(Bloomberg Opinion) -- Gifts.
What do you get if you buy a share of Snap Inc. stock? A conventional simple answer is that you own a small fraction—roughly 1/1,258,171,112—of the company, but that is obviously imprecise. You can’t walk into their offices and take 1/1,258,171,112 of their pens. You can’t walk into their offices at all, unless they invite you. You don’t seem to “own” the company in any normal sense of that term.
A more sophisticated answer would talk about the bundle of rights attaching to stock, but … what rights? You can’t vote to elect the directors and officers who actually run Snap: Snap’s public shares are non-voting, and the voting power is actually controlled by the company’s founders. (My Bloomberg Opinion colleague Shira Ovide points out that Snap won’t even bother holding an in-person annual meeting with its shareholders.) You are entitled to your 1/1,258,171,112 share of any dividends that Snap pays, but Snap has no obligation to pay any dividends, and it never has, and it has said that it does “not anticipate paying any cash dividends in the foreseeable future.” If Snap is liquidated then you get your 1/1,258,171,112 share of whatever money is left over after paying off its debt, but don’t count on that paying your kids’ college tuition. If Snap is sold to another company then, yes, you probably do get your 1/1,258,171,112 share of the proceeds, so that is something; that is a real ownership-like right. But remember that Snap is controlled by its founders, who have already cashed out hundreds of millions of dollars, so there is no particular reason to expect Snap to be acquired in any shareholder’s lifetime, and no way for the shareholders to force a sale.
There are other, more faux-sophisticated answers. You might point out that you own a share in the company that grows in value as the company does, and that right now you can sell that share on the stock exchange for $13.31. But that evades rather than answering the question: What does the person who buys the share from you expect to get from it? The value of a stock in the market is supposed to be equal to the present value of its future cash flows, and there’s nothing about the stock itself that promises you any cash flows. Or you might say that Snap’s directors and officers have a fiduciary duty to you to maximize the profits of the company and the value of your shares, but even if that were true—it’s pretty debatable—it continues to avoid the question. If Snap made massive consistent profits for decades, it would still never have to give any money back to shareholders, and the shareholders would have no way to force it to. “I own a 1/1,258,171,112 share of a massive pile of cash,” you could say, but you could never spend it.
This is all standard dorm-room financial capitalism I guess but here is a fun paper from Amy and David Westbrook about “Snapchat's Gift: Equity Culture in High-Tech Firms.” They argue that, under conventional theories, there is no reason for Snap shareholders to expect anything:
This article explores the familiar rationales for equity investing, including stock appreciation and dividends, and the logical shortcomings of those rationales in these circumstances. Adopting Henry Manne's "two systems" of corporate affairs, law and economics, we show that corporate law fails to ensure that corporations return business profits to shareholders. A similar analysis of the market for corporate control, concludes (with Manne) that the market for corporate control depends upon shareholder voting.
So why do they invest? Here’s the Westbrooks’ answer:
In expecting a return on investment even in the absence of legal or market mechanisms to secure such return, shareholders are not irrational. Instead, investors rely on cultural understandings of appropriate reciprocity. Marcel Mauss’ path-breaking essay, The Gift, helps to explain the equity culture in which shareholders invest in Snap and other high-technology firms, and in which such firms operate.
It is an anthropological approach to corporate governance: Just as in traditional societies, chieftains give each other gifts that create obligations of reciprocity without any formal legal contracts or any explicit notion of exchange, so Snap’s managers have received a gift from its shareholders and thus have a cultural obligation to reward those shareholders’ generosity.
Even if the Snap shareholders lack a legal right to compel certain behavior on the part of the Snap managers, they have taken the always risky step of investment, and have thereby been connected to the management. The shareholders are committed, and in some moral sense owed good faith management, and so it may yet be rational, morally if not legally, for the shareholders to expect something in return for their investment.
Perhaps contra the suspicion of management at the center of corporation law since at least Berle and Means, there is no self-evident reason to believe that Snap’s management will not do the right thing, at least more or less. As Mauss explains, “[t]he unreciprocated gift still makes the person who has accepted it inferior, particularly when it has been accepted with no thought of returning it.” … To the extent that the founders are in a particular “tribal group,” they may act in the best interests of their companies and their shareholders regardless of whether such behavior is “required” by legal doctrines like shareholder wealth maximization or by pressures from the market for corporate control.
I have no particular problem with any of this. I am constantly going around saying that the financial industry is a Maussian gift economy, and I agree that traditional norms are as important as legal requirements in explaining how people act in corporate settings.
But I don’t actually think that’s what’s going on here. My analogy would be to the rise of paper currency and the demise of the gold standard. A stylized history: Once upon a time, people thought gold was intrinsically valuable, so they used it as money. Eventually they realized that carrying around pieces of paper that said “exchangeable for one gold” was more convenient than carrying around the actual gold, particularly if there were sufficiently robust legal mechanisms to make sure that the paper was actually exchangeable for the gold. And then the pieces of paper—and even more abstract instruments, like electronic ledgers listing how many pieces of paper each person owned—became just incredibly, incredibly convenient, a centerpiece of an economic life that was vastly richer and more efficient than the old economy where you had to cart around gold ingots. And then one day, after many years of this, the government said “you know what, these pieces of paper aren’t exchangeable for gold anymore.” And everyone just sort of shrugged and said, it’s fine, we like the paper, it’s not like we were exchanging it for gold much anyway, that was a nice idea but it’s not really central to how the system actually operates. And now the pieces of paper work because they work, not because they reference some other thing.
Similarly, people like common stock of public companies. Like, it’s a nice thing. You can trade it, and put it into indexes, or keep it out of indexes, and structure derivatives on it, and decompose it into factors, and read and write quarterly stories about the company’s earnings, and use the stock to express a thesis on those earnings or the macroeconomy or the social-media era generally. You can build models of the value of the company—based on discounted cash flows or comparable-company multiples or user-based metrics—and then divide that value by 1,258,171,112 to get the expected price of a share of stock, and if the actual price is higher or lower then you have a trading opportunity. You can build vast edifices of financial capitalism out of tradable shares of stock in corporations.
And sure it says on page 1 of the textbook that the share of stock represents a claim on the future cash flows of the corporation, and sure that fact is in some sense the foundation on which the whole thing rests. But the whole thing is good, and people and business models and industries rely on it, and the notion of treating shares of stock as part-ownership in a corporation is so useful that it doesn’t particularly matter if it’s true. The shares of stock have a particular kind of value because everyone treats them as having that particular kind of value, and everyone treats them that way because that is a collectively useful way to live. It turns out in practice that if you chip away at the foundation, the edifice is so artfully constructed that it will keep on standing in midair.
Incidentally this mostly explains initial coin offerings too.
The ex-chief executive officer of a New Jersey-based payments company has been sued by the U.S. Securities and Exchange Commission over claims that he used a girlfriend to trade on inside information about the firm’s pending takeover.
Robert O. Carr, who was sued by Heartland Payment Systems LLC last month, tipped Katherine Hanratty that the firm he ran was going to be acquired by Global Payments Inc. and gave her $1 million to buy shares in a scheme to profit from the deal, the SEC said in a complaint filed Tuesday. Hanratty was also named in the regulator’s complaint, which said she sold the stock for a profit of $250,000 after news of the $4.2 billion acquisition became public in December 2015.
Bloomberg reporter Katia Porzecanski emailed me the story with the comment “lol this is so basic.” Man is it ever. You sometimes see insider-trading complaints that make a big deal out of someone buying a bunch of call options just before a merger, when they had never traded options before that. But here Hanratty allegedly bought $900,000 worth of Heartand stock, and had apparently never traded stock before: She allegedly “emailed herself a to-do list that included ‘HPY,’ the stock ticker symbol for Heartland, and conducted internet searches on how to buy stock,” then walked into a bank, deposited a $1 million check from Carr, and “inquired of the bank manager as to how to open a brokerage account.” When she did find a broker, she “stated that the source of her funds was a ‘gift’” and told her broker “that she felt obligated to purchase Heartland stock because she received the gifted money from the owner of the company.” In a world without insider trading laws, it would all be sort of cloyingly sweet, but here we are.
In insider-trading cases with a close relationship between tipper and tippee, there is sometimes doubt about whether the tipper was in on it. There are cases where a husband trades on his wife’s inside information where the wife is an innocent victim: She told her husband about what was going on at her job, hoping that he would be understanding and supportive as she worked late nights to get a merger done, and instead he went out and insider traded on it. There are other cases where a boyfriend trades on a girlfriend’s inside information where the girlfriend is a knowing participant: She told her boyfriend what was going on at her job so that he could trade on the information and they could have more money. The innocent-victim-tipper cases are always more interesting, and I briefly hoped that this might be one, since the complaint starts out with a sort of understanding-and-supportive exchange of inside information:
Later that day Hanratty emailed Carr hoping that the board of directors meeting was “good.” Carr responded via email that the board of directors meeting had been good. Hanratty in turn responded via email that she was “[g]lad it went well.”
But it allegedly quickly turned into insider trading not only with Carr’s knowledge but at his insistence: He gave Hanratty the money, and after buying the stock she told him “I have done exactly what you recommended I do with it and made you the beneficiary of the account.”
Service vs. sales.
One thing that investment bankers sometimes do is take private companies public in initial public offerings that allow the companies’ young founders to cash out hundreds of millions of dollars. I would like to hope that at least some of these IPOs end with the investment bank giving the founder an oversized novelty check, and the founder going down to her local community bank and filling out a nine-digit paper deposit slip to put it in her checking account that previously held $37.11. Why not? But for the most part when you take a 20-something tech founder with no money and give her hundreds of millions of dollars, it is also just good customer service to tell her, hey, I know a guy who can help you invest that, if that’s of any interest to you.
Obviously if the guy you know happens to work at your firm, and your firm stands to take an annual percentage fee on any assets that she invests with the guy, then that is helpful for your firm and thus for your career.
But also obviously if the guy you know does a good job investing her money, charging reasonable fees and providing good customer service and high returns, then the founder will be more favorably inclined to your firm generally, and will be more likely to use you for future investment banking business, which is also helpful for your firm and thus for your career.
And for her! It’s good if she gets good service from your firm because you are hoping to win more business from her. That is how business is supposed to work. The whole thing is a nice virtuous cycle.
Anyway here is a story about how Goldman Sachs Group Inc. has a new “push to have its dealmakers help the bank’s wealth managers land new clients”:
Goldman’s annual client growth tends to come from those who recently made fortunes by selling companies or taking them public with the help of the investment bank, said Christopher French, who heads private wealth management in Europe, the Middle East and Africa.
“We’re very much focused on the origination of new clients,” he said in an interview at the firm’s annual Charity Forum. While there’s no formal commitment or expectations that newly liquid entrepreneurs use the bank’s wealth-management services, “it’s obviously a very positive introduction,” French said.
“Trying to win over the investment-banking clients for their private wealth business isn’t going to make them catch up with Morgan Stanley or Merrill,” said Danny Sarch, a wealth-management recruiter for more than three decades. “But that might not be what they’re going for. The issue is whether it will help them win more investment banking. When it works, it truly is synergistic.”
There is a balance here: It is annoying for the client, and embarrassing for the banker, to end every market-update meeting with a public-company CEO by saying “hey if you ever need help managing your money you should call our guy.” You don’t want to give your bankers a quota, making them push eight products a day. But if you have just handed someone a brand-new fortune, yes, offering to help her invest it is only polite.
(Disclosure: I used to work at Goldman, though I never made anyone enough money to worry about pitching private-wealth management to them.)
Credit portfolio trades.
A popular story about bond exchange-traded funds goes something like this. If you want to get exposure to bonds, generically, or to some type of bonds, you can buy a bond ETF. Bond ETFs trade on stock exchanges; they are very liquid, so buying them is cheap and fast. The underlying bonds, meanwhile, trade by appointment; you have to call up a dealer to buy or sell them, and the dealers don’t want to take any risk, and it takes days and costs full percentage points to do anything in the bond market. This mismatch between super-liquid ETFs and increasingly illiquid bonds is Bad: Eventually, a bunch of people will want to get out of the ETFs all at once, which will require ETF market makers to actually sell the underlying bonds, which they will find impossible because, you know, there is no bond market liquidity, etc.
In this story, the problem is self-reinforcing: The more of a pain it is to buy actual bonds, the more bond dilettantes will be pushed into using ETFs to get their bond exposure, which means that the actual bond market will become smaller and more cutthroat and more illiquid, etc.
But maybe that isn’t true? Here is a story about “credit portfolio trades,” in which an investor wants to sell a big chunk of bonds, and the dealer, instead of taking a lot of risk on its balance sheet to buy the bonds, and instead of spending days calling around to other investors to try to line up buyers, just smushes the bonds into something resembling an ETF portfolio and gives the bonds to the ETF instead in exchange for ETF shares. (Or vice versa if the investor wants to buy.) Then of course the dealer has ETF shares, but ETF shares are, remember, much easier to sell than bonds; the dealer can just bop them out on the exchange. The dealer has transformed illiquid bonds into liquid ETF shares, helping the customer sell a lot of bonds—actual bonds—quickly and cheaply. This requires some fiddling at the edges—the investor tends not to want to sell exactly the bonds that go into the ETF—but bond ETFs tend to have some flexibility about what bonds they will accept, and you’d assume that the dealer and the customer would also be a little flexible to make the whole thing work.
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