rket, however, does not always produce positive outcomes for investors. Such activi ties as leveraged buyouts (LBOs), as an example, create situa tions in which individual investors may suffer negative out comes, as well as creating conditions, in some instances, which are also detrimental to the economy in other ways.
The effects of the stock market as an institution on the economy are considered in the following discussions. The first of these discussions considers the stock market as a source of business capital, while the second discussion examines the effects on the economy of LBOs.
The Stock Market As A Source of Business Capital
Cost of capital refers to the cost to the corporation of investment capital (Bolten, & Conn, 1981). The cost for 3borrowed money is the relevant interest rate (Brigham, 1988). The cost of equity capital is a combination of float charges, dividend payments, and dilution of existing equity (Moyer, McGuigan, & Kretlow, 1981). Each financial instrument has a separate cost of capital determination.
Studies covering the time period from the mid 1970s through the mid 1980s indicate that new equity stock financing carries lower cost of capital than do other long term financial instruments (Mackenzie, 1987). The question arises, therefore, as to why a larger proportion of long term corporate investment capital is not raised in this way. The answer lies with both the corporate generators of capital and the investors who pur chase the long term corporate financial instruments. On the corporate side, existing shareholders are reluctant to dilute their ownership to too great a degree, preferring, instead, to pay the higher costs for other types of capital generation. On the investor side, there is often a preference for fixed return securities, as opposed to common stocks, and, in many instances, major investors, such as banks, are not permitted to purchase common stocks with their funds availab...