Bohanon & Curott: Shares of common stock are not lottery tickets

Let’s say 5,000 people put up $1,000 per person. Each person gets a ticket with a unique number from 1 to 5,000. Over the next 50 days, a winning number will be drawn, and the winning ticket holder gets a $100,000 prize. At any time, one can sell his or ticket. Anyone who wants can make side bets on future daily drawings. George may bet an even $1,000 with Frank that the winning number tomorrow will be from 1 to 2,500, even though neither George nor Frank owns any lottery tickets.

Let’s say another 5,000 people put up $1,000 per person. Each person gets 100 shares of common stock in Alice’s Restaurant Corp. (ARC). A young man named Arlo takes the $5 million, issues himself a number of shares (not a secret—folks know about it) and opens four restaurants. At any time, shareholders can sell all or part of their shares. Those not holding shares can make promises (side bets) to deliver shares at a future point. George may pay Frank $1,000 today because Frank gave George the option to buy 100 shares of ARC from him at $15 a share between now and the end of the year.

The two schemes are similar in many ways. Both are risky. There is a good chance participants in either scheme will soon have nothing to show for their $1,000 stake. But the first scheme is called gambling. Some people think it is immoral. Such a scheme is illegal because the state jealously guards its exclusive right to run such operations. Nevertheless, lots of people enjoy gambling. But gambling is what economists call a zero-sum game because the winner’s reward can be no more than what participants put in the game.

However, the second scheme creates a business that has the potential to generate more in consumer value than it uses in producer costs. If Alice’s Restaurant does this and generates profits, Arlo and the shareholders can all be better off. This is what economists call a positive-sum game—and in this case, it is called equity investing. Not exactly the same as the first scheme. A few people think equity investing and trading is immoral. Even more frown upon the “side pots” called derivative markets. Make no mistake, government regulates equity investing and both common stock and derivatives trading. But despite the current turmoil in the market, shares of common stock are not lottery tickets.•

__________

Bohanon and Curott are professors of economics at Ball State University. Send comments to ibjedit@ibj.com.