From: John Conover <john@email.johncon.com>
Subject: Re: Shift to seeing systems LO5749
Date: Tue, 20 Feb 1996 23:29:39 -0800
RonDavison@aol.com writes:
> Replying to LO5712 --
>
> Why would stock prices increase when layoffs are announced?
>
Again, I think the reason given depends on who is telling the
story. But you asked, so here is a common reason given-from
classical/neo-classical economic theory. It is assumed that folks
(pension funds, corporations, banks, private investors, etc.,) want
something to invest their money in. There is competition between the
stock market, savings accounts, precious metals, etc. It is assumed in
classical economics that national fiscal policy determines the rate of
returns on savings accounts, (in the US's case, the FED's prime
rate-the savings rate is close to the prime, or so, in general.) How
much fiscal policy influences the capital markets, again, depends on
who is telling the story.
So, the story goes, in a very simple scenario, someone who had some
money to invest would have to make a choice between putting it in a
savings account, or putting it in the stock market. One could get,
say, 3% per year return on a savings account, and for a stock to be
competitive, it would, also, have to return 3%. So, if a stock
returned, say, 1 dollar per year in dividends, then the stocks value,
(in this over simplified, illustrative example,) would be $1 / 0.03 =
$33.33. A more sophisticated and realistic analysis would include
inflation, risk, etc.
So, if you have a layoff, then that implies that dividends are going
up, (or not going down so far, as the case may be,) and that would
make the stocks value increase-which is kind of the idea of what the
CEO does for a living. (The CEO is the custodian of the share holder's
investment-that is the legal, fiduciary, responsibility of the CEO-as
chartered by the BOD, who are elected by the share holders-to oversee
that the CEO does so. The fiduciary responsibility is mandated by
state law, which varies from state to state, but in a nut shell, the
state requires that the CEO operate in the best interest of the share
holders-or else; don't collect $200 for passing go, and go straight to
jail.) So, if the layoff would increase the the annual dividends to,
say 2 dollars, then the share holders equity would double, since the
stock value would be $2 / 0.03 = $66.66, and the CEO would be a
hero. Note that A. Greespan manipulating the the prime rate has an
effect on stock valuation, also, or so the story goes, so if the FED
drops the prime to 1.5%, the stocks value would double.
As it turns out, a stock's valuation in the long run, (say, over many
years,) pretty well follows the above scenario, but there is so much
speculation that the short term is regarded by many, (namely the
programmed traders,) to be strictly speculative, (and usually
considered to be fractal.) Again, whether this is true, or not,
depends on who is telling the story, but for more details see,
"Fractals, Chaos, Power Laws," Manfred Schroeder, W. H. Freeman and
Company, New York, New York, W. H. Freeman and Company, 1991, or
"Chaos and Order in the Capital Markets," Edgar E. Peters, John Wiley
& Sons, New York, New York, 1991.
There are several obvious issues here, like layoffs may be short
sighted, since you make the share holders happy today, at the expense
of tomorrow, (because the layoffs occurred in R&D, etc.) And other
issues are not so obvious, like the pension funds, (who the programmed
traders work for,) owning 33% of US business, (I've seen numbers
higher than 50%, but I don't think anyone really knows for sure,)
which really means that the CEO works for insurance companies and
banks, and is under a lot of pressure to never, but never, let the
share holder's equity depreciate, and always, but always show a return
that is significantly better than what the investors could get at a
bank, or in precious metals, or in bonds, etc.
But this may have advantages: the way you sell a CEO on a new concept,
(your management concept, development concept, etc.,) is to put it in
terms of increasing share holder's equity. Works every time ...
You asked,
John
--
John Conover, john@email.johncon.com, http://www.johncon.com/