It seems to make a bit more sense if you view it instead as the investor giving the company a loan, and then getting paid back a return on their investment as compensation for the use of their money for a while. Then you can at least see where the value comes from that the investor offers the company. The investor could have used the money for other things, so they are giving up an "opportunity cost" to help the company be successful in their endeavor. As I was having all of these thoughts, it really sunk in that the phrase "it takes money to make money" is a very central and deep principle that drives a lot of this and explains a lot of this. The hidden value is in the fact that it takes money to make money, both from the point of view of the company and the point of view of the investor. Having a large pool of money gives you the ability to do large-scale projects that you couldn't otherwise accomplish. But there's a very spooky synergistic effect that if you put a whole bunch of money together and do something with it, then when you disassemble it back into the pieces afterwards and pay back everyone who put money in, you end up with more than you started with. Despite the fact that none of the people involved could have made the same thing happen with their money on their own.

So the phrase "it takes money to make money" explains where the investor's value comes from from the point of view of the company and why the "profit" can be viewed in some sense as another expense that was required to produce the product (because if there were no profits then there would be no investors to give them enough money for the endeavor in the first place). And it also explains why the investor is better off throwing their money into a pool with a lot of other investors instead of trying to do something with it themselves or just keep it in the bank. There is still the awkward question of how non-profits are able to do the things they do, although perhaps the answer there is just that a lot of them survive on donations. Initially, when I started thinking about this, I thought the difference was that for-profits require constant growth while non-profits expect to keep doing the same thing for a long time. And there is some truth in that, but I think there is also some truth in the insight that certain projects cannot be done unless there are either investors who can make a good return on their investments, or there are a lot of generous people willing to support a cause who will either donate money or put up money to use to get things started without requiring a return on their investment. Of course, if they do that, then they are losing out on whatever money they could have made doing something else with that money... but some causes are worthwhile enough that people are willing to do this.

So the phrase "it takes money to make money" I think explains where the hidden value comes from in stocks that seems so elusive initially. But that leads to more questions, about why this is considered value and what kind of value that is. And it also ties into the question of where the profits come from initially. At this point, I was near the end of my walk, and I think I came up with an answer, although the answer I came up with is kind of cynical and a bit disturbing and I'm not sure it's right (hopefully there is another way to look at it). The value ultimately seems to come from the fact that when there is a power imbalance between two groups of people in any game, the group in the position of advantage can exploit their position to extract value out of the group in the weaker position. So the extra value that comes out of the consumers after all of the workers who produced the product (including the management) are paid... that is drained out of the consumer group as a vampire would drain blood from its victim. The larger the financial backing behind the group in power, the easier it is to drain money from the groups lacking as much financial backing. Unfortunately, I think this may be the ultimate the origin of the phrase "it takes money to make money". The larger a coalition you form, the more power you have over those who form only smaller coalitions, and the more you can throw your weight around and bully others into submission. This is true not only for corporations, but also for labor unions or any groups. The larger the coalition the better your position. And if "it takes money to make money" is a theorem of capitalism, then a closely following corollary would seem to be "the rich get richer and the poor get poorer".

That said, I think there is one reason to be a little more optimistic about this--it's based on the analogy of a zero-sum game where whatever is gained by one group is lost by another. And in real life, that's not really the case. In reality, every person who is alive is continuously adding value to the world all the time, through their creativity, through their labor, and just through their being a person that other people like to be around. (Ok, there may be people like bin Laden or Hitler whose lives are a net subtraction from the total value in the world, but that's beside the point... the vast majority of people add value.) But even without it being a zero-sum game, I think the effect of leverage is very real and it is interesting that the idea of profit and growth is very tied into this idea of exploiting leverage. So my tenative conclusion is that profit and growth are ultimately due to exploitation, but the corollary of "the rich get richer and the poor get poorer" doesn't always follow because it's not a zero sum game. What happens instead is just that the rich get much richer, and the poor either stay the same or get only slightly richer, depending in large part on the political system in place.

Oh, debt! That's right, I put debt in the title and I almost forgot to say anything about it. Another thought that struck me as interesting after I got back from my walk was how one person's investment is another person's debt. I've heard a lot of people talking about the national debt lately. But what's called the "national debt" is actually a collection of treasury bonds (and other similar certificates) that investors buy when they want to invest in the future of the US. So every time the debt increases, it means that someone is supporting the US and placing a bet that we will continue to grow and do well as a nation in the future. In the same way that investors who buy a stock in a company are placing a bet that the company will do well in the future. Someone I was arguing with a month ago thought that the "debt" couldn't grow forever and it would soon lead to a collapse of the US empire unless we could find a way to "pay it off" and "get out of debt"... and that the higher it got the worse off we were. The first part is not true at all, and the last thing is true only if the debt/GDP ratio increases, not the debt itself. The existence of the debt itself is just an indication that people support the US, in the same way that stockholders support a company. So it's not something it would ever make sense to "pay off" or "get out of", although it does make sense to make sure our debt/income ratio doesn't get too high. Paying off the debt would be like all of the investors of a company dumping their stock, at which point the company would have to just shut down... it's not something that would ever happen unless the company was ready to die for other reasons. But the important point is that the price to earnings ratio should be healthy, so that you can continue to grow sustainably. Stocks are expected to go up, it just means that the "value" of the company has increased. (And in the case of the US, I think most of the increase in value over time is due to population growth, not the kind of phantom value discussed earlier.)

Comments

[bittercrackbaby.livejournal.com]

TIVO's stock jumps in recent years is due to courts upholding large IP judgements related to DVR technologies.

[spoonless.livejournal.com]

You're right. I knew there were some court settlements, one being around the same time, but I had assumed since they publicly unveiled Premiere on March 2nd and the main surge happened on March 4th, they were related. But the court settlement happened on March 4th itself, and apparently most of the surge happened within an hour after the judge announced the decision.

http://www.ipwatchdog.com/2010/03/04/tivo-stock-surges-over-50-on-patent-decision-in-echostar-case/id=9496/

I should have known that markets react far more quickly than a 2 day delay. At any rate, I feel a bit silly for selling it (since part of my reasoning was "this is just hype") but on the other hand I've kind of wanted to get rid of that stock for a long time and this was a nice excuse to drop it. It's just too volatile for a retirement portfolio.

[puellavulnerata.livejournal.com]

Well, for stock values we can regard the future profits of the company as an income stream (or, more generally, as a distribution over the space of possible future income streams), and argue that, given a certain time discount rate and risk aversion, a rational investor (in the sense that other preferences would be self-inconsistent) ought to be indifferent between that income stream and some (finite as long as the income stream's future growth rate is sufficiently small and interest rates do not asymptotically approach or reach zero) lump sum in the present. Thus, a sole proprietor owning a business can, in principle, given some set of expectations for the future, place a dollar value on it.

Now, suppose it's a publicly traded corporation. Internally, it still functions a lot like the sole proprietorship does: it hires people to do stuff, and sells some product, and hopefully makes a profit. Now, though, the management and the owners are in general different people, and the profit has to ultimately get to the owners somehow. For example, it can pay dividends to the stockholders. Then, being a 1/N stockholder gets you an income stream 1/N of what total ownership would get you, and so there's some 'rational' price for a 1/N share just as in the sole proprietor case as argued above.

Now, notice two things: first, the company doesn't have to spend all of its profits paying a dividend. It can also keep some in cash, or spend it expanding itself. Why should it do that? Because it has growth opportunities, or faces uncertainty about its future income stream and wants to hold liquid assets to buffer it, and that profit it just made is an easier source of capital for those purposes than issuing more shares or borrowing from a bank would be. A sole proprietorship would face the same choice on a logical level: if it makes a profit, whether to keep that in the business or transfer it to the owner personally, even though there isn't a *legal* distinction between the two.

In steady state, there wouldn't be any growth opportunities and there would be a certain finite amount of liquidity needed to buffer all expenses to a given confidence level for a given expected mean and variance of income and expense, so we can regard a 'mature' business as one that has reached this steady state and should try to return all profits to its owners, but an immature business would still have growth opportunities and should hold on to most of its profit. Of course, we can distinguish different points on a continuum between these extremes. Even old, mature businesses which have no growth opportunities in terms of introducing new products or improving their products or whatever would still have slow growth due to population increase, after all. I suppose the ultimate question is whether the expected return on re-investing a dollar at the margin into the business is higher than that on returning it to the stockholder so she can invest it elsewhere.

So, logically, the company faces a choice of how much of its profit to reinvest into itself and how much to return to its stockholders to use for other purposes, and this is independent of its form of ownership. The method of effecting that return varies a lot, though. For a sole proprietorship it's as simple as transferring from one bank account to another; for a corporation, it could pay dividends, but current tax laws make this a pretty inefficient method. Thus, most companies try to buy back their own shares instead, and if the efficient market hypothesis is true, then the market capitalization of the company should decrease by exactly the amount they spend doing so, and they've transferred that amount to the stockholders that just sold their shares.

[spoonless.livejournal.com]

I had initially intended to mention dividends, just to say "let's not consider them for this" but it looks like I forgot to mention them at all.

Dividends was one of the first things that popped into my head as I was trying to think of what the value to an investor is. But most stocks don't pay dividends, and even for the ones that do that doesn't seem to be the primary reason why people buy them--it's still mostly because they expect the price to go up in the future.

But you add some really good points here that help explain things. I did not think about the issue of companies buying back stock to transfer value back to the investors. That's an interesting effect in and of itself.

An important point I was trying to make though is that even if the company never pays dividends (or buys back some of its stock) there is still some value being transferred to the stockholders every time the company makes a profit. That's because even if they use the profits to grow the company, that causes the stock price to go up. So I think what you say is right, that this is where the value comes from from the point of view of the investor... the investor knows that she will get a share of the company's profits one way or another. But it's interesting that that can happen in rather indirect ways.

[puellavulnerata.livejournal.com]

Yeah. Stock buybacks are the dominant means of returning value to investors in the US economy for tax reasons, so just thinking about dividends will make you underestimate the volume of that flow. I suspect that the idea that stock buybacks will, by increasing the price, effectively transfer to the on-paper value of the people holding the stock is true *in expectation value* in that if the stock prices were systematically wrong with respect to it there would be arbitrage opportunities, but that sort of analysis doesn't tell you anything about whether to expect the *variance* to be larger in one case or the other, and that a situation where most investors buy because they expect the price to go up rather than because they expect to receive a dividend income is more prone to speculative feedback loops.

As for value being transferred to investors whenever the company mnakes a profit, I don't think that's actually true. If you own 100 shares of XYZ that are worth $10 each at the current market price, you don't actually have $1,000, you have 100 shares of XYZ that you believe are worth $1,000 and which, as long as the present volume of trade in XYZ is much larger than 100 shares, you could sell for $1,000.

It definitely isn't true that the stock price goes up every time a company makes a profit; it happens all the time that companies release quarterly earnings statements saying that they made a profit, but less than had been expected by whatever analysts and widely-held beliefs were influencing the market price, and the stock goes down because of it. The information about the company's actual performance was influences the stock price relative to what expectation of its performance was already priced into it by the market, not in relation to some particular absolute scale.

Thus, I think the best way to describe this situation is something like this:

1.) XYZCorp announces a profit of $0.25/share, when everyone was expecting $0.30/share.

2.) Some investors decide to sell; the price goes down.

3.) The ones who buy those shares are, in effect, making a bet that the future of XYZCorp is brighter than those numbers make it look.

4.) If you owned some shares and just hold them, your investment is worth less on paper, but there hasn't actually been a real transfer; you just have lower expectations for the future and a lower estimate of how much what you own is 'really' worth. The real transfer has been between the people who just sold XYZ and the people who just bought it.

[spoonless.livejournal.com]

I still don't fully understand something about the distinction between profit that's reinvested and profit that's "passed to the investor" through dividends or buybacks.

One thing I've heard that seems inconsistent with what you're saying there, is that stock prices will drop instantly as soon as dividends are paid. And this makes sense, since if the price remained exactly the same then everyone would want to buy right before they were paid and sell right after they were paid.

So it seems like in that way, dividends work the same way in which reinvestment works. Whether you expect the profit to be paid in dividends, or whether you expect the profit to increase the value of the company by growing it, either way the stock price goes up to take that into account. And then when the dividends are paid it goes back down a little. So I agree that in either case there can be a lot of anticipation, where it's already built in to the stock price even before the quarterly earnings are announced... as long as they are *projected* to have a profit. But I'm having trouble wrapping my mind around what's different about the profit being paid in dividends versus being re-invested in the company, from the point of view of someone holding the stock. (Other than the differences you mention in your other comment, like volatility and the fact that if you're not getting dividends then you lose everything if you hold the stock all the way until the company dies.) You may be right but I'm not quite seeing it.

Also, ironically... the only stock I have that actually pays dividends, I have it set so that the dividends are automatically reinvested in the stock (it buys additional shares with no transaction fee instead of actually paying me money). So in that case, I will lose everything anyway if I waited till the stock price eventually went to zero. (Of course, it's a mutual fund so that's not really going to happen.)

[puellavulnerata.livejournal.com]

If it's reinvested in the company, it might not pay off the same as investing it elsewhere. If the company's sitting there with a bunch of cash, and then they pass it back to their investors in a dividend, of course you expect the market capitalization to drop by exactly that amount: the company has the same future prospects for income, just that much less cash sitting in its bank account right now.

On the other hand, if it spends that money on some project intended to improve its future income, one doesn't just expect the market cap to drop by the amount they spent; they have less cash, but have presumably a better expectation of future income. The difference between the new market capitalization and the old one minus the amount spent can be interpreted as the market's estimate of how much that new internal investment was worth.

[spoonless.livejournal.com]

Hmmm... actually, I think your explanation backs up exactly what I was getting at.

Maybe I didn't explain it well. What I'm saying is that it doesn't seem like it makes any difference to the stockholders financially whether the profits are transferred in dividends, the stock is bought back, or the profits are reinvested in the company. In any of the three cases, they receive their share of the profits. It's just three different ways of them getting it.

Let's say there are 1 million shares and the company makes an unexpected profit of $1-million. As soon as they announce it, the price per share should go up by $1. So at that point it has already really been transferred to them. If they pay that $1-million out in dividends, then it drops back down by $1 to what it already was, but they get the cash. If they don't pay dividends but re-invest it in the company or buy shares back, then it stays at the increased amount and they don't have the liquid cash but they still have the value in their portfolio and can sell it, cashing in on it, at any time. Right?

[puellavulnerata.livejournal.com]

Why would the effect on stock price be the same if they re-invest the money in their business? Wouldn't that depend on *how* they re-invest it?

To make the point perfectly clear, suppose they reinvest it in a burnt offering of dollar bills to appease to gods of business.

[spoonless.livejournal.com]

Maybe there are different ways of thinking about it, but here is the way I have been thinking about it... so let me know if there is anything wrong with this:

- when the company makes an unexpected profit of $1-million, the value of the company immediately increases by $1-million. If they pay it to the stockholders directly in dividends, then it decreases by $1-million. If instead they spend it on new equipment for the company, or new locations, or whatever... then yes, it depends on how they spend it what happens. If they purchase $1-million of value for the company with that $1-million, then nothing changes. But if they get ripped off or squander it, the value goes down. If on the other hand, they get an especially good deal then it goes up. But I think those are after-the-fact corrections, where they have lost or gained value unexpectedly after making the initial $10-million.

I guess the difference in the way we're looking at it is that I'm seeing the company as having added value immediately any time its net assets unexpectedly increase, even before they spend it on anything. And it seems like automatically, if the company has more value then the stockholders have more money since they own a piece of the company. Paying the stockholders just seems like a formality, although I suppose there may be reasons for doing it that way.

The only thing I'm feeling now that doesn't quite make sense with the way I'm looking at it, is the issue of buybacks. I guess if I'm right about how it works, then the instantaneous stock price shouldn't actually change at all when they buy back stock. If they had the money and could have used it for something constructive, but instead used it to pay back existing investors, then the price would drop a bit, but that's exactly counteracted by the opposite effect of the pie being split fewer ways, so overall it seems the price should remain the same. Hmmm. So am I just wrong on that? If so, where is my wrong assumption?

[spoonless.livejournal.com]

Oh, regarding the idea of a "mature" company reaching a steady state situation where it no longer expects to grow...

Is that something any companies actually do?

(That's a serious question.)

My understanding was that in the business world, "grow or die" is the rule. Although I wonder how true that is really... surely it is more true in some sectors than others.

[puellavulnerata.livejournal.com]

Well, those are sort of Platonic ideals. In reality, you have a situation where the company has to decide how much of its profit to spend internally, and how much to return to its owners, and there's a whole range of choices rather than two possible points like that. In fact, you can even go further off the ends of the scale than those two positions. Start-ups routinely not only reinvest every dollar they receive but seek outside investment too, and in theory there's no reason a declining company couldn't just give up, sell all its capital assets and declare one big, final dividend. The latter seldom happens in practice, of course, even if it might be for the best; human organizations seem to have a built-in bias for self-perpetuation even at the expense of their original purpose.

Realistically, I think the typical life cycle of a business goes like this:

1.) The Start-Up Phase: a few people with an idea create a company; they need to persuade some investor that their idea is a good one, etc. The company typically isn't profitable yet, but if it's successful it sees revenue growth and goes through several rounds of venture capital, maybe eventually an IPO. At this point, it's small but growing, and mostly under the control of people who understand it fairly well, and who are working hard to make their idea reality and are thus quite committed to its success.

At this point, everything the company makes is reinvested, and it also seeks outside investment regularly. It's still flexible enough to tweak its underlying structure and ideas to try to fit a niche. Eventually, either it finds that niche and starts growing, or doesn't and fails.

2.) Maturity: the former startup has found its niche and grown to the natural limits of that market. It's a lot bigger and maybe not very flexible any more, and possibly the people managing are no longer its founders, but it figured out how to do something some customers somewhere value well enough to survive, and it regularly makes a profit, and sometimes still manages to do something new and clever and find new growth. However, it's near the natural limits of its premises, and it's starting to accumulate internal inefficiencies, and if the larger conditions change such that its current strategy is no longer well-adapted, it might be rather slow to recognize that and have difficulty adjusting.

This is probably where the possibility of pro-growth bias starts to creep in. Suppose that overall real economic growth is 2% per year; if reinvesting a marginal dollar of profit into the mature company will yield an annualized return of 1%, then management should not make this investment. They should pass that dollar back to the stockholders so they can invest it somewhere else and get more. They probably won't do that, though. If they keep it, they're still managing a company that's a bit bigger than it was, and so they might see bigger salaries, more prestige, and so on. This sort of situation is a conflict of interest between ownership and management inherent in the corporate form of organization.

But, notice that even a sole proprietorship might make the same mistake: the owner/manager there knows lots and lots about her business, and is probably confident in it and doesn't want to believe it has reached its natural limits, whereas she knows far less and is less prone to have favorable biases about investments in someone else's business.

3.) Decline: eventually, the conditions which supported the business change. Its product becomes obsolete or its input costs shift or consumer tastes shift. It tries to adapt, but it's large and has entrenched internal interests and factions who will resist changes that disadvantage them. Maybe it manages to halt the decline and even find a new strategy which allows growth, but often it won't. Relatively few organizations evade this; look at the Dow Jones component stocks today vs. the ones in 1910 and see how much they have in common.

[spoonless.livejournal.com]

This is probably where the possibility of pro-growth bias starts to creep in. Suppose that overall real economic growth is 2% per year; if reinvesting a marginal dollar of profit into the mature company will yield an annualized return of 1%, then management should not make this investment. They should pass that dollar back to the stockholders so they can invest it somewhere else and get more. They probably won't do that, though. If they keep it, they're still managing a company that's a bit bigger than it was, and so they might see bigger salaries, more prestige, and so on. This sort of situation is a conflict of interest between ownership and management inherent in the corporate form of organization.


Wow, this is really interesting stuff, especially this paragraph! Thanks for writing it out.

[puellavulnerata.livejournal.com]

So, if we have this picture of organizational life cycles, then we can't have a steady-state economy full of steady-state companies, but instead a hypothetical zero-growth economy would still be full of firms at different stages of the cycle and would oscillate around some average case. Now, connecting back to the idea that the stock buyback as a mechanism of transferring profit from company to stockholder is higher variance than dividends, here's something interesting:

Suppose dividends are the dominant means of effecting that transfer, and you have an opportunity to invest in a startup. You can do that, and if it's successful it'll give you a steady stream of dividends throughout the maturity phase of its life cycle. Even if you hold that stock until it reaches the decline phase and it eventually goes bankrupt, if it had a good successful run your total net present value in that scenario might beat other investments.

On the other hand, with stock buybacks, you lose everything if you hold the stock for the organization's entire life cycle. The existence of a profitable phase and the buybacks guarantees that there will be opportunities to sell that give you a good return, but you do have to take them to get anything at all. It does rather obscure the idea of spending a fixed sum now to gain a future stream of income in the mind of the investor.

[puellavulnerata.livejournal.com]

(continued)

So, the 'value' of owning stock is the expectation that, through some means or other, the company will return a profit to its shareholders at some point in the future. Of course, expectations about that future vary quite a bit among investors, so it's also *speculative*. If you buy a share of XYZ at $10 and sell it at $20 to another investor rather than to XYZ itself in a buyback, then your $10 profit came from that investor minus what went to whoever you originally bought it from. If at some point in the future XYZ buys it from her at $30, then you, in effect, bet that it would go up to $20 and won, but not higher and lost. On the other hand, if the day after you sell a zombie plague breaks out in XYZ's main office (or any other unexpected disaster) and the person who bought it from you is stuck with a worthless share, then in effect you won your bet.

Whatever XYZ does that makes it a profit is presumably actually creating value directly, but in one sense that sort of speculation is zero sum, and if the 'noise' of speculation overwhelms the 'signal' of the company actually returning profit to its investors, you end up with distortions. I think a good conceptual model is that investment markets are a sort of non-linear amplifier, where the input signal is the actual peformance of the companies being traded and well-considered, independently formed expectations of their future performance, but there's also a lot of feedback in the form of 'herd behavior' by investors copying strategies that look successful for others - i.e., buying a stock because it's been going up in the past rather than because you have a good reason to believe it's undervalued by the market. Like an audio amplifier, it can have a sort of crossover point where on one side the signal is dominant, and on the other feedback takes over and the output is determined by internal properties of the amplifier itself rather than by the input. The equivalent in financial markets is a speculative bubble.

[geheimnisnacht.livejournal.com]

Long post! Let me start simple and we can work from there:
-Value-
Humanity is interested in a happy* existence. Objects, actions, and ideas have value (directly) if they keep us alive or keep us happy, and have value (indirectly) if they improve the value of other things (such as improving their efficiency). Currency is a medium for value-exchange. Investment creates net value because concentrating resources generally leads to higher efficiency. It is win/win for the investor and the investee(?).

*happy being a loose term for "without hardship, emotionally/mentally fulfilled, etc"

And in the case of the US, I think most of the increase in value over time is due to population growth

Nope. If so, then we would expect real GPD per capita to be roughly constant, which has not been true. Since 1910, GDP per cap has risen from ~$6k to ~$40k (both in 2005 dollars). Meanwhile, population has only ~tripled, which is a smaller effect. Basically, you've forgotten to account for all of our manufacturing infrastructure and scientific advancement, which allow us to produce more for a given man-hour.

http://www.measuringworth.org/datasets/usgdp/

[spoonless.livejournal.com]

And in the case of the US, I think most of the increase in value over time is due to population growth

Nope. If so, then we would expect real GPD per capita to be roughly constant, which has not been true. Since 1910, GDP per cap has risen from ~$6k to ~$40k (both in 2005 dollars). Meanwhile, population has only ~tripled, which is a smaller effect. Basically, you've forgotten to account for all of our manufacturing infrastructure and scientific advancement, which allow us to produce more for a given man-hour.

Good point.

The point of my statement there was to say that the growth in US GDP is probably not due to exploitation, but due to more healthy positive things. So I was not in any way trying to say that it was *just* due to population growth. However, you add an important and interesting correction... that growth of technology and infrastructure was twice as important as population growth.

I vaguely remember thinking of adding "and growth of technology and other things" after that last statement as I wrote it seemed tangential to the rest of what I was saying.

At any rate, after thinking about this more yesterday I am thinking of other ways in which the profits derived from "it takes money to make money" could be due in part to things other than exploitation, although I haven't quite worked that one out. I may due a followup post.

[ankh-f-n-khonsu.livejournal.com]

Hrm... Long reflection, but it didn't seem especially insightful.

Do you understand how much federal debt has? Add in state debt? Average that for each man, woman and child?

Treasury bonds aren't value. They're fiat. Whose buying them?

And stocks - they have more to do with the sociological agenda of the corporate model than you seem to give credit.

Have you watched any of Adam Curtis's documentaries?

[ankh-f-n-khonsu.livejournal.com]

"how much federal debt the US has"

yay for MID's! :)

[ankh-f-n-khonsu.livejournal.com]

Hrmm... After further reflection, I'm not sure 'not very insightful' works. The reflection was replete with insight. It just fell within a frame that excluded other insights (which I find more valuable). For example, you mention that the profit comes through exploitation - and this is where more Marx and less Buffet would be ... Insightful. ;)

[spoonless.livejournal.com]

Do you understand how much federal debt has? Add in state debt? Average that for each man, woman and child?

Yeah, I spent a long time arguing this with people a few months ago on a mailing list. And in the end, it turns out that it's really not that much. I've worked out the numbers, based on http://www.usdebtclock.org/ and other sources, and it turns out, we could easily pay off the entire debt in 10 years if we *wanted* to. It would just require every American to take a 10% paycut for those 10 years. However, the real question is, why would we want to? Paying the debt off is not something that would be desirable for anyone (either us or for our investors) so it would make no sense to do or even consider. Again, it would be the equivalent of a company buying back all of its stock from its stockholders... not something any company would ever do.

[ankh-f-n-khonsu.livejournal.com]

I think the way you're framing your inquiry reflects a very imperialistic bias.

"And in the end, it turns out that it's really not that much." According to your own source, you're saying $700,000 in debt for each and every American family 'is really not that much'?

And why would you automatically think the solution is for the worker to take a pay cut? I think this also indicates strong cultural bias. From the sound of it, your experience in academia has cut you off from working class experience.

And why is the discussion framed around what a company would want to do? Since when is that a valid frame of social organization?

[spoonless.livejournal.com]

I think the way you're framing your inquiry reflects a very imperialistic bias.

That's strange to hear, considering it is usually the imperialists who are worried about the American empire collapsing or losing its world dominance.

Having too much debt is seen as a threat to our world dominance since borrowing money makes you dependent on whoever lent you the money. I think the worry is usually that we will become too dependent on foreign powers, in the same way that when we lend money to 3rd world countries (for example, through the World Bank of the IMF) they tend to become dependent on us.

Hearing you concerned about this seems quite backwards to me. The only number on that debtclock page that is troublesome is the 88% of the GDP number--it should be down closer to 50% if we really wanted to be a more solid empire. Although it's always going to be a bit higher during economically tough times and a bit lower during the boom times... so it's not terribly out of line.

While I don't think there is any truth to the idea that our empire may suddenly collapse because the debt has grown too large, I do think there is some truth to the concern that if it goes over 100% or so, we may slowly start to lose world dominance and eventually not become a major power any more. Although that will take a long time.

So I'm wondering, why are you so worried about that happening? I would expect an imperialist to use worries about the debt as an excuse for more aggressive conquest. If they can convince people that our empire is in danger of become enslaved to foreign powers, then it becomes easier to justify pre-emptive attacks and conquest. "Oh no! Our great empire will collapse if we don't act now! Friends, countrymen, come to our country's aid!"

At any rate, there is nothing to worry about. That $700,000 number is the most meaningless number on the page, I have no idea why they put it there because it isn't even related to the national debt. That whole section you are looking at is the total US debt, not the national debt. The total US debt is debt that private companies have to foreign investors. The size of that number ($57-trillion) just indicates that the New York Stock Exchange is the most popular exchange to trade on in the world. Many investors in the US may only have US stocks, but almost every investor in every country is going to have at least some US stocks. Why? Just because we have the biggest economy, not much other reason than that. There are more business opportunities here than in other countries, so investors stuck in other countries invest in our companies. Calling that $57-trillion "debt" is a little bit silly, but it's entirely pointless to divide it by the number of US families. You might as well divide it by the number of cows in the US. Neither of them is in the slightest bit responsible for that debt.

[ankh-f-n-khonsu.livejournal.com]

That's strange to hear, considering it is usually the imperialists who are worried about the American empire collapsing or losing its world dominance.

No, this is full-out ideologic bias.

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Having too much debt is seen as a threat to our world dominance since borrowing money makes you dependent on whoever lent you the money. I think the worry is usually that we will become too dependent on foreign powers, in the same way that when we lend money to 3rd world countries (for example, through the World Bank of the IMF) they tend to become dependent on us.

That's part of it, yeah. How many "3rd world countries" have you lived in?

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Hearing you concerned about this seems quite backwards to me.

No doubt. You're clearly looking at the world through the eyes of an imperialist.

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So I'm wondering, why are you so worried about that happening? I would expect an imperialist to use worries about the debt as an excuse for more aggressive conquest.

Well, I didn't say I was worried about anything so I guess you're projecting someone else's argument onto mine. However, I am definitely of the opinion that the collapse of the US economy is underway - in part due to its unmanageable debt. So if you're curious as to why I'm "worried" about that happening, I'd think that about as silly as asking why someone would be "worried" about Obama committing war crimes. Of course he's going to commit war crimes - just like every other president of the 20th century. Similarly, of course the US economy is facing imminent collapse. It's falling into the same holes countless other civilizations have - (cf. Jared Diamond)

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At any rate, there is nothing to worry about. That $700,000 number is the most meaningless number on the page, I have no idea why they put it there because it isn't even related to the national debt.

Go back to sleep America, everything is under control. Right. Spoken like a true imperialist. ;)

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This exchange concerns me - above and beyond the pleasant ideologic asymmetry (i.e., fodder for conversation) - because I am sensitive to how easily academics become disconnected from the working-class experience. The "Ivory Tower" stereotype doesn't arise out of nowhere. As I'm also en route to my own career in academia, I'm going to make a concerted effort to see that these classist prejudices don't seep into my worldview.

[spoonless.livejournal.com]

No doubt. You're clearly looking at the world through the eyes of an imperialist.

I think you may be confusing imperialism with capitalism, they are two different things. Not all capitalists are imperialists.

Well, I didn't say I was worried about anything so I guess you're projecting someone else's argument onto mine.

Ok, fair enough. So the other people I have argued with are actually worried it will collapse, while you are more shall we say... excited that it may collapse? Or just indifferent?

Similarly, of course the US economy is facing imminent collapse. It's falling into the same holes countless other civilizations have - (cf. Jared Diamond)

I'm not sure how his name got in there (is the last line a quote from him?) But coincidentally, I just started reading his book Guns, Germs, and Steel a week ago. I am really enjoying it, have just finished Part I and got 1 chapter into Part II.

As I'm also en route to my own career in academia, I'm going to make a concerted effort to see that these classist prejudices don't seep into my worldview.

Oh? That's exciting... which field would you persue?

Regarding my "classist" prejudices, and being out of touch with the working class, I think if those prejudices are there they have likely been there much longer than I've been in academia. So I wouldn't worry about it for yourself. My father is a landlord (of fairly low-rent housing) and an investor, so from birth I was raised in a way that made me pretty conscious of the differences between my white collar class and the blue collar class of our tennants. And I tended to support anything that would help my class at the expense of the blue collar class (not entirely sure if that's what you mean by working class). I think being in academia helped me to look at things from a more detached perspective and let go of the fight for my own class somewhat and just try to think about what's best for everyone.

[ankh-f-n-khonsu.livejournal.com]

Not all capitalists are imperialists.

That's just silly. Of course they are.

Here, try this one: Slavoj Žižek

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Oh? That's exciting... which field would you persue?

See here.

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I'm not sure how his name got in there[.]

• Collapse

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I think being in academia helped me to look at things from a more detached perspective and let go of the fight for my own class somewhat and just try to think about what's best for everyone.

Yes, I can see how you might come to think like this. Academics are no less susceptible to the Dunning-Kruger Effect than non-academics.

[spoonless.livejournal.com]

Oh wow, I may have to read Collapse at some point. It sounds like he is talking about environmental issues rather than economic issues though.

[spoonless.livejournal.com]

Also,

When I said everyone could take a 10% paycut, I should have been more clear. I am talking primarily about cutting income from capital gains, since that is where most income comes from. If you just cut workers income (paychecks) then that would not be enough to pay of the debt.

The national debt is $12-trillion, which is $40,000 "per citizen" but to state it that way is very misleading since it's the government's debt, not each person's debt. It's not like a dinner where everyone splits the check equally. The government collects revenue through progressive taxation, so if it *did* for some bizarre reason decide it wanted to pay of the debt, it would just have to raise taxes by 10% (or more likely, raise upper income brackets by more than 10% and lower income brackets by less than 10%). Only a third of US citizens actually pay taxes, so that means two thirds of the population would not have to pay anything. Of the other two thirds, most people would just be paying a little, while the people making millions per year would be paying most of it.

[ankh-f-n-khonsu.livejournal.com]

In case you haven't already, I thought you might like to meet solarbird: http://solarbird.livejournal.com/934731.html

[spoonless.livejournal.com]

Thanks, added.