Trust, Money, and Companies
While companies are ubiquitous, and most people have a general idea of what they are, a fully-formed understanding of the concept of a company is less prevalent. At the base level, it’s just an entity doing business. The extra nuance comes from all the structure needed to make that practical. They have to be mostly flexible, but in other ways predictable. A company unites a group of people with resources to produce something another group values. As a result, we have structures like incorporation, limited liability, shares, customers, and employees.
This exploration approaches companies primarily through the lens of shares (often used interchangeably with equities or stock), as this perspective illuminates many facets of corporate existence and value.
Ultimately, what’s interesting here is how trust plays a role in a societal value of companies, and thinking on how holding wealth in the form of a company does not deny the consumption of others in the way holding wealth in personal use property. But first, we must review some of the structure that explains that conclusion.
Shares and Value: Beyond the Last Transaction
When we think about shares, we tend to fixate on their monetary value, often defaulting to the last transaction price reported in public markets. Public markets provide a predictable mechanism for negotiation, but the outcome (the price itself) is constantly in flux, driven by the expectations and preferences of buyers and sellers. It's crucial to remember this price is just one data point, a reflection of the most recent negotiation. The underlying value, and the reasons it changes, are far more complex.
It’s helpful to remember that corporations must be formed. When we discuss buying shares on a stock exchange, it's common to describe it as "investing in the company." However, in most transactions on the secondary market (where investors trade existing shares amongst themselves, rather than buying newly issued shares directly from the company), our money goes to the previous shareholder, not the company itself. The company's assets aren't directly increased. This contrasts sharply with instances where the company issues new shares to raise capital (the primary market) – in that case, the money does flow into the company, representing a direct investment in its operations and assets. While the distinction might seem subtle to the shareholder, it's fundamental to the company's financial structure.
The Foundation of Trust in Corporations
Forming a corporation, especially one with multiple contributors, requires significant trust. Early investors contribute assets (money, property, intellectual capital, even time and effort in the case of founders) in exchange for shares. This initial act is deeply rooted in personal trust – trust in the founders, the business plan, and the charter outlining the company's purpose and governance.
Corporations institutionalize a different form of trust compared to simple personal loans. Assets are pooled and entrusted to the corporation, managed by directors and officers, to conduct business. Even if all initial investments were equal, it's an act of trust because control shifts from the individual to a multi-party entity operating under agreed-upon rules.
This trust dynamic becomes more complex as companies mature. Later-stage investors might contribute money for newly issued shares, diluting existing shareholders. Here, trust operates on multiple levels: new investors trust the existing organization and its track record, while existing shareholders trust that the new capital will be used effectively to increase the overall value, justifying the dilution of their stake.
Investing in Shares vs. Investing in the Company
We often call all shareholders "investors." Yet, purchasing a share from another individual on the open market is, strictly speaking, investing in the share (an expectation of its future value) rather than investing in the company (providing it with new capital). No new assets enter the corporation through this secondary transaction. However, the transaction price can act as a signal, influencing how others perceive the company's value and, indirectly, the valuation of its assets. This signaling effect depends on the decisions of external parties and isn't intrinsic to the transaction itself.
The Disconnect Between Share Value and Assets
A critical entanglement between money and corporations is the valuation of shares. We often describe the wealth of individuals in monetary terms, but for the extremely wealthy, a large portion of this wealth typically consists of shares in corporations, not cash. While companies hold monetary assets, this amount is often a small fraction of the company's total market capitalization (the aggregate value of its shares).
A corporation's value includes tangible assets (real estate, equipment, inventory) and intangible ones (intellectual property, brand reputation), plus financial assets like cash or debts owed to it. However, the share-based valuation frequently diverges from the net value of these assets on the balance sheet (assets minus liabilities).
Valuation Below Net Assets: This situation is often unsustainable for for-profit entities. It signals that the market predicts the company's future assets will decline. Rational shareholders would likely prefer liquidating the company and distributing the proceeds rather than holding shares expected to lose value. (Nonprofits, lacking this profit motive, operate differently).
Valuation Above Net Assets: This is common and indicates market confidence. Shareholders and potential buyers expect the company to generate future profits, increase its asset base, and potentially distribute value through dividends (cash payments to shareholders) or stock buybacks (company repurchasing its own shares, concentrating ownership and often boosting the price).
Expectations, Trust, and the Organization
Ultimately, the gap between share price and current net assets hinges on expectations about the company's future performance. This reflects the collective confidence – the trust – placed in several key areas:
Leadership: The perceived competence and integrity of directors and officers.
Organization: The effectiveness of the company's internal structures, processes, and employee relationships. This includes the ability to innovate, execute plans, and adapt.
Market Position: The company's competitive standing, customer relationships, and the demand for its products or services.
If these factors align to create a strong expectation of future growth and profitability, the share-based value can significantly exceed the current asset value. This premium reflects the market's trust in the company's ability to generate future returns.
We must also consider the expected rate of return and risk premium. Investors have alternative uses for their capital. A company must be expected to generate returns above what could be achieved elsewhere with similar risk. Higher perceived risk demands a higher potential return, adjusting the current share value downward relative to the full expected future value.
Shareholders constantly balance their own assessment of value against the market's collective expectation (the current price). The price reflects a dynamic interplay of these expectations, influencing decisions to buy, sell, or hold.
The Central Role of the Organization
While initial investment is crucial, the long-term value of most corporations stems from their conduct of business. This requires more than just initial assets and a charter; it requires an effective organization. This organization encompasses the skills, knowledge, relationships, and collaborative processes embodied by its employees and structures.
Building an effective organization takes time and effort and represents a significant intangible asset. While officers can dismantle structures (terminate employees, cancel contracts, sell assets), creating or rebuilding them is complex and uncertain. The trust embedded within the organization – between colleagues, in leadership, and in shared processes – is vital and fragile.
When share prices are multiples of tangible asset values, it signifies immense trust placed specifically in the organization's ability to continue creating value. This trust can erode quickly due to mistakes, perceived ethical lapses, or changing market conditions. Rebuilding lost confidence is challenging; trust, once broken, is difficult to repair.
Separately, modifying or restructuring an organization to make it more effective is also inherently difficult, costly, and uncertain, potentially disrupting valuable existing relationships and processes with no guarantee of a better outcome. An organization needs both trust and effectiveness. Without genuine effectiveness, positive results won't materialize, eventually undermining trust regardless of initial expectations. Conversely, an effective organization may struggle to secure the necessary resources and latitude to prove itself if it lacks sufficient trust from investors and stakeholders.
Furthermore, an organization's value is contextual; its effectiveness depends heavily on the specific market it operates in. An organization highly effective at producing luxury goods might be entirely ineffective in a market demanding low-cost commodities. Its value is tied to factors like the level of demand for its specific offerings, the intensity and nature of competition, the prevailing regulatory environment, its position within the supply chain, and its ability to adapt to technological shifts within that market. These external factors collectively define the company's market position, which, as noted earlier, is a crucial component of the trust placed in the company. An organization optimized for a stable, predictable market may falter in a rapidly changing one, even if its internal processes are efficient in isolation. Therefore, assessing an organization's value requires understanding its capabilities in relation to the dynamics and demands of its particular market environment.
From Personal to Organizational Trust
Initial investors place a relatively personal form of trust in the founders and the initial plan. As a company grows and establishes a track record, the basis of trust shifts. Later investors rely more on the impersonal evidence of the organization's strength, its market position, and its financial performance. The trust becomes less about specific individuals and more about the proven capabilities of the system.
Wealth, Shares, and Extracting Trust
Thinking about the immense wealth ascribed to highly valued companies requires remembering the nature of that wealth. While an individual shareholder with a small holding can usually sell shares near the last transaction price, large shareholders face challenges. Selling a large stake can signal diminished trust, potentially depressing the price. It removes potential buyers and sends a negative message, especially if the seller is perceived as having insider knowledge.
Therefore, converting the trust implied by a high market capitalization into the depersonalized, liquid trust of money isn't straightforward. The company must continuously perform or be perceived as capable of future performance to maintain its share price.
Why Care? The Social Perspective
From an individual shareholder's view, understanding these dynamics informs investment strategy. But from a broader social perspective, the focus shifts. Wealth represents potential. Unlike personal assets often used for direct consumption (like living in a house one owns), owning shares represents a claim on potential future earnings generated through productive activity that (usually) provides goods or services to others.
Consumption vs. Investment: It's helpful to clarify what we mean by consumption, as the term can be used in subtly different ways. One meaning refers to the simple act of using something up, preventing its immediate alternative use. Eating an apple prevents it from being used in a pie. This type of consumption is straightforward. However, there's a more specific economic meaning: consumption implies using resources in a way that not only prevents another immediate use but also doesn't enable a significant new one, effectively reducing the overall potential usefulness remaining in the economy, usually to fulfill an immediate need or want. Burning wood for warmth consumes the wood, and the benefit (warmth) is temporary. In contrast, investment uses resources in a way that transforms them to increase future potential usefulness. Using wood to build a machine that speeds up pie-making consumes the wood but creates an asset (the machine) with future value exceeding the wood alone. Similarly, using an apple to make a pie consumes the apple but creates a pie, presumably of higher value or demand. When discussing economics broadly, "consumption" usually refers to this second meaning – activities that decrease the net potential usefulness available to society. Share ownership itself doesn't fit this definition of consumption; it represents potential that can be directed towards either future consumption or further investment.
Addressing Key Implications
What does it mean to the economy when someone sells a share? When shares are sold between individuals (secondary market), it's primarily a transfer of ownership and money. It doesn't directly alter the company's assets or operations. The economic impact depends on what the buyer would have done with the money versus what the seller will do with it (consume, invest, hoard). It also acts as a price signal reflecting changing expectations. When a company sells new shares, it directly brings capital into the firm, usually intended for investment, potentially boosting economic activity.
What does it mean to the economy when a share has a higher transaction price? A higher price signals increased collective trust and positive expectations about the company's future profitability, innovation, and growth. It makes it potentially easier and cheaper for the company to raise new capital if needed. It increases the paper wealth of existing shareholders, which might lead to increased spending (a "wealth effect"), but the link is indirect. It primarily reflects confidence, not necessarily immediate economic change, though sustained high prices across many companies can correlate with broader economic optimism and investment.
Should we care when share prices change? Yes. For individuals, it impacts wealth. Socially, significant price changes, especially large drops or high volatility, signal shifts in confidence and trust. Widespread declines can indicate economic trouble, potentially leading to reduced investment and hiring. Conversely, stable, rising prices reflecting genuine productivity gains can signal economic health. Prices act as a crucial, albeit noisy, information signal in the economy.
Should we care about wealth represented by shares? Yes. This wealth represents control over significant economic potential. Its concentration raises important social questions about fairness, opportunity, and how that potential is deployed – for broad benefit, narrow consumption, or further productive investment. Understanding it not as "stuff" but as concentrated trust helps frame these questions more effectively. The concern isn't just the existence of wealth, but how the underlying trust was earned and how the resulting power is used.
How does this relate to consumption? Share wealth is potential, convertible to money primarily through selling shares, receiving dividends, or company buybacks. Only when converted to money and spent on goods/services does it directly drive consumption (in the economic sense of using up potential). Companies themselves consume resources, but ideally create more value than they consume, fueling profits and justifying share value. The decision of a shareholder to sell and consume versus hold or reinvest is a key link.
Can trust be extracted? The value represented by trust in a company (manifesting as share price) can be converted into liquid money through:
Selling Shares: The most common way for individuals, exchanging trust-based potential (the share) for depersonalized trust (money). This however does not “extract” trust, but exchanges it.
Dividends: The company distributes profits (money) directly to shareholders. While this is extracting trust, it is limited to trust in the form of money. A company can convert some assets to money by sales, but it cannot convert its organizational value to money. That can only create profits over time through the conduct of business.
Share Buybacks: The company uses its money to buy its own shares, concentrating ownership and returning cash to selling shareholders. But like dividends, you cannot buy back shares without having money on hand to do so.
Liquidation: Selling all company assets and distributing the proceeds (a final extraction). But in this case, any remaining organizational value is destroyed. With no organization left to conduct business the value of that trust would be destroyed.
Illicit means (fraud, embezzlement) can extract money while destroying trust.
What are employees' relationships to companies? It's a relationship built on mutual trust, extending beyond a simple contract. Employees invest their skills and time, trusting they will be compensated and treated fairly. They form the core of the "organization," contributing significantly to the company's value and the trust placed in it by the market. Their collective knowledge and relationships are intangible assets.
What are relationships between companies? Companies exist within a network of suppliers, customers, competitors, and partners. These relationships rely on trust, enforced by contracts, reputation, and shared incentives. Supply chains, strategic alliances, and customer loyalty are all built on inter-company trust. These relationships define the company's market position, a key driver of its value.
Conclusion: The Economy is a Trust Engine
This is part of a series I’m writing on trust and the modern economy, which functions as a vast engine fueled by different layers and types of trust. Money provides the depersonalized, widely accepted base layer, enabling transactions between strangers and forming a societal measure of value. Loans, often facilitated by banks, bridge personal trust (lender-borrower assessment) with the depersonalized trust inherent in the monetary system they transact in. Companies represent even more complex structures. They are initially founded on the personal trust placed in founders and their vision, but evolve to incorporate and depend heavily on organizational trust – the confidence in their internal processes, leadership, and employee capabilities – and market trust, reflected in their brand reputation, customer loyalty, and ultimately, share prices. This entire interwoven system of personal, organizational, market, and depersonalized monetary trust allows for cooperation, specialization, and value creation on a scale utterly impossible through purely personal relationships. The engine not only utilizes trust but provides the conditions to generate new trust.
By understanding money, companies, and finance through the lens of trust – in its personal, organizational, market, and depersonalized forms, operating at local, national, and international scales – we gain a more nuanced perspective on economic value, wealth, fairness, and the foundations of prosperity.
I intend to cover more topics in this line, clarifying how the concept of depersonalized trust should refining our understanding of components of our financial and economic system. Taxes might be soon. But likely next I’ll want to cover something timely, international trade.