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A lot of money

So here’s what I don’t understand about the Facebook IPO (Well, here’s the part that I don’t understand that I actually care about slightly, unlike the part where some rich people get richer and others inexplicably don’t): what’s it all for?

As I understand it, the point in a capitalist system of having markets in stock and shares is to raise capital. If my widget factory needs upgrading, I need capital to upgrade it, and while sure it would have been nice if I had set aside a portion of the revenue every year into a capital account for that purpose, that would have meant less money for me to spend on stuff, and that didn’t happen. So now I need capital. One option is borrowing from the moneylenders, repaying it later with interest, and then not being in debt any more and keeping the added revenues from the upgraded widget factory for myself. Or putting then into the capital account, I suppose. So: moneylenders is one option, if they will lend. There is risk there, though, as if I can’t pay back, I lose everything.

Second option is taking on a partner who has some capital lying around, a capitalist who is looking to invest, and that’s awesome, because any risk gets shared with the investor. The drawback is that my new partner gets a share of the profits. Also, I have to find one.

So instead of finding one partner, I find a bunch of partners and sell each of them shares, as many as they want and can afford. This would be insanely complicated if we didn’t have a mechanism for doing it, so we made a market exactly for this sort of thing. Hurrah! So if I need a million dollars, I can sell half a million shares at two dollars each, and keep half a million shares for myself, and I’m done.

Of course, all my new partners may want to share in the profits, too, but (a) there’s a mechanism for that, and (2) it’s evidently possible to train all those shareholders to only care about the profit from selling, not from holding. So the only downside is that at any moment my million partners are crazy people who have no interest in the long-term, haven’t been my partners for long, don’t know anything about widgets, and could not conceivably care less. It’s win-win!

But seriously—the market makes some sense to me as a way to gather together a thousand tributary streams of money into a mighty river of capital. And if that river runs dry, the widget factory doesn’t get upgraded: I do understand that. I am a socialist, and I view capital with extreme suspicion, but I do understand that it serves a purpose. Like fire, capital is a dangerous but necessary servant, and a catastrophic master. So is a machete. Don’t want to live in a world without machetes, but I want to make sure they stay where they’re put.

What is the widget factory upgrade that Facebook needs those billions of dollars for? The exact numbers aren’t clear, but if the total value of the stock is fluctuating around one hundred billion dollars, given that they spent some billions of dollars setting it up and that the people who owned shares of Facebook last year still presumably own half of it without putting more money in, that’s still, well, unless I am making some fundamental mistake, what happened in the last week is tens of billions of dollars being transferred from investors to Facebook, in exchange for the stock. Right? Thirty, forty billions? What is the plan for that money? What could Facebook possibly require thirty billion dollars in capital for? I mean, that’s a hell of a server farm.

Tolerabimus quod tolerare debemus,


It does seem likely that Facebook will be sitting on a lot of cash; I imagine the most likely thing they'll use it for is acquiring other companies, sometimes because they want to own that company or its product, and sometimes because they want to hire the company's staff.

But the other reason to go public is that it gives a real-world value to the shares that you haven't sold, which is good for hiring (you can offer people stock that's actually worth something) and for retaining staff (until they're fully vested, I suppose), and allows your senior staff to put a number on their vast wealth, thus facilitating the rubbing of hands and cackling.

Yeah, and I suppose that the investors who bought shares privately over the last decade were told that there would be an IPO, and that their investment would become a much more liquid thing. Pressure to follow through on that is legitimate, even if there aren't big plans for the pile of cash. Other than this, of course.

I guess my perplexity is also about the news stories—and I'm talking here about fairly lengthy public radio pieces—didn't ask what the money was for at all. Even Charlie Pierce (who was right about what he said didn't mention that the FB bank accounts will have a lot of money just sitting there looking for something to do.


I think one thing that's going on is that Facebook was probably largely owned by venture capitalists, i.e. a few partners who said "I'll give you a million dollars in exchange for a share of the profits". So those guys are ready to get their million dollars back, and are thus selling their shares to the public, so that they can go invest their million dollars in something else.

I don't know a whole lot about exactly how venture capital works, but my impression is that it has something of a mix of the features of a bank loan and a stock sale. In particular, the VC explicitly intends to get their investment back some day, like a bank loan; and intends to profit by capital appreciation (selling their share for more than they paid for it) rather than by income (taking a portion of the company's income).

The whole thing of stocks that don't pay dividends, but which are only valuable for their potential capital appreciation, seems crazy to me. And I am a capitalist. :^) But I think the stock market aspect of capitalism is supposed to be about investing in companies that do something useful (and getting a share of the income in return), not in playing a speculation game. Because in a speculation game, one of you is *wrong*, whereas in an income game, everyone wins. (You get a million dollars (from me) to open your pizza place, I get $50K a year to compensate me for the risk that you can't make a good pie after all.)

Re what the stock market aspect of capitalism is supposed to be about versus what the stock market actually is about: I don't think the "investing for a share of income" vs. the "investing to profit on the appreciation of your investment" aspects of the stock market can be separated in this fashion. Speculation in the markets is as old as the markets themselves, going right back to the Dutch Tulip Bubble. The market manipulations in the United States in the nineteenth century were epic and were regularly damaging for the economy. The scope of the damage was fairly limited because the finance economy was fairly isolated from the totality of the real economy, as a large percentage of the U.S. population lived in rural areas, had no debt, and was directly involved in food production, so that money would become tight/disappear for a while, but people could still eat. When the U.S. a) urbanized and b) brought a much higher percentage of citizens/consumers into the debt economy from 1900-1930, the groundwork for the Great Depression was laid because market speculation's reach into the real economy was greatly extended. In the wake of the Depression, the real economy was protected from the risks of zero-sum speculative market activity by robust regulations that limited its size and scope. Those regulations, as we know, have been systematically disassembled since the 1980s, with a consequent return of the boom-and-bust cycles that naturally arise when the speculative aspect of financial markets are let loose, as the speculative aspect of the market has preyed upon the income-generation aspect of the market ever since. The really worrisome thing, of course, is that market speculation's reach into the real economy is much greater than in was in the 1920s, since a half century of relative stability in financial systems encouraged further integration of the real economy with a (heavily regulated) stock market.

I would agree that the income-generation aspect of markets is generally economically virtuous while the speculation aspect of markets is generally economically vicious, but I don't think it is sound historically to treat the one former aspect as what the market is "supposed to be about" and the other as an insane departure from normative practice. When markets are created, both aspects of financial dealing are enabled, and the creation of markets has been driven by the desire to practice both aspects. Indeed, the speculative side has been dominant more often than not in the history of capital markets. That's how I read the history of the thing, anyway.

As a second-string commenter, I'll just pass on what I was told about the logic of not paying (and not asking for) dividends: money paid out as dividends to stockholders is money taken out of the operating capital of the company. Since capital can be re-invested into the growth of the company, and since a successful company can grow at better than savings-account rates, the shareholder would prefer to see that money used to increase the value of the company of which they own a share.

Presumably, if they don't believe that the company will use its capital to grow at better than savings-account rates, they'll sell their share and buy something else. Or put it in their savings account.

Chris—that's more or less what my machete metaphor is about. I do think that the market (in this case the stock market) is inherently dangerous, and that people (probably through their government) have to keep an eye on it. This isn't the same as saying it's bad, just that it's dangerous.

Dan—first of all, you are a first-string commenter. On the Varsity squad. As are we all, as are we all, except the spammers. Second: The thing about the whole not-dividends-but-growth idea is that it relies on the value of the stock you own growing as the company grows, but that value is actually set by whatever somebody is willing to pay for it. And the company has no direct control over that. Sure it makes sense that my shares in the bigger company are worth more, but that doesn't guarantee that somebody will pay more. Whereas, if you give me a dividend, I have the dividend, and that's money.

The difficulty, presumably, is in balancing the desire for growth (which is real, I certainly don't mean to say it isn't) and an expectation of immediate income. Well, and I suppose that the problem with grow or my money goes elsewhere means that every company has to grow faster than every other company, which pressure will predictably lead to every company fraudulently claiming that its growth is larger than is possible, because as irilyth says up there, somebody in that scenario has got to be wrong, and admitting it means disaster.


Myself, I think it should be illegal to sell stock publicly without offering dividends. I think Dan's explanation of why such stock can be an attractive purchase is correct, but as that strategy means that at some point you have to sell your stock to realize any profits, and as stock prices will never continue to rise indefinitely, stocks without dividends are purely speculative instruments, adding volatility and risk to the market and serving mainly to enrich some (usually a few) investors at the expense of other (usually many) investors rather than spreading wealth broadly to all investors.

Mandatory minimum stock dividends create problems of their own, starting with deciding on the minimum dividend. Suppose you set a 2% mandatory annual minimum dividend. If that is 2% of the current stock price, then a rising stock price rapidly creates a massive cash flow problem for the business (and is an easy way for large investors to kill any business). If it isn't tied to the current stock price, then it's not really a mandatory minimum. (2% of Apple's stock price 10 years ago is 0% now.) The only way around that is then to set caps on stock prices, which freezes the market entirely.

Tie the dividend to the stock purchase price? The only way to effectively do that is to ban secondary or derivative markets.

Require companies to distribute a percentage of profits to investors as dividends? Same problem as requiring companies to pay taxes on a percentage of profits -- it becomes an accounting shell game.

So dividend policies go in long-term cycles following investor sentiment towards dividends. That points towards a possible influence on the market through requiring companies and brokers to prominently display the dividend rate at the current stock price, much like requiring lenders and credit card issuers to prominently display an APR, or requiring the prominent display of a vehicle's gas mileage. That seems to have some influence. But then what happens when brokers and companies work to persuade investors that they should be looking for a lower number rather than a higher number?

Dividends are really a more important question for individual investors, I think. But since the cost of buying and selling stock has dropped by an order of magnitude, dividends have become much closer to fungible with simply buying or selling stock. Suppose you own $5000 of a company's stock (current value). What's the difference between getting a $100 dividend vs. selling $100 of the stock? On the flip side, if you're getting a $100 dividend you don't want, just buy another $100 of the stock. Right now the biggest effect seems to be due to tax policy on investors, which offers more flexibility if there is no dividend.

Perhaps we might consider a more narrowly tailored approach of not making an initial public offering of stock without a small mandatory minimum dividend that is linked to a percentage of profits for the first three years the company is publicly traded. After this period, the company can change its policy on dividends. Sure, that opens up an accounting shell game, but some stock holders will have an interest in that accounting being fairly conducted, and it's less in the public interest with respect to the stock market to have profits accounted for accurately (there's public interest and regulation in that regard already, for other reasons). The public interest with respect to the stock market is to discourage speculation. In that respect, perhaps increasing the cost of buying and selling stock so that it is no longer as attractive for having an income stream than dividends would be. Decreasing transaction costs would seem to facilitate speculation. As I hear it, rapid capital flows contribute to market volatility.

I think a universal transactions tax would have a much greater effect in shifting the balance between speculation and investing. But eliminating the derivatives market (or capping it as a moderate percentage of the underlying investment) would be even better.

Back to FB, it seems that a reporter, James Surowiecki, for the New Yorker, actually read the prospectus, and says: Its I.P.O. prospectus is up front about the fact that it envisages no “specific uses” for the sixteen billion dollars it just raised, most of which it will park in U.S. treasuries, like an aging retiree.

So that answers that. Except: Only $16B?


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