4.1.2 The publicly traded corporation

And that, naturally, is the major difference between the privately held company and the publicly held company: in the latter, capital can flow in (or out) through the sale of equity shares on a public market. The fluctuating value of those publicly traded shares will change the value of the firm and therefore affect its ability to borrow money or raise more capital. The speculative nature of equity markets affects, positively and negatively, the ability of publicly traded companies to attract capital.

In order to become a publicly held company, a privately held company must go public through an IPO and raise equity capital from investors who become equity shareholders. One of the greatest differences, then, between the private and public firm is all the disclosure regulations that surround the publicly traded company (all the SEC filings, quarterly statements, etc.).

So, the publicly traded company can do all the things that the privately held company can do, listed earlier, plus raise equity capital on the public markets. Some of the things it can do will have different names. The distribution of corporate profits, for instance, is called dividends in the case of publicly traded companies. But the functionalities are the same. In addition, publicly traded companies can also buy back their equity shares by buying their stock on the market, often enhancing the value of the remaining shares.

In publicly traded corporations, the management runs the company and satisfies the shareholders in good times through dividends (paying out profit) and increased equity value (increasing stock price), which keep the investors holding on to the stock (or selling happily at a higher price) and thus increasing the company’s equity value.

The equity shares are the ownership stake in the enterprise. They represent the value of the enterprise. Their value should be related to the current and expected profitability and cash flows of the company. On a double-entry accounting balance sheet, their value should reflect current assets, property, machinery, and goods owned, as well as the expected stream of incoming revenue, accounts payable, and likely future earnings, net of any debt or other obligations.

Theoretically, the wealth of the enterprise could be distributed to the different stakeholders of the company by means of the salaries and benefits for the management and workers, the contractual exchanges with customers or providers of goods and services, and the distributions and benefits to the investor shareholders. All of the wealth of the firm could be distributed in these different ways. In other words, all of the wealth generated by a publicly held corporation (over and above the servicing of debt obligations and the costs of operation) could be equitably distributed to workers, management, and outside affiliates, like the consumers or suppliers. But those distributional decisions are controlled by the management, under the supervision of the board of directors, and ultimately by the shareholders. As a result, it is usually the management and shareholders who extract wealth from the firm.

The extraction of wealth by shareholders and management happens in a few ways. First, there are dividend distributions: the enterprise distributes part of its profits by means of a dividend on shares. Second, there is the value of the shareholding itself. If the firm is publicly traded, then that value can increase and be sold on the stock market at a profit. Management can find ways to affect stock prices (e.g. stock buyback programs) and thereby increase share value.

By contrast to ordinary creditors (e.g. banks that loan to the enterprise or other bond holders), the shareholders assume more risk in return for the prospect of receiving a greater return. If things go badly, their equity stake may be wiped out. They have no guarantee of recouping their investment in case of bankruptcy, by contrast to a secured or primary creditor. If things go well, their return is not fixed by contract, as with debt obligations, but can exceed expectations.

In this sense, there is a gambling aspect to capital investment. It is a form of elegant, economic, educated gambling. Many of the early stock companies, like the West or East India trading companies, began as forms of gambling by the Dutch and British elite. And at the time, the ties to the slave trade were thick. It would also be important to discuss Lloyds of London in this regard. What is clear is that a logic of gambling undergirds capital investment. Like the horse track or casinos, betting on a commercial enterprise through stock acquisition is principally about making a profit and cares little, or at least, has little incentive to care for the welfare of the others affiliated with the enterprise.