Friends, Although I know how stock markets work and I have been an
active trader myself, I am still struggling with the most basic
question of all. What is the stock markets didn't exist ? - Google
would still be a private company, but so what ? It would still make
the kind of profits it makes today ?

What is the most compelling reason for stock markets and how does it
contribute to the overall economy ?

Theoretically they provide companies with a source of funds, and
individuals (often via institutions) with a place to invest.

Actually they strike me as a load of froth.

Individuals can invest (save) in banks, and banks can then invest in
or own companies.

In some economies banks invest heavily in/own companies.
There is also the rise of private finance companies which take
companies off the stock market.

I happen to know that placating the stock market is extremely
expensive and occupies a lot of time of top management. The drive for
ever increasing short term results makes long term investment
difficult.

Since senior managers are perfectly well aware that their shareholders
would sell them for dog meat at the drop of a hat, their incentive is
to /appear/ to act in the shareholders interests, although their own
interests are diametrically opposed.

I studied Economics at Uni, and have worked for the City, so my views
are based on observation rather than 'politics'.

frde is right in that without stockmarkets, other financial mediaries
would grow and take their place: banks becoming more active, groups of
investors buying/funding companies...

However I can't buy some of the spiel:
"I happen to know that placating the stock market is extremely
expensive and occupies a lot of time of top management."
The stock market is very efficient in terms of the dollars that are
invested.  If the markets didn't exist then the costs of investing in
businesses in any way would be devastatingly higher than they are
today.

"The drive for ever increasing short term results makes long term
investment difficult."
The S&P 500 has maintained a 12% return over 30 years and I see no
reason to doubt its continued performance...  The market as a whole
has averaged 11% over 85 years.  Since the stock market is so well
developed, investors expect a reasonable return for their risky
investment... Knowing this, collectively they would not be willing to
invest as much if the expected return wasn't ~12% and therefore stock
prices would fall.  These lower prices would then be a bargain for
investors because the P/E ratios would then be higher.  There is
simply an equilibrium at about 12% returns in the long run regardless
of how foolish many short term investors are.

Well I can only talk from what I've seen and heard.

In the early 1980's I wrote the Commission analysis system for a major
US stockbroker's London Branch - very interesting.

I can think of a number of defensive mergers that were of little use
to the companies themselves, if anything destructive.

I know that flotations are expensive, a company I worked for was
involved in the Deutsche Telecom float. We used to describe ourselves
as the fleas that lived on the rats that ...

Is there any chance that the S&P figures exclude dropouts ?

I cannot help seeing similarities between stock markets and Names at
Lloyds of London - something that is useful for big players, which
attracts and fleeces small players.

As an index, the S&P 500 includes the 500 stocks active at any given
time.  If 1 greatly underperforms and then is traded for another
stock, then that previous underperformance (while it was still in the
S&P) is included in the S&P rate of return.

I didn't research for the exact number, but it looks like the S&P 500
has about 30 changes per year... that's a 6% turnover rate.

Look back a few hundred years.  merchants and land owners were the
only ones with real wealth.
Stock markets allow all access to the wealth, though most of us dont
become rich off of it.

Admittely looking back doesnt help that much because so much else has
gone on (i.e. global communication, travel and distribution, etc.)

Perhaps you should look at some countries who financial makret are
still in their infancies.  Look in the middle East.  There is high
unemployment and a great deal of wealth, but that wealth is held by a
few and the masses have no mechanism to get it on it.

Funny, I was thinking about this thread today, when reading an article
saying that stock markets do not create wealth - floating a successful
company is not creating wealth.

200 years ago - 1806 - there were numerous farmers, tenant farmers,
factory owners etc who were considered pretty well off.

I don't see how stock markets allow the average joe 'access to
wealth', more they allow financial intermediaries the opportunity of
ripping them off.

I think it is appropriate to look at the history/origin of stock exchanges.
The idea of exchanges goes much further back, as you can read on the
first site below - and elsewhere.  This suggests that the question 
"what if if the stock markets didn't exist?" is purely hypothetical  -
 someone would invent them.
 
The concept of an exchange as an open market to deal in commodities
and financial instruments is a natural development from the physical
marketplace, where goods are brought to be sold.  If the goods are
fairly standard (grain or metal, for example), someone was clever
enough to consider that it didn't have to be brought to market if it
was going to be sold for delivery elsewhere.  This idea goes even
further back in time, as the second site tells.

http://en.wikipedia.org/wiki/Stock_exchange
http://en.wikipedia.org/wiki/Commodity_markets

Stock markets would have to be outlawed to make them not exist, but I
expect that they would anyway, unless stock companies were not also
outlawed.

As far as the Google example that the asker used-- the owners of
Google would not be nearly as rich as they are today. They were
millionaires from Google's ads before they conducted their IPO; now
they're billionaires.  You can understand why they wanted to do that,
then ;)

I don't believe that if they didn't exist, banks or something else
would spring up to take their place in the exact same way.  Banks are
around now for loans, but that doesn't give companies an influx of
money that they do not have to pay back as IPOs do.  Banks are
for-profit institutions and would want their money back; many people
both make and lose money on stocks (and not to the detriment of the
original company).  The company never has to pay it back unless they
make huge profits and want to give a small dividend, or they want to
buy back shares of stock for the company itself.  Not having the stock
market would not be good for companies who need an influx of cash or
for banks, who would have to deal with so many more loans.

"I happen to know that placating the stock market is extremely
expensive and occupies a lot of time of top management. The drive for
ever increasing short term results makes long term investment
difficult."

This is true, but this is a mistake of senior management.  To not
invest in R&D or upgrading infrastructure, for example, in order to
announce higher profits and placate investors, is a terrible business
decision that is becoming more common. Should the whole stock market
be done away with because of a few CEOs wanting to add to their glory
by announcing high profits, not caring about the company 10 years from
now? I don't think so.

"I don't see how stock markets allow the average joe 'access to
wealth', more they allow financial intermediaries the opportunity of
ripping them off."

I can see this how stocks allow the 'average Joe' access to wealth. 
Anyone can invest in the stock market and make money that way (they
can also invest and lose, of course, which is what many people do). 
Some poor people have invested and become millionaires/billionaires. 
(I'm thinking specifically of someone with good investing sense like
Warren Buffett, a great example of someone poor who became rich
through investment.)  It can be an equalizer for those who know how to
play.

I take your point, and should add that I studied Economics at Uni and
have worked for the City writing financial software. I've also knocked
around pretty senior levels of management - some of whom have made
enormous sums of money from flotations.

What I'm saying is that I'm not a ranting anti capitalist.

Warren Buffet is a very interesting example, he buys large or
controlling stakes in companies - and sits on them. Berkshire Hathaway
could function without a stock market. One might say that he needed a
stock market to get his initial funds - but I could see other ways of
him raising them.

For example I had close links with a UK company that floated for £1
Billion, their initial finance was from a bank that took 30% of the
equity.

It is true that 'ordinary Joes' have made millions, for example in the
early days Xerox was short of cash and offered to pay their workers in
shares, as a result it was not uncommon to find a millionaire working
a lathe.

Similarly, last year, I went down to the flotation party of a company
I used to work for, it went for £200 million, a fair number of the
guys I worked with were extremely well off.

In the two cases above, the stock market did not 'make' the money, it
simply provided a way of getting at it.  Of course there were other
ways.

Companies can, and often prefer to, raise money from the banks or by
issuing Eurobonds. Banks are a bore, because they insist on attending
board meetings, and then to add injury to insult, they send you a bill
for their attendance.

In the UK, the vast majority of the money invested in shares really
belongs to institutions. They do not perform particularly well,
possibly because they indulge in overly 'active management'.

CEOs and FDs are under immense pressure to appear to provide growth,
since the market is geared towards 'total return', I am not convinced
that short term growth is particularly healthy - it is 'broadening'
rather than 'deepening'.

I believe that I coined the term 'Old Product Development'. 

MyOarin could probably confirm this, but my understanding is that the
bulwark of the German economy is the 'Mittelstand' which consists of
privately owned companies that don't care about the stock market and
are looking 20 years ahead.
Personally I reckon that the German economy is the most solid in
Europe, and they make the UK look like a bunch of chancers.

I remember when BMW realized that Rover was a dog, there were rumours
that the Quandt family would sell out - a complete joke.

My reservations about the value of the stock market are based on
observation, the problem I believe with 'markets' in general is that
they become an 'end' rather than a 'means to an end'.

Finally I should add that the 'Free Market' is an artificial
construction, without government regulation it would become Oligarchy
and then Monopoly, that is not very controversial - my view is that
the ultimate state is Mafia.

Well, Warren Buffett does have a different way of going about
investing than others do-- I just used him as an extraordinary
example.  He did start as a teenager, though, buying farmland and then
selling it for a profit (the same way most people do with stocks). 
But he made his money by buying Berkshire Hathaway -- through stocks--
and reviving it by turning the business around.  He would not have
been able to do that without the stock market.

I know a person who started out with very little money and now makes a
living just from the stock market.  It seems to work for him (a few
times he's had some big losses but he always gained it back.)  He's
not a millionaire, but there are some who became millionaires this
way.

Buffett actually believes that people should have a set number of
stock trades in their lifetime; then they would think before they
bought or sold a stock.  He has interesting ideas that seem to work
for him but I'm not sure how they would translate to other people. 
Other people "hold" stocks for bad reasons and lose loads of money
that way.  During the dotcom boom-- sure, people lost 90% of the value
of the stocks that they were holding... but directly prior to that
they had earned 200% on their money! Why didn't they sell then? 
Greed-- they thought it was a neverending profit source and wanted to
make 300% or 400%.

There are two different theories of the stock market-- the efficient
market theory holds that the markets are completely efficient and no
one will ever make money over time; the competing theory suggests that
this is a falsehood, because markets are ruled by fear and greed, as
are the people who run them.

"frde is right in that without stockmarkets, other financial mediaries
would grow and take their place: banks becoming more active, groups of
investors buying/funding companies..."
                                            Jack of Few Trades
"MyOarin could probably confirm this, but my understanding is that the
bulwark of the German economy is the 'Mittelstand' which consists of
privately owned companies that don't care about the stock market and
are looking 20 years ahead."
                                            Frde

Yes, I think that is right  - or has been right.  In recent years,
passing on management of these companies to the next generation (will
son take over?) and the problems of inheritance or transferring
ownership have become more complicated.  Also, the German stockmarket
has become a lot more open to IPOs, attractive to more privately owned
companies than in the past.

The financing of these types of companies and also stock corporations
in Germany after the war and into the early 1980s was to some extent
an example of what Jack said, banks providing the financing for
expansion.  They did this based on their close relationships with the
owners and a deeper understanding of their activities and financial
statements than banks elsewhere probably had.  German companies were
generally undercapitalized by US banks' standards and expectations
(Argh!  Spent years trying to explain that!), but the German banks
were comfortable with the understanding that their loans were
quasi-capital because they knew they would be rolled over, despite the
legal and balance sheet presentation as short or medium term (< 4
years) financing.
The banks had no incentive to suggest that the companies go public;
that would only have reduced their interest income.  The banks were
also the stockbrokers, controlling the stock market and access to it,
so the companies didn't have much choice.  If one had gone to another
bank to go public, that bank would have been suspicious; if its "house
bank" had learned about it, which it would have, it would have reacted
like a cuckolded wife.
But the system actually worked quite well for decades (maybe also
before the war, but I wasn't around to know) after the war, a period
of growth  - the "economic Wonder" -  for a long generation of bankers
and company owners who had grown up working together.  Globalization
of capital markets and the fact that many of the privately owned
companies had become international players with exposure to
international financing practices and of a size that made these
available to them have weakened the old system, and many of the major
privately held companies have become stock corporations (the first
step) and then gone public.
The banks have changed, too.  "Investment banking" has become a term
and major activity of German banks, investment banker teams being
hired and paid more than old school German bankers ever dreamed of
earning.  The Swiss Josef Ackermann, present CEO of the Deutsche Bank
AG comes from international investment banking.

Anyway, that doesn't answer the question.  I commented on that above.

Cheers, Myoarin

@KeyStroke
Interesting point about Buffet's lifetime quota of trades.

The problem with the DotCom bubble is that most punters are pretty
daft, my aged and rather foolish mother took the advice of an idiot UK
stockbroker (and told me I did not know what I was talking about).
She, and a shed load of others lost a packet.

There is another problem, I strongly suspect that CEOs deliberately
run down companies which are then bought up on the cheap.

@MyOarin
Thanks for the background.
In the UK, in the early 1970's people like Jim Slater realized that
large companies were run by 'families', yet over time their
shareholdings were trivial. It was quite easy for them to snap up the
companies and asset strip them.

My impression is that most UK share holding institutions operate a
'hands off' approach - and sell out at the drop of a hat.

The Japanese, Koreans and Chinese all operate a 'bank based' approach,
despite rumour mongering, all are very successful economies.