[OPE-L:2293] Re: profit rate equalization and fictitious capital

Allin Cottrell (cottrell@wfu.edu)
Mon, 20 May 1996 07:32:29 -0700

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I'm not sure that I quite understand Iwao's question, so this may
or may not be an answer. But anyway... I take Iwao to be asking
about the relationship between (a) the equalization of returns on
financial assets, and (b) the equalization of profit rates on "real"
capital assets. As I see it, the relationship is this: Equalization
of returns on paper assets is basically a matter of arbitrage; there
is no reason why it should not be virtually instantaneous. If
something happens such that the profitability of firm X is suddenly
increased, then the stock price for firm X should rise right away to
match. Existing stock-holders make a windfall gain; but for
potential new buyers the now higher pice means that the expected
return is equated with that on the stocks of other firms whose
real profitability has not increased.

This is quite distinct from the equalization of returns on real
capital; but it may set in motion a process that tends in that
direction. With X's stock price increased (cet. par.), Tobin's
'q' (ratio of market value to replacement cost of assets) will
have risen above the average, and the maximization of the
present value of the firm calls for the issue of new stock (and
the acquisition of new real capital assets). If the resulting
expansion of output on X's part tends to depress the price of X's
product and reduce X's marginal profitability, then we're moving
towards profit-rate equalization (although a lot can happen along
the way).

Allin Cottrell