Flow of Funds: Overview of the Stock Market
Corporate Equities
Stocks of publicly traded corporations
Equities, also called stocks or shares, are ownership interests in corporations and the primary public security in capitalist systems.
In the U.S., except for preferred shares, equities usually carry the right to vote in election of corporate directors, the right to participate in profits in the form of dividends, and a residual claim upon corporate assets upon liquidation, once all creditors are paid off.
Most public equities are traded on a stock exchange and corporations are regulated by state law, the exchanges, and by the SEC on matters of financial disclosure, insider trading, and fair treatment of shareholders.
Most importantly, shareholders have no responsibility for liabilities of the corporation.
Why People Buy Stocks
Investors buy equities for three reasons:
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the hope of being able to sell to other investors for a profit;
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anticipation of a share in the future stream of dividends, or in the proceeds upon liquidation of a company; or
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the ability to control a corporation and direct its affairs.
The valuation of equities differs considerably, depending upon which of these reasons drives investors.
Since the 1980s, most stockholders in the U.S. have been motivated by expectations of selling stocks to others for capital gain.
As a result, stock prices have risen to levels not justified by probable returns from future dividends and the stock exchanges have taken on characteristics of a market in collectibles (like baseball cards, antique furniture, or fine art) in which trading values are divorced from practical utility.
Corporate Buybacks Raise Prices
Over the last two decades, the main purchasers of equities have been mutual funds and corporations redeeming their own shares.
Most U.S. public corporations are run by professional managers, paid under performance schemes linked to stock prices.
Their need to manipulate stock prices upwards motivates stock buybacks.
Individual stockholders have been net sellers of directly-held equities.
The growth of mutual funds has been possible because unsophisticated investors in tax-differed retirement plans believe the Common Stock Legend.
