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Who Needs the Stock Market? Part I: The Empirical Evidence

Data on historical and current corporate finance trends drawn from a variety of sources present a paradox. External equity has never played a significant role in financing industrial enterprises in the United States. The only American industry that has relied heavily upon external financing is the finance industry itself. Yet it is commonly accepted among legal scholars and economists that the stock market plays a valuable role in American economic life, and a recent, large body of macroeconomic work on economic development links the growth of financial institutions (including, in the U.S, the stock market) to growth in real economic output. How can this be the case if external equity as represented by the stock market plays an insignificant role in financing productivity? This paradox has been largely ignored in the legal and economic literature. This paper surveys the history of American corporate finance, presents original and secondary data demonstrating the paradox, and raises questions regarding the structure of American capital markets, the appropriate rights of stockholders, the desirable regulatory structure (whether the stock market should be regulated by the Securities and Exchange Commission or the Commodities Futures Trading Commission, for example), and the overall relationship between finance and growth. The answers to these questions are particularly pressing in light of a dramatic increase in stock market volatility since the turn of the century creating distorted incentives for long-term corporate management, especially trenchant in light of the recent global financial collapse. A second paper in this series will examine the theoretical justifications for the importance of the stock market as perhaps the central financial institution in the United States.