Contacts:Prof. Bohumir Pazderka (613) 545-2340
Prof. Lewis Johnson (613) 545-2325
or
Filip Palda, Professor
Ecole nationale d'administration publique, Montreal and
Senior Fellow, The Fraser Institute (514) 990-5204
Release date: April 11th, 1995
MEDIA RELEASE
Vancouver>>> A new study released today by The Fraser Institute restores balance to the debate about stock markets.
"Stock markets are no gamble. Rather they help people protect themselves from financial risk, raise money for important ventures, discipline company managers, and reap rewards for longterm investments." This is the message of a book by Lewis Johnson and Bohumir Pazderka, Professors at Queen's University School of Business. They draw on their research, on research by the OECD, and on findings of hundreds of academics to bring us the real story about stock markets.
"Options and other derivative securities do not cause risk" they say, but protect timid investors from risk. The rise of derivatives trading has not made stock markets more volatile and listing of options on stocks of Canadian companies has had no effect on the volatility of the returns or on their trading volume.
"Large institutional investors are not short-sighted" the report goes on. These investors take into account the long view by bidding up the prices of companies that undertake research and development.
The authors point out that "Mergers and takeovers are not money grabs by corporate raiders, but rather a method the stock market has developed for disciplining wayward company managers." The threat of takeovers keeps managers attentive to the needs of their shareholders. Between 1977 and 1986, mergers and acquisitions in the US made shareholders of target firms richer by $346 billion and the shareholders of buying firms, richer by $50 billion.
"Stock markets are efficient," ascertain the authors. Exhaustive evidence suggests that investors use every scrap of available information in weighing whether to place or withdraw money from a company.
Most people and indeed investors themselves, would probably not think of stock markets working for the social good. We hear mostly one-sided judgments by the popular media: "pay your money and take your chances" or "my gain is your loss". This timely and important book gives us another viewpoint and makes the reality of stock markets more refreshing to read than the hype.
For further information or to receive your copy of the book, It's No Gamble: The Economic and Social Benefits of Stock Markets, call Beverley Horan, Director of Marketing, The Fraser Institute at (604) 688-0221 extension 316, FAX (604) 688-8539, or call Toll Free 1-800-665-3558.
It's No Gamble: The Economic & Social Benefits of Stock Markets
Synopsis
Chapter 1 explains that stock markets are places where entrepreneurs can present investors with their ideas for creating wealth. Few entrepreneurs have enough money to go it alone and need the support of investors. On the stock market, an entrepreneur can appeal to many investors. That is, he can encourage others to pool their funds in his company. Pooling of funds limits the risks any one investor faces and at the same time, allows the company to gather the funds it needs to grow. To further encourage timid investors to make their money available, stock markets have invented "derivative securities. Derivatives such as "puts" and "calls" are based on the value of the underlying stock. If you own a stock and want to protect yourself against a fall in its price, you can pay a premium and buy a "put" on the stock which eliminates all the downside. The person selling you the "put" bears all the risk, Stories about companies who invested in derivatives and crashed seldom mention that these companies sold derivatives. They acted as insurance agents for other investors. If reporters do not cry when Allstate reimburses victims of fire, they should not shed tears for companies who sold derivatives and lost. This chapter cites exhaustive evidence that the rise of derivatives has not made stock markets more volatile. The listing options on Canadian stocks has no effect on the volatility of the returns of their stocks or on their trading volume.
Chapter 2 asks whether the rise of institutional investors has made stock markets impatient and myopic. Institutional investors in Canada account for 60% of trading volume on the TSE. Some critics maintain that institutions are only out for a fast buck. They have to look good to their clients so they pass over companies with poor short-term prospects but good long-term prospects. Professors Johnson and Pazderka show evidence to the contrary. Stock markets reward companies that take the long view. Companies that invest heavily in R&D find that, all else constant, their stock prices rise. This means that stock market investors recognize the importance of taking time to develop a product and are willing to put their capital behind projects that may not show an immediate profit.
In Chapter 3 of their book, Professors Johnson and Pazderka suggest that mergers and takeovers of companies listed on stock exchanges help to make those companies efficient. A company is usually taken over because investors on the outside suspect that the company is badly run, or that its full potential is not being realized. Investors take the company over, discipline wayward managers, and get rid of inefficient operations. A study of 663 successful US tender offers between 1962 and 1985 shows that takeovers increased the value both of acquiring companies and of acquired companies by 8% on average. Between 1977 and 1986, mergers and acquisitions made shareholders of target firms richer by $346 billion and made the shareholders of buying firms richer by $50 billion. This suggests that managers had not been doing all they could to make shareholders well off. In the 1980s, junk bonds were used to finance many takeovers. Junk bonds have a bad name in the media, but they allowed investors to buy badly managed companies and restore efficiency.
Chapter 4 explains that stock markets are like laboratories where new ideas get tried out. Stocks are experiments in the creation of wealth. Investors are like scientists who put money behind experiments they think will succeed. This constant assessment of where the best opportunities lie means that every new scrap of information about a company's fortunes is quickly reflected in the price of the stock. This is known as stock market efficiency. Efficiency is important because it means that resources are being put to their best use. For example, news that the TB bacillus is getting stronger should signal investors to put resources behind biomedical companies with a chance of developing a drug against the bacillus. The chapter presents strong evidence to support the notion that stock markets are efficient. The chapter also points out how Canadian stock market efficiency could be improved.
Chapter 5 looks at stock markets in emerging economies such as those of Eastern Europe, Latin American, and Asia. The main problem of these economies has been the puzzle of converting from a state-run to a privately-run system. How do you set a value on government industries that are going private? A clever solution is to give citizens vouchers representing a share of state owned industries. Citizens then trade these vouchers with the help of investment companies who specialize in knowing what value lies in each industry. Apart from being a fascinating reminder of how stock markets decide what is valuable, emerging economies also show us that it is easy to privatize state-run industries. This is an example Canada might wish to note, given the heavy burden it pays for inefficient government enterprises such as its post office and railroads.
Chapter 6 is a thoughtful discussion of ethical issues behind takeovers and insider trading.
Chapter 7 looks at the direction regulation of the stock market might take. Professors Johnson and Pazderka suggest that there is room for two types of stock market in Canada. There should be a market for small, poorly informed investors, which is closely regulated to limit not only their choices, but also their potential losses. But there should also be a market with few regulations on which large, well-informed investors can trade.