The Fruits of Civilization (31-2-1) Limited Liability

 Limited Liability

The key provision which facilitated stock companies was limited liability, whereupon shareholders had only their investment at stake. A corporation’s creditors cannot come after the personal property of shareholders.

England allowed limited liability to trade guilds and monastic communities with commonly held property by the 15th century. In the 17th century, the British crown was awarding joint-stock charters to monopolies, such as its East India Company. Joint-stock companies became a norm in North America and Europe by the end of the 19th century.

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The reason stock markets exist is that companies’ appetite for capital exceeds what prudent lenders can stomach in terms of risk. Stock markets represent a democratization of risk.

From a rose-tinted perspective, stock markets let those with capital participate in economic growth by linking their savings to business profits. Another, mythical benefit is to engender the efficient allocation of capital.

The regulatory framework, necessarily so, is rigged to favor liquidity. The result was the evolution of focus in investors toward short-term gains, with knock-on infection into corporate management. Bosses became bent to “beating the numbers” at the expense of longer-range horizons. Such an environment encourages excessive risk-taking, including the sort of empire building, or, conversely, divestment, that may curry investors’ blessing.

In recent decades, the sharp edge of short-termism has rubbed off because large companies rarely turn to the equity market for new finance. When internal reserves prove insufficient, businesses prefer to borrow, as interest is tax-deductible. For many established corporations, being on the stock exchange is primarily a public-relations exposure, and a legacy of an earlier time, when the company cut its capital teeth on stock sale proceeds.

Most new companies that grow quickly do so through private investment. New flotations on the market are mainly a way for early-stage investors to cash in their stakes. Here, the effort is entirely publicity: to generate a buzz that punters too may make a quick buck by getting in on the “ground floor.” This was how the dot-com bubble blew.

A highly developed stock exchange cannot be a club for the cult of ethics. ~ German economist Max Weber