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THE STOCK MARKETS: CHAPTER OVERVIEW

Stock m a r k e t s allow suppliers of funds to efficiently and cheaply get equity funds to
public
corporations (users of funds). In exchange, the fund users (firms) give the fund suppliers
ownership rights in the firm as well as cash flows in the form of dividends. Thus, corporate
stock or equity serves as a source of financing for firms, in addition to debt financing or
retained earnings financing. In the 1990s, the market value of corporate stock outstand-
ing increased faster than any other type of financial security. Figure 8–1 shows the mar-
ket value of corporate stock outstanding in the United States in 1994 and 2010 by type of
issuer. Notice that from 1994 through 2010, stock values increased 237 percent, compared
to 229 percent growth in bond values (see Figure 6–1) and 212 percent growth in primary
mortgage market values (see Figure 7–1). However, stock prices fell precipitously during the
financial crisis of 2008–2009. At the end of the third quarter 2007, U.S. stock market values
peaked at $26.4 trillion before falling to $13.9 trillion in March 2009, a loss of 47.3 percent
in less than 1
½
years. However, stock prices recovered along with the economy in the last
half of 2009 and 2010, doubling in value from March 2009 to March 2010.
Legally, holders of a corporation’s common stock or equity have an ownership
stake in the issuing firm that reflects the percentage of the corporation’s stock they hold.

Chapter 8
Stock Markets
245
Specifically, corporate stockholders have the right to a share in the issuing firm’s profits,
as in dividend payments, after the payment of interest to bond holders and taxes. They
also
have a residual claim on the firm’s assets if the company fails or is dissolved after all debt
and tax liabilities are paid. Bond holders, on the other hand, are creditors of the issuing
firm. They have no direct ownership interest in the firm, but they have a superior claim to
the firm’s earnings and assets relative to that of stockholders.
Further, common stockholders have voting privileges on major issues in the firm
such as the election of the board of directors. It is the board of directors, through the
firm managers, who oversee the day-to-day operations of the firm. The board is charged
with ensuring that the firm is being run so as to maximize the value of the firm (i.e., the
value of its equity and debt claims). Thus, while stockholders have no direct control over
a firm’s day-to-day operations, they do decide on who will oversee these operations and
they can replace the board when they feel the firm is not being run efficiently from a value-
maximizing perspective.
The secondary market for corporate stock is the most closely watched and reported
of all financial security markets. Daily television and newspaper reports include recaps
of the movements in stock market values (both in the United States and abroad). This is
because stock market movements are sometimes seen as predictors of economic activity
and performance. This is also because corporate stocks may be the most widely held of all
financial securities. Most individuals own stocks either directly or indirectly through pension
fund and mutual fund investments, and thus their economic wealth fluctuates closely
with that of the stock market.

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