Benefits To Main Street

Strategy Helps Markets to Price Capital Competitively; Companies Secure Capital for Expansion, Job Creation

Companies need capital to start up, grow, and stay competitive. Financial services firms help businesses raise capital by issuing such securities as stocks (equity ownership in a company) and bonds (loans that pay interest).

Well-functioning markets ensure that both companies and investors obtain or receive fair prices for their securities. Viable projects will likely be financed while those that will probably fail will be rejected.

The cost of capital determines how much financing businesses will seek. Senior management will compare those costs against the returns (such as profits and higher share prices) they expect to earn after using the capital for expansion, merger, acquisition, or operational improvements. If capital costs exceed projected returns, companies are unlikely to risk expanding operations.

Financial markets drive economic growth. When a business buys new equipment or expands its facilities, it likely adds employees to its payroll. Longer term, capital spending forms the base for gains in productivity and living standards. A sharp slowdown in capital spending usually comes with job cuts.

As financial detectives, short sellers look for securities or commodities that are overpriced. They arrange through their prime broker to borrow the securities and then sell them. They later cover the securities they loaned with shares bought at a lower price. They profit from the difference between the sale and purchase prices — selling high and buying low. Through this process, the short sellers’ detective work helps to align securities’ prices with fundamental values. When short selling is constrained, stocks can get overvalued. “Virtually every piece of empirical evidence in every journal article ever published in finance concludes that without short sellers, prices are wrong.”(21)

If investors buy overpriced securities, their savings aren’t put to work as well as if they were to invest in fairly priced securities. The result: less capital is available, which makes it difficult for companies to obtain the funds needed to expand and create jobs.

Short sellers also help markets to function more efficiently, providing liquidity, for example. That’s important to investors, who want to be reasonably assured that any securities they buy can be converted readily into cash. Liquidity lowers the cost of capital because investors are willing to accept a low “risk premium” for holding liquid securities.