Are Stocks a Ponzi Scheme?

[Toocold]

"the job of corporations is to maximize profits to the shareholders"

I think a better way to say this is the job of the corporation is the maximize the short and long term benefits to shareholders, of which profits is obviously important. Those who focus on maximizing profits, such as Martin Shkrili, often find themselves profiting in the short term but not so well in the long term.

A good example is the recent change at Disney. Even the old/current CEO expressed concern how much the ticket prices were being raised at the parks, just because (as he said it), the market can "bare it."

 

[ERD50]

There is definitely a huge difference. For a sole proprietorship if the "business" has negative net worth then the owner's personal assets are at risk ...

OK, thanks, I see. But how would that apply/relate to a large corporation? The corporation's assets are all out there for the taking, there are no 'personal assets'.

And while CEO's should be held (and sometimes are) for some personal liability, even a very highly compensated CEO isn't going to make a dent in a Mega Corps balance sheet if MegaCorp goes under. And no CEO would jump in and try to right a sinking ship if they were on the hook personally. Even in the case of a failure, a really good CEO might take a $100M debt down to $50M before eventually needing to declare bankruptcy. His/her reward would be to be on the hook for the remaining $50M? Not gonna happen!

-ERD50

 

[Gumby]

OK, thanks, I see. But how would that apply/relate to a large corporation? The corporation's assets are all out there for the taking, there are no 'personal assets'....

The question would be whether creditors could go after the shareholders' assets to satisfy their claims. Under our modern form of corporation, they can't do that. So I can safely invest in Altria stock and know that the worst that can happen is that I lose my investment. My house and bank accounts are not at risk if Altria goes under.

 

[NW-Bound]

That is one theory; there are others. Specifically, if we as a society are willing to grant limited liability to equity holders (i.e- the worst that can happen when the business fails is that the stock you bought goes to zero, but you are not liable to pay more, no matter how much the company owes creditors) then we may be entitled to ask more of you in terms of the corporation undertaking other missions.

I don't know if we can require anyone, individuals as well as corporations to do good.

But we certainly can and have put boundaries on what they can do to prevent them from doing harm.

Yes, you can make as much money as you can, as long as it's legal.

 

[OldShooter]

I think that if a corporation treats its customers and employees fairly, delivers fair value to its customers and compensates its employees fairly that over tlong run the shareholders will benefit... perhaps not each and every quarter, but over the long run... corporations can walk and chew gum athe same time and a myopic focus on shareholder profits to the exclusion of all other things is a sure-fire recipe for mediocrity. ...

Yes, agreed. This is just the recipe for a successful company. The subtlety is that happy customers, quality products, happy employees, etc. are really key means to the end of maximizing shareholder value.

 

[PatrickA5]

Would Boards/Executives care so much about shareholder value if options/grants were illegal?

 

[ERD50]

The question would be whether creditors could go after the shareholders' assets to satisfy their claims. ...

But I don't understand how this would even work.

Anyone buying a share of stock is buying everything - the company's assets and liabilities. So when it comes to paying off debt, it comes from assets. When those are gone, well, that's all your share of stock represented. Why would I have to dig into my pocket to cover a shortfall? Wouldn't I need to set some sort of reserve for that? What if shareholders A through Y had zero net worth, and Z was holding millions. Does it all fall to Z?

And isn't that what bankruptcy is all about? A court takes the remaining assets and distributes them to claimants. Isn't that the end?

-ERD50

 

[RobbieB]

If I was personally liable for the actions of people I've never met then I would not be an investor.

And I'm sure lot's of other folks would agree. So much for innovation.

 

[Car-Guy]

I'd never buy another share of stock if I were at risk for more than what I initially invested.

 

[Gumby]

But I don't understand how this would even work.

Anyone buying a share of stock is buying everything - the company's assets and liabilities. So when it comes to paying off debt, it comes from assets. When those are gone, well, that's all your share of stock represented. Why would I have to dig into my pocket to cover a shortfall? Wouldn't I need to set some sort of reserve for that? What is shareholders A through Y had zero net worth, and Z was holding millions. Does it all fall to Z?

And isn't that what bankruptcy is all about? A court takes the remaining assets and distributes them to claimants. Isn't that the end?

-ERD50

Suppose that you and I are co-debtors on any obligation (bond, contractual claim, etc.). You file bankruptcy, your assets are liquidated and handed over to the creditor, but there is still a shortfall in the amount owed. That creditor is then going to come after me for the shortfall. And the creditor could take my house, my car and my bank accounts to get his money.

If you and I were partners in a traditional partnership, we are each part owners of the business, entitled to a share of the profits. But if the partnership went bankrupt, each of us would be personally liable for any partnership debt. And that means that not only the assets of "the partnership' are at risk, but so are our personal assets (one of the reasons modern law firms are no longer real partnerships, but LLPs).

By contrast, if I am a shareholder in a modern corporation, I am still a part owner of the business and entitled to a share of the profits. But if the corporation goes bankrupt, my liability is limited by law to losing the value of my investment in the company (my stock goes to zero). My personal assets cannot be seized by a creditor to cure a deficiency.

The key point to this is that the limited liability of corporate shareholders is a creation of the law - a deliberate choice. There are very good arguments for why the law should make that choice, but, as I mentioned, it is a choice, not a law of physics.

 

[RobbieB]

I guess that's why we now have so many LLP's eh?

 

[pb4uski]

Yup... the 'ol corporate veil.

 

[OldShooter]

If I was personally liable for the actions of people I've never met then I would not be an investor. And I'm sure lot's of other folks would agree. So much for innovation.

Exactly. That is why the invention of the limited liability company was necessary.

"With their legal personhood, permanent capital with transferable shares, separation of ownership and management, and limited liability for both shareholders and managers, the Dutch East India Company (VOC) and subsequently the English East India Company (EIC) are generally considered a major institutional breakthrough." (https://ideas.repec.org/p/ucg/wpaper/0036.html)
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[ERD50]

Suppose that you and I are co-debtors on any obligation (bond, contractual claim, etc.). You file bankruptcy, your assets are liquidated and handed over to the creditor, but there is still a shortfall in the amount owed. That creditor is then going to come after me for the shortfall. And the creditor could take my house, my car and my bank accounts to get his money. ...

Thanks for the detailed response. Yes, I certainly understand this, like if I co-signed a loan for a relative. If they don't pay, I'm on the hook for all of it (barring any exclusions in the contract).

... The key point to this is that the limited liability of corporate shareholders is a creation of the law - a deliberate choice. There are very good arguments for why the law should make that choice, but, as I mentioned, it is a choice, not a law of physics.

Right, it is a legal construct and a choice. But it just seems so awkward to extend liability to the shareholders. If the corp had 1M shareholders, and ended up owing creditors $10/share, they'd need to collect that from 1M shareholders. Maybe the brokerage would pull it from the shareholder's account, but then what to do if not enough to cover it? Gets messy fast. And as others have said - many would just not want to own stocks with that sort of risk hanging out there. What would that do to the the economy, and in turn, to the overall well being of the general public? There might be more harm in lower employment, lower wages than to any benefit in holding shareholders responsible for debt?

Creditors (and suppliers with outstanding accounts receivable) are bearing some risk if the court says they only get $x on the dollar.

But more basically, isn't it really the bankruptcy laws that allow for some of these ethical concerns? As I said earlier, a share of stock represents the assets and liabilities of the corp. As long as the corp is allowed to declare bankruptcy, and its liabilities are cleared, the shareholder would not be on the hook any further either. So it seems any ethical issues are really with the bankruptcy laws (which I agree can seem unfair to the creditors)?

-ERD50