Friday, October 30, 2015

What if Apple pegged its stock price at $1?

 Would it make sense for Apple to peg its stock price at $1? If so, how would it go about doing this?

From the perspective of shareholders, there's an advantage to a firm's shares being valued not only as a pure store of value but also as useful in trade, or as money. All things staying the same, the increase in demand that is created by the monetary usefulness of a share will ratchet up the multiple applied to a firm's earnings, resulting in a higher market capitalization and richer (and happier) shareholders. As long as the costs of making shares more moneylike aren't too high (I'll assume they aren't), Apple will prefer that its shares be ubiquitous and pervade all corners of an economy, much like a U.S. dollar note or a bank deposit.

The problem is that people aren't fond of unstable exchange media (see here & here). Bills and deposits tend to show low price variability. And because retailers keep prices sticky in terms of the unit of account, a $100 deposit or $100 bill is guaranteed to purchase $100 worth of stuff one month hence. Unlike bills and deposits, volatile assets like Apple shares can crater at any moment, thus ruining their effectiveness as a monetary medium.

Could Apple solve this problem? If Apple were to peg its stock price at $1, it would provide individuals with all the benefits of a dollar bill or deposit. Add in some infrastructure for allowing payment via stock (say a permissioned block chain), and demand for Apple shares would treble as they stole business from banks. Apple's market cap would spike.

What about investors, say hedge funds and mutual funds? Why would they want to own an asset that never deviates from $1? They need a return, after all, to justify holding Apple in their portfolio. The answer, in short, is that the peg wouldn't reduce Apple's return to zero; rather, it would change the form of the return. Instead of rewarding shareholders with a higher share price, Apple management would reward them by augmenting the quantity of stable-value shares they own.

Say Apple's earnings are to grow 10% over the course of a year. Without a peg, investors expect one share of Apple, currently trading at $1, to be worth $1.10 in one year, providing a 10% return. With a peg, investors will instead expect the quantity of $1 shares in their portfolio to grow from 1 to 1.1, thus providing the same 10% return. Think of the 0.1 increase in shares as a stock dividend to all existing shareholders.

If Apple has a blowout year and earnings grow 20% rather than just 10%, investor demand for Apple shares will rise, putting upwards pressure on the peg. Management will grant existing owners whatever extra stock dividends are necessary to relieve the pressure. Likewise, a rise in the monetary demand for Apple shares, perhaps due to a liquidity crisis, will by counterbalanced by a stepped up pace of stock dividends, ensuring the peg's integrity.

Conversely, downwards pressure on the peg will be relieved with a series of reverse stock dividends. Shareholders will find that, where before they had $1 share worth $1, they have been docked 0.01 shares and only have 0.99 shares worth $1 dollar.

For the public to accept Apple's pegged shares as an exchange medium, they need to suffer from some sort of money illusion. After all, even though Apple is enforcing its $1 peg and providing nominal stability, this is little more than an illusion. The reverse stock dividend mechanism threatens to reduce the quantity of shares in each individual's portfolios, thus diminishing their overall purchasing power. Will people be fooled by the $1 price? I don't know, but if so, Apple can increase its market capitalization for free and thus enrich its shareholders.

This leads into a bigger question that I'll let others try and answer. What quirks of human psyche (or institutions) lead publicly traded companies to universally set a floating stock price and a fixed quantity of shares? Why not let the quantity float and the price stay fixed? If we were perfectly logical beasts, we should be indifferent between the two.


  1. Why "a floating stock price and a fixed quantity of shares? Why not let the quantity float and the price stay fixed?"

    Presumably it's because we don't expect the (far from monolithic) management of a company to know its value. For better or for worse, we rely on markets to determine the value of the company's shares -- which often does not vary proportionately to earnings. The problem with your formulation is that the company's management will either (i) fail to keep up sufficiently quickly with the actual market value of the shares, (ii) engage in behavior driven by principal-agent type frictions or mostly likely both.

    Markets may be a very bad way of determining prices, but it's not clear that there are better alternatives.

    1. "Markets may be a very bad way of determining prices, but it's not clear that there are better alternatives."

      Are you saying that a scheme with fixed prices and floating quantities is not a market-driven solution? If so, I'd disagree. As long as management is faithful to the $1 peg, the market determines the number of shares outstanding, and therefore the total market cap of Apple.

    2. Ahh. OK. I'm willing to grant this as a theoretical proposition. I can't help getting caught up in the practical difficulties of managers dealing with intraday share issues, etc. (The image in my head right now is an Open Market Desk at Apple doing its best to get its repo policy just right.)

    3. Apple's Open Market Desk --- I like that. ;)

      You're right that it would be difficult. They might have to supplement the stock dividend tool and its reverse equivalent with short term tools, say using its stash of cash to support the peg or stock sales from treasury to relieve upward pressure.

  2. I wonder if this post was inspired by the convention of money market funds maintaining a $1 share price. This hasn't resulted in MMF shares displacing dollars as a unit of account. It's more an aesthetic choice than anything.

    1. MMF shares haven't displaced dollars as a unit of account, but surely they've displaced notes and deposits as a medium of exchange. MMF shares can be transferred by cheque and debit card.

    2. Yeah, but the transaction is in terms of dollars, not shares. The share price doesn't matter. In fact some fund complexes allow check writing on regular bond funds.

  3. JP, great points and I like the approach, but we miss when we use Apple for illustration. Much better to just apply the $1 peg to the Fed. We could make the Fed into an ETF, really, with a few rules. Instead of Treasurys on the balance sheet, swap the Fed’s notional assets 1:1 dollars for shares — float the entire asset side of the Fed’s balance sheet into a special purpose vehicle, on the exchange, that pays holders weekly in (new monetary base) new currency or reserves per share. (retire/annul the Treasury debt and make base money provision market-driven.)

    Think money market ETF, Fed operates the SPV to keep NAV steady — issuing or redeeming new shares, and is essentially pay-in-kind — with NEW shares accompanied by 1:1 NEW base money to holders. On average, long run new monetary base creation “yield” would be about 6%. (You buy the SPV shares to get base money issuance.) Float the Fed’s capital on the liability side while we’re at it, to monitor and price their counterparty risk and arb (its only other liabilities being base money currency and reserves).

    Require banks to hold some proportion of of assets % NGDP in the SPV. If they lend more — or otherwise desperately need reserves — they buy the SPV to gain more base money, the NAV goes up, and the Fed supplies the shares/reserves. On the flip side, if NGDP is sluggish — likely below 6% — then other buyers would boost the NAV premium of the SPV and lower its yield (just like you or I buy bonds). The Fed then enters and provides the new shares to bring 1:1 NAV back — the economy grows, so most of the action will be on the positive NAV side.

    But if NGDP overheats, then investors pass over the SPV return and buy elsewhere, and NAV premium falls (just like you or I sell bonds — yield rises). This (more rare) negative NAV scenario — here’s the ETF part — banks and people redeem reserves/currency back to the Fed SPV to bring NAV back into line, and get a note/option enabling future share buying at that discounted price.

    Apple is a small potato. The big cheese money market peg is the Fed.

    1. "Much better to just apply the $1 peg to the Fed."

      I'm not quite following. What does the Fed peg the dollar to? You can't peg the dollar to the dollar.

    2. Right now, the fed's assets are unconnected with the base money liabilities - there's no deliverable to the liability. Just as apple floats, and buys and sells shares to keep the peg, the fed should float the (unused and moot) asset side of its balance sheet as units that give the right to receive base money. Just as apples earnings grow, so will the demand for base money grow. The market will determine how many Apple shares are outstanding as Apple creates or absorbs shares, so ought the fed simply create or absorb base money as the marketplace demands, to maintain a 1:1 peg between its assets and liabilities.

      The fed could hold a "rusty nail bag" spv (or just call it maiden lane) as its main asset. Assets are entirely moot. The main value of the fed is its monopoly on base money creation. That's quite an asset to own, eh? Float that asset, peg circulating base money to that floating asset value.

  4. I'm having trouble understanding the meaning of a dollar peg, or what it implies in practical terms. When we invest in Apple, we care about the total value of our equity, and the dollar is our numeraire. Shares are useful as an accounting unit, but we could dispense with that. Let's say that I pay $5M to buy 1% of Apple. Then I get 1% of all dividends as well as the liquidation value if it is ever wound down. I'm not sure how pegging accounting units would change these numbers.

    On the other hand, if Apple borrows a fixed amount (like $1) then this creates an information-insensitive liability, and while we don't use corporate debt as money, it is used as collateral which is a way of converting it into money via a hierarchical structure.