What value do Financial Markets provide to society?
Recently my friend made a statement, “There is a common consensus that stock trading adds little to no value to society.” Having followed stock markets since my childhood, I was only partially surprised to hear such a comment, the only surprise being that the friend is a fellow MBA student. I have heard similar statements many times before and know that many people hold the same view, but hearing it from a fellow business student intrigued me to write this post.
Harvard Professor Mihir Desai poses this question in his Book, How Finance works? He asks whether the people in the Financial markets, the traders, analysts, managers provide any value or are they leechers sucking value out of companies and ordinary people. He says that these people are solving the problem of asymmetric information. While there are many views to this question, I want to put my thought into words.
First of all, we have to understand that any market comprises people, its participants; Buyers or Sellers, Providers or receivers, and agents. So a statement that puts financial markets in good books but looks down upon the people of those markets is ironic.
So how does stock market/stock trading provide value to society? First and foremost, it provides a mechanism for companies to raise capital. Whether that company deserves to raise money and how much and at what cost is left to the people. Even though the process of raising the capital by issuing stock is initiated and assisted by Investment Bankers, once the stock starts trading in the open markets, it is assumed that Efficient Market Theory will work. The theory says that over a period of time, the market will fairly price a stock. I agree there are many subjective words used, but most of the time, collective intelligence works.
The financial market (includes insurance market, bond market, etc.) employs more than 7million people in the US. This represents significant livelihood. To the participants of the stock market, it provides a way to build wealth. Beat inflation, not only sustain the value of your money but increase it. The stock market has also destroyed people’s savings and retirement funds, but it has been the best vehicle to grow your money over a long period, sometimes the only vehicle.
Stock markets have rewarded the companies that have saved our society. Think Moderna, should not we reward the company for coming up with a vaccine against COVID? or should we also not reward the people who backed Moderna not only with confidence but with their money? The stock price of Moderna rose from $20 in Jan 2020 to $416 as of this writing. Whether this reward is fair or not is subjective and again left up to the Efficient Market Theory. Another thing is thousands of people played a role in vaccine development, but few were disproportionately rewarded. However, this problem is of equity and company structure, not of the stock market. What about the people who are in the middle of the stock market? Do they add any value? Absolutely they do. They bring together the people — the help in making a robust market. They help in bringing liquidity in the market; the stock market is the most liquid of all markets. How much would you reward them? How much would you reward a real estate agent that brings buy-side and sell-side together? These people in the middle help transfer the information and bring people together. If you value and respect facebook for bringing people together, then you value these facilitators of the stock market.
Another thing to point out is the stock market is a very small part of the wider financial market which comprises bonds, insurance, etc. The bond market is multiple times bigger than the stock market.
Like everything, Financial markets have their problems. The main problem is asymmetric information. Another significant issue is equity; Not all participants have equal influence. Another issue is accessibility, but with technology, far more people are able to access these markets than before. The stock market forces the managers to make short-term decisions that benefit just the stock of the company. This short-term behavior is not only damaging to the company’s health but, in many cases, to the environment, employees, and the general public.
This article is not meant to be an exhaustive list of how financial markets add value to society and the issues in it. I would like to invite my classmates at the Foster school of business to a healthy discussion about what Financial markets bring, their problems, and ways to solve them.
