Stock Prices and Social Wealth

Abstract

A rise in the price of a company's stock is commonly believed to signal an equivalent rise in both the value of the company and in aggregate social wealth. This belief can be traced to three influential ideas in modern finance: the Efficient Capital Market Hypothesis (ECMH), the Capital Asset Pricing Model (CAPM), and what might be called the principal-agent or shareholder primacy model of the firm. In the decades since these ideas were first developed, scholars have produced an extensive body of theoretical and empirical work that revises, extends, and in some cases challenges them. This article reviews some of that work and concludes that the relationship between stock prices and social wealth is far more indirect and complex than generally understood, even if investors are assumed to be rational. It offers examples of a variety of situations in which stock prices predictably will fail to capture corporate value and suggests a research agenda for developing more accurate means of measuring the corporate sector's capacity to generate social wealth.

JEL Classification: D80, G1, G3, K22