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Working Paper: August 14, 2001
Rationalizing the Irrational, Valuing the Intangible: Genealogy and the Inscription of the Stock Market 1
By Todd Alway

In terms of its salience with respect to both the economy and the popular media, the stock market2 has achieved unprecedented levels of recognition and debate. Given its increasing role in the creation of both personal and corporate capital, it is unsurprising that the popular press has responded with a flurry of publications designed to maximize investor acumen. In theorizing the essential nature of the market and its corresponding behavioral patterns, such works offer to reduce the uncertainty associated with investing in securities whose appreciation is nonfixed. Where the basis of market behavior can be established, stock ownership qua stock ownership becomes a rational investment decision rather than a speculative gamble. While the works which result do not always share the same conclusions vis a vis the nature of the market, the attempt at essentialization and hence the ability to predict future movement marks a shared characteristic. This common element relies, therefore, on treating the stock market as an object which, while exhibiting periods of volatility, of bullish and bearish behavior, has an essential character unrelated to the practices which take place with respect to it. While activities within that market may change, the nature of the market itself does not.

Treating the stock market as a rationalizable object is, consequently, the necessary prerequisite behind the current prevalence of market analysis in both popular culture and the construction of broader public policy.3 Correspondingly, it is the assumed object status of the stock market which presents itself as a suitable target for genealogical analysis.4 Where contemporary debate focuses upon which essentialization best characterizes the nature of the stock market, genealogy offers to reveal the conditions of possibility for the debate itself; to delimit the political rationalities, discursive technologies, and regulatory sites through which the stock market emerges as a rationalizable object. That said, a genealogical analysis demonstrates that the stock market's object status only obtained prominence over the course of the later half of the Twentieth Century. Inscribing this emergence was the use of quantitative measurement techniques towards market qua market returns on equity. Quantitative analysis of past price movements, rather than speculation on the subjective reasons why investors bought and sold, produced the stock market as an object capable of being measured in and of itself, an object capable of sui generis revelation. Significantly, while the sui generis revelation which resulted was a confirmation of randomness and unpredictability, this did not alter the object status of the market, only the manner in which randomness itself was rationalized. Unpredictability in price movement in the immediately prior discursive environment, one in which the market was conceptualized as an arena of exchange which reflected investor behavior, was regarded as indicative of the speculative irrationality of market participants. However, what emerged in the context of the market as an object was a paradoxical treatment where the unpredictability of market direction acted to confirm the markets organic rationality. Future unpredictability in price was taken as proof that present prices incorporated all relevant information. The rationale constructed is one where the market becomes an organic, rational, and efficient allocator of capital on the sole basis of information flows.

Associated with this shift in market rationality and the technologies by which it is effected is the manner in which valuation has been defined and measured. Specifically, while, in the context of the market as an arena of exchange, value was calculated as a product of the tangible assets of the relevant company (which may or may not have been accurately reflected in the equity's price, which was produced via exchange in the market arena), where the market emerged as selfcontained and organically rational, value became a necessary correlate of equity price. Given its quantitative origins, this resulted in the attempt to quantify the surplus, or intangible value, between the previously definitive tangible book value and the equity's market capitalization. In terms of the regulation of the market, this has meant pressure to standardize new accounting practices designed to visualize intangibility. In sum, the shift towards treating the market as an object rather than an arena has changed the rationale of regulation from the control of individual excess (in the form of fraud or speculation) to the enhancement of the efficient functioning of the market itself through the tangibilization of the intangible. In the process, the rationale legitimating public intervention into the functioning, fluctuation, and social consequences of the markets' behavior in order to protect market participants has been seriously undermined.

Marketing an Arena:

Any discussion of the emergence of a new political rationality of the stock market must begin with two caveats: First of all, there is no instantaneous moment which one can identify as marking the rupture of the new rationality from that of the past. Secondly, and relatedly, a political rationality cannot be considered as a homogeneous totality with respect to any given era. Rather, what is seen in the historical record is an overlapping of various oftentimes-contradictory rationales at any given point in time, with hegemony being constantly contested around sites of institutional rule. Old ways of thought linger on, while new ones are constantly in development. Nevertheless, hegemony if not totality in thought does emerge.

That said, there does appear to be a significant shift when one compares how the market was hegemonically conceptualized at the beginning of the Twentieth Century and how it was conceptualized at its end. Specifically, while the institution of the Stock Market was present at both ends of the temporal continuum, what was conceived as taking place within that institution appears to have undergone considerable change. Thus, prior to World War One, transactions within the market were clearly differentiated between those which were intended for investment
5 and those which were intended for speculation. The market itself constituted an arena in which individual transactions took place, while its "character" was a reflection of the disposition of the contracting parties. Thus, where bull market behavior was identified, it was regarded as a reflection of individual behavioral peculiarity or mass speculation, not as something intrinsic to the stock market itself. As Benjamin Graham puts it, "the earlier bull markets had been frankly speculative in their enthusiasm; they made no pretense to vindication by established investment principles (p409)."

John Maynard Keynes provides an illustrative example of the "market volatility as behavioral reflection" viewpoint, a rationale where opinion on opinion rather than on prospective yield is determinative of market movement: "A conventional valuation which is established as the outcome of the mass psychology of a large number of ignorant individuals is liable to change violently as the result of a sudden fluctuation of opinion due to factors which do not really make much difference to the prospective yield ... in estimating the prospects of investment, we must have regard, therefore, to the nerves and hysteria and even the digestions and reactions to the weather of those upon whose spontaneous activity it largely depends (ppl54,pl62).
"6

Given this understanding of market behavior as reflective of investor psychology rather than as a sui generis property, and the corresponding treatment of the stock market as an arena in which investment decisions are expressed rather than an object containing its own rationale, it is unsurprising that the bull market runup of the 1920s was regarded by the authorities of the day as an object for intervention, an intervention necessary to prevent the "orgy of speculation"7 from spiraling out of control and damaging the broader public. For example, the Federal Reserve stated in February 1929 that it would "restrain the use of credit facilities in aid of the growth of speculative credit." Herbert Hoover, for his part, noted in his memoirs that "I sent individually for the editors and publishers of major newspapers and magazines and requested them systematically to warn the country against speculation and the unduly high price of stocks." 8 The view that the stock market boom and subsequent bust were the byproduct of investor psychology and moral shortcoming (both fraud and speculation) rather than market qua market factors was what informed government action as well as the subsequent establishment of the Securities and Exchange Commission as a public regulatory body in 1934. 9

Nevertheless, and in light of the previous caveats, the differentiation between speculation and investment began to change in the 1920s, which "succeeded in mixing up speculative and investment viewpoints in inextricable fashion" as "historical optimism and growth selectivity" put the emphasis of the traditional investors on the difficult to calculate growth dynamic (Graham, p409). This merger was actualized in the wake of a 1924 study10 which correlated stock market and bond returns, showing that the former "had consistently outperformed standard bond investments over any tenyear period, taking into account both income returns and price changes (Graham, p409, my italics)." This quantification of the market as a selfcontained object of analysis (in terms of returns based upon price changes) was to have a significant impact on how volatility and the market itself was to be later rationalized.

Marketing an Object:

It is an extension of the quantitative technologies outlined above which created the conditions for the emergence of the stock market as a rationalizable and ultimately rational object. Specifically, the emergence of technical analysis to predominance in the 1950s
11 and its attempt to find "predictable dependencies in stock price changes (Blume, p4)" both ensconced the stock market as an object which could be rationalized, and brought to the fore an analytical technique capable of transcending the rationale which initially animated it. Thus, when it was revealed that the statistical "patterns" which were uncovered by early technical analysis through data mining, patterns which were to be used to predict future market movements, could be replicated by hypothetical experiments with random numbers, this was taken to indicate that the stock market itself followed a random and unpredictable path. 12 However, rather than resulting in an abandonment of the attempt to characterize the stock market as a rationalizable object, this finding was paradoxically taken as proof of the market's organic rationality. Once constructed as an object by quantitative techniques, the task became one of rationalizing results; in this case the "rediscovery" of the "random walk" process 13, where "future steps or directions cannot be predicted on the basis of past actions" 14 as offering proof of the Efficient Market Hypothesis and the market's organic nature.

The Efficient Market Hypothesis simply states that a market is efficient if "all securities reflect all available information about the assets (Blume, pIO)." Where all past and present information is incorporated into the price, "the only reason for prices to change ... is the arrival of unanticipated new information (Blume, p I I)." Such information would cause the price to move up or down in accordance with its positive or negative character. However, since the arrival and nature of unanticipated information is by definition unpredictable, one would expect to see price movement in an efficient market as being random and unpredictable. As noted, this was the pattern which was revealed by the study of technical analysis and the "patterns" which it revealed for the market. As such, the random nature of market price changes revealed by a quantitative analysis of technical analysis was taken as proof that the markets were themselves rationally efficient. Such a market is rational because the prices contained within it are an immediate reflection of the incorporation of information; the market will rationally determine the price of an equity based upon the available information rather than upon, for example, investor emotion or purpose.

Valuing the Intangible:

More than just an esoteric theory of market behavior, the efficient market hypothesis has been characterized as "the best established fact in all of the social sciences."
15 Its impact on market perception has, therefore, been palpable. In this context, the posited relationship between price and information has significance for how value has been and is calculated and perceived. While a market as arena approach equates value with bookvalue, itself a product of the surplus of tangible assets over liabilities and separable from the stock market in equity ownership, 16 the Efficient Market Hypothesis produces value as something directly correlated with stock market price. Consequently, increases in the ratio of market price to tangible book value have to somehow be accounted for in terms of an increase in the intrinsic value of the represented company. If that were not the case, then the market could not be said to be rationally responding to information flows. As Law notes, "they believe that stock market prices actually reflect underlying values and that, contrary to Keynesian theory, changes in prices reflect changes in intrinsic values and not changes in the possible irrational opinions of traders (Law, pl7l)."

The response from market participants to the dilemma of quantification has been an attempt to codify total value in terms of the sum of the tangible and "intangible" assets of the company, where intangible assets are often a priori equated to the difference between market capitalization and book value.
17 These "intangible" or symbolic assets, including Brand name, internally generated intellectual property, customer satisfaction, and business model, are quantified according to various nonstandardized accounting technologies, in an attempt to rationalize price. Numerous attempts have, therefore, been made to develop proprietary accounting standards which would illuminate and control the measurement of the intangible assets of a corporation and hence rationalize the pricevalue correlation. 18

The problem is that the measurement of intangibles is not clearly defined according to generally accepted accounting principles, principles which rely upon tangibility, separability, and control, measures associated with cost rather than price.19 It is difficult on the surface to add cost value to symbolic value in any one to one sense. As the FASB puts it, the issue becomes one of how to "add 5 widgets and 10 customer satisfactions in any comprehensible or meaningful fashion (Upton, p9l)."

Consequently, and especially in light of the market runup of the 1980s and 1990s, accounting principles regarding the calculation of intangibility, and the institutions in which those technologies are standardized, have become active sites of struggle. The attempt to develop measures of intangibility has confronted the standards setting boards such as the FASB with the pressure to actively create rather than merely recognize new accounting principles.

Subjects and Objects, Recognition and Regulation:

As a site of struggle, regulatory institutions structured towards the Stock Market have thus had to confront a new target over the course of their mandate. In particular, as our analysis of the 1920s demonstrated, where the stock market was conceptualized in terms of its being an arena of exchange, the purpose of regulatory institutions was to filter out immoral and socially hazardous behavior, rather than regulate the market object per se. In the context of accounting standards, it is thus unsurprising to note that the 1933 Senate Committee on Banking and Currency "pointed to the lack of uniform standards for preparation of financial reports as a contributing cause of unwarranted speculation in stocks during the 1920s and thus of the 1929 market crash."
20 Likewise, the Securities Act of 1933 had as its purpose "to provide full and fair disclosure of the character of securities ... and to prevent fraud in the sale thereof. (in Van Riper, p6). " Individual behavior in the market arena rather than the structure of the market itself was the target of regulation. Recognition and compulsory disclosure, rather than the active creation of standard accounting practices was the main regulatory function. 21

Conversely, with the emergence of the market as a rationalizable object in the context of the "discovery" of its sui generis properties, the proper target of regulation became that market itself. However, the purpose of regulatory action has not been towards controlling the possibly socially deleterious consequences of the identified market structure, but of decreasing the friction involved in the flow of information. In the process, as the Financial Accounting Series Special Report demonstrates, the regulatory purpose has become one of creating accounting standards where no generally accepted accounting principle exists, accounting standards which are a response to the perceived needs of the m9rket object itself. In the process, the quantification of intangible assets in the context of historically unprecedented pricebook ratios has become the dominant issue, rather than the possible social consequences which would result should equity prices revert to historically normal levels. In the context of such a Rational Object, facilitating the allocatory function of the stock market rather than managing the public welfare has subsequently emerged as the primary goal of public regulation.




In writing this paper I have benefitted from conversations with Brady Willett of Fallstreet.com

2  By stock market, I am not referring to any specific institution in which stocks are traded (NYSE, TSE, ect), but to the general market in which the trading of equity ownership is conducted.

3  As the emergence of the 401 (k) savings plan in the U.S. demonstrates.  See Robert Shiller.

4  In constructing what follows, I have tried to rely upon the formulation of genealogy laid out in William Walters, "The discovery of unemployment: new forms for the government of poverty", Economy and Society

5
  "The chief characteristic of the former was a stable and perhaps increasing dividend rate ... One of the dependable signs of an investment issue was an average market price close to or exceeding the par value." Benjamin Graham, et al., Security Analysis, Fourth Edition, Toronto: McGrawHill Book Company, 1962 [1934], p405. Contrarily, according to Blume, p6, intrinsic value for earlier investors was related to book value rather than future earnings. Graham himself is (along with notable disciple Warren Buffet) an advocate of the fundamental approach to value which focuses upon prospective earnings which requires that the future be somehow quantifiable.

6  John Maynard Keynes, The General Theory of Employment Interest and Money, New York: St Martin's Press, 1961 [1936]

7  Attributed to Philip Snowden, Chancellor of the exchequer for the United Kingdom, Bierman, p3l

8  Both of the preceding examples were noted in Harold Bierman, The Causes of the 1929 Stock Market Crash, London: Greenwood Press, 1998, pp 29, 3 1. Interestingly, Bierman argues that stock market prices were not too high but were consistent with the random walk explanation characteristic of the Efficient Market Hypothesis which will be discussed later.

9  Created to "protect the nation's small investors from corruption, fraud, and manipulation", Marshall Blume, et al, Revolution on Wall Street, New York: W. W. Norton and Company, 1993, p128. Prior to this, the Stock Markets were selfregulating.

10  Edgar Lawrence Smith, Common Stocks as Longterm Investments

11  Marshall Blume and Jeremy Siegel, "The Theory of Security Pricing and Market Structure", Financial Markets, Institutions and Instruments, 1, 3 notes the paradigmatic text as Edwards, R. and J. Magee, Technical Analysis ofStock Trends, Boston: John Magee Inc., 1954. Blume and Siegel's description of the evolution of the efficient market hypothesis guides what follows.

12  "Noted in Blume, p9 as Roberts, H. V. "StockMarket 'Patterns' and Financial Analysis: Methodological Suggestions", Journal ofFinance, 14, 1, 1959. This is taken to explain the often noted fact that most institutional investors and mutual funds rarely outperform the broader market indexes.

13  Noted in Blume, p9 as first appearing in a 1900 Ph.D. dissertation.

14  Burton Malkiel, A Random Walk Down Wall Street, New York: W. W. Norton and Company, 1996, p24

15   Noted in Warren Law, "Wall Street and the Public Interest", in Samuel Hayes, ed., Wall Street and Regulation, Boston: Harvard Business School Press, 1987, p 17 1. Again, this is not to suggest that it was universally accepted, which it was and is not (see Robert Shiller, Irrational Exuberance, New Jersey: Princeton University Press, 2000, and Law himself who suggests that market irrationality is produced by individual moral shortcoming), just that it is hegernonic.

16  This suggested that the prescient investor could profit from arbitraging the difference between bookprice and marketprice (the point of the fundamental analysis of Benjamin Graham (see Malkiel)). Such an investment approach is precluded in EMH since all information is already included in the market price.

17  Upton, px

18  Upton, p3039 notes many of these.

19  See Wayne Upton, "Business and Financial Reporting: Challenges from the new economy", Financial Standards Accounting Board, Financial Accounting Series: Special Report, 2001, available at
www.fasb.org

20  Robert Van Riper, Setting Standardsfor Financial Reporting, London: Quorum Books, 1994, p5, my italics.

21  The 1938 Committee on Accounting Procedure "was charged not with establishing rules or standards but merely with identifying acceptable accounting practices (Van Riper, p7)."


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