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How Stocks Promote Growth

This article explores the functions of financial markets and evaluates private property as an incentive for conserving and improving scarce resources. It specifically discusses how stocks promote growth by increasing the availability of funds for growing firms, lowering interest rates, and improving management. The article also addresses why firms may not always grow and how they obtain funds, both for privately owned and publicly traded companies. Furthermore, it highlights the benefits of lower interest rates and better management in fostering growth.

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How Stocks Promote Growth

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  1. How Stocks Promote Growth Mr. Way, Economics, 4-26-12 12.2.9 Describe the functions of the financial markets. 12.1.4 Evaluate the role of private property as an incentive in conserving and improving scarce resources, including renewable and nonrenewable natural resources.

  2. How Stocks Promote Growth • Increase the availability of funds for growing firms • Lower interest rates • Improve management

  3. Why don’t firms always grow? • Companies need cash to expand. • Buy/rent capital • Pay workers • Buy materials • Bureaucratic/Legal issues • Advertising • Even when a company finds all the money to pay for these, it has no guarantee of success; the expansion may not be profitable after all.

  4. Where do they get the money? • For a privately owned firm, they have two options, each with its downside. • Profits from previous years/Personal savings • Takes a long time to accumulate the money • If they had more money right away, they could expand immediately and increase profits! • Take out a loan • Requires interest payments, lowering profit • If the expanded firm isn’t profitable, the owner will have debts they cannot repay -- “ruined” • The risk to the owner discourages growth.

  5. Where do they get the money? (2) • For a publicly traded firm, it’s easy: • Sell partial ownership of the company • Instant cash to pay for expansion of business! • Cost of failure falls on investors, decreasing the risk of loss for the original owner, making them more likely to take the chance. • However, shareholders will also take a cut of the profits – often more than interest on a loan would be.

  6. Lower Interest Rates • If some companies get their funds from investors, they don’t need to take out loans from banks. • This means less demand for bank loans. Since the price of a loan is the interest rate, the interest rate will fall. • If the interest rate is low, this lowers the risk to anyone taking out a loan, encouraging companies to expand more.

  7. Better Management • Most shareholders demand the highest possible profit on their investments – they’re the ones taking the risk, after all. • To achieve this, they use their power as owners to hire the best CEO available to run the firm. • New managers find ways to cut costs, increasing productivity, profits, and therefore future growth.

  8. Summary Questions: • How does the stock market increase the availability of funds for companies? • (directly and indirectly) • How else does the stock market promote growth in the economy?

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