Langues appliquées - Anglais : Economie, gestion, droit, AES - 4e - 45

stock markets

Starting in 1988, with amendments since then, the NYSE and other stock markets adopted a series of
rules called circuit breakers, which now halt all trading for one hour, two hours, or the remainder of
the trading day when the Dow Jones Industrial Average (a widely followed average price of a sample
of stocks) declines below its previous day's closing value by defined percentage amounts (which are
adjusted every quarter). These restrictions on trading vary with the severity of the drop in the Dow
and with the time of the day when the drop occurs. Circuit breakers were designed to head off panics
among market participants and forestall crashes like the ones in October 1929 and October 1987.
Stock Exchanges and Corporate Capital Needs
Although corporations often raise needed funds by selling stock, they do not normally do so through
the stock exchanges. New stock issues are typically handled by a special type of bank, called an
investment bank. In contrast, the stock markets trade almost exclusively in "second-hand securities" -
stocks in the hands of individuals and others who bought them earlier and now wish to sell them. Thus,
the stock market does not provide funds to corporations needing financing to expand their productive
activities. The markets provide money only to persons who already hold previously issued stocks.
Nevertheless, stock exchanges perform two critically important functions for corporate financing.
First, by providing a second-hand market for stocks, they make individual investment in a company
less risky. Investors know that if they need money, they can always sell their stocks to other investors
or to stock market specialists at the current market price. This reduction in risk makes it far easier
for corporations to issue new stocks. Second, the stock market determines the current price of the
company's stocks. That, in turn, determines whether it will be difficult or easy for a corporation to
raise money by selling new stocks.
Some people believe that a company's stock price is closely tied to its operational efficiency, its
effectiveness in meeting consumer demands, and its diligence in going after profitable innovation.
According to this view, firms that use funds effectively will usually have comparatively high stock
prices, and that will enable the firms to raise more money when they issue new stocks through their
investment banks and sell them at the high prices determined by the stock market. In this way, the
stock market tends to channel the economy's funds to the firms that can make best use of the money.
Other people voice skepticism about the claim that the price of a company's stock is closely tied
to efficiency. These observers believe that the demand for a stock is disproportionately influenced
by short-term developments in the company's profitability and that the market pays little attention to
management decisions affecting the firm's long-term earnings growth. These critics sometimes suggest
that the stock market is similar to a gambling casino in which hunch, rumor, and superstition have a
critical influence on prices.
Whether or not stock prices are an accurate measure of a company's efficiency, if a company's
stock price is very low in comparison with the value of its plant, equipment, and other assets, or when
a company's earnings seem low compared to its potential level, that company becomes a tempting
target for a takeover. Perhaps the firm's current management is believed not to be very competent and
those who seek to take control of the company believe that they can do better. Alternatively, if the
demand for a company's stocks is believed to be inordinately influenced by short-term developments,
such as temporarily low profits, others may believe that it is a bargain in terms of the low current
price of the stock and its more promising future earnings prospects. A takeover occurs when a group
of outside financiers buys a sufficient amount of company stock to gain control of the firm. Often,
the new controlling group will simply fire the current management and substitute a new chairman,
president, and other top officers.
From Baumol/Blinder, Economics, 12E © 2012 South-Western, a part of Cengage, Inc.
Reproduced by permission. www.cengage.com/permissions.

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