Comments (6)

• PEmberton

  Take a look at "Cost and Choice" by James Buchanan, available for free on econlib.org

  Published: April 12, 2004 7:10 PM

• Michael Davlin

  Exactly what I was going to suggest, but I wasn't aware that it was now available online. It's a great little book. Thanks for the tip, PEmberton!

  Published: April 12, 2004 8:13 PM

• Jeffrey

  In addition to the vast bibliography available under the "price and cost" entry to the Austrian Study Guide, the critical discussion in MNR's MES&PM has just been put online in Chapter 6: "The highest ranked utility forgone, there­fore, is defined as the cost of any action... The nature of the cost, or utility forgone, of a decision to spend money on a particular consumers’ good, is clear in the case where the cost is the value that could have been derived from another act of consumption. When the cost is forgone investment, then what is forgone is expected future increases in consumption, expressed in terms of the individual’s rate of time preference..."

  Published: April 12, 2004 8:34 PM

• Kevin Carson

  Buchanan was my first thought, as well.

  Incidentally, Buchanan's first chapter has a great answer to Bohm-Bawerk's challenge of Adam Smith. Smith argued that labor had been the basis of normal exchange-values in simple commodity exchange, back when there had been little accumulation of capital and exchange was mainly between self-employed producers. B-B wanted to know why this should be so, and on what model of human behavior it was based. Buchanan answered the question with opportunity-cost:

  "If the individual hunter knows that he is able, on an outlay of one day's labor, to kill two deer or one beaver, he will not choose to kill deer if the price of a beaver is three deer, even should he be a demander or final purchaser of deer alone. He can "produce" deer more cheaply through exchange under these circumstances.... Since all hunters can be expected to behave in the same way, no deer will be produced until and unless the expected exchange value returns to equality with the cost ratio."

  So the labor theory of exchange-value can be explained in subjective terms; it can be derived from the disutility of labor, coupled with an a priori understanding of man's nature as a being who maximizes utility.

  Published: April 13, 2004 12:17 PM

• Don Lloyd

  All,

  Thank you for the references. I actually found 'Cost and Choice' on my bookshelf. Reviewing it didn't produce any major revelations, but did confirm the validity of a subjective, choice viewpoint. I suspect that most actual applications of opportunity cost are largely compatible with both subjective and objective interpretations.

  What I'd really like is a convincing refutation of my claim that a company suffers no opportunity cost when it grants stock to its employees.

  Nobel Lauriat Robert K. Merton bases much of his support for option expensing on the claim that a grant of stock is an opportunity cost to the company and that the cost is equal to the market value that the company could receive in cash in exchange for selling the stock on the market.

  My claim is that this fails to satisfy the required characteristics of an opportunity cost in the following ways:

  1. Since a company can create as much new stock as it finds desirable, for either sales or grants, independent of how many sales or grants may already have occurred, shares have no economic scarcity to the company itself. The limitations to grants and sales are the result of the fact that, eventually, and not that far into the future, additional grants or sales are no longer capable of providing a benefit to shareholders, and it is only the lack of permission of shareholders themselves that can restrict the number of shares below the number that can benefit shareholders with either sales or grants.

  2. Merton assumes that stock sales are always a benefit to shareholders. In immediate terms, they are basically a wash, an exchange of new stock for an amount of cash that the market considers equivalent. In the longer term, shareholders will only benefit if the management can invest the received cash, either internally or externally, for a risk-adjusted return that will exceed the projected return on the stock itself, given its current market price. Since it is inconceivable that the management can find investments satisfying this requirement for an unlimited amount of cash, the stock sales are self-limiting. An equivalent argument applies to the grants of shares. It is certainly true that the full market amount of a potential sale cannot possibly approximate the net benefit precluded, if, in fact, there were any preclusion.

  3. Management acts as the agent for the shareholders when choices are made for the grant or sale of stock. The fact that those choices may be defective or in self-serving conflict, has nothing to do with the question of an opportunity cost.

  Thanks, Don

  Published: April 13, 2004 2:31 PM

• Noah Yetter

  It seems to me that you can only count an alternative as an opportunity cost if the course of action you did choose precludes the alternative in some meaningful way. And in order for that to obtain, the chosen course of action must consume /some/ scarce resource (including time).

  At the margin, it doesn't seem as if granting a share precludes selling a share. Since shares aren't scarce to the company, and granting or selling them is very-nearly-"free", it seems these activities fail the above criterion.

  However, taking into account the upper limit on shareholder tolerance for dilution might change that. If there's some number of shares existing shareholders are willing to tolerate being granted/sold (or equivalently, a degree of tolerable dilution), then each share thus created subtracts from that total and thus expends a scarce resource. In that sense, Merton is correct that the opportunity cost of granting a share is selling a share, and I can't shake the sense that the magnitude of that cost is in fact the market price of the share.

  There's another complicating factor though, namely the fact that the share grant wasn't a one-sized transaction (since those don't exist): the company must have received some value from it. For instance, granting a $20 share might have substituted for paying $20 in cash salary. If that's the case, then granting the share incurs a $20 opportunity cost but saves the company $20 in salary payments and is thus a wash. Alternatively the company could sell the share for $20 and pay it out in salaray, again a wash. And since existing shares are diluted the same regardless of whether the share is granted or sold, it makes no difference to shareholders either.

  At this point, I'm just confused ;)

  The thing about this idea that strikes me as the most bizarre (which I'm sure is due to my unfamiliarity with the nuts & bolts of equity markets), is that when a company "goes public" it isn't divided into a permanently-fixed number of shares (though those shares could later be split for convenience). The ability of a company to "print" stock just blows my mind, even in light of the limitations on that practice we've outlined here. If I understand your quibbles & questions with existing stock accounting practices, it would seem a fixed-block-of-stock model would solve most of them, by making shares scarce.

  
  (BTW, you should cross-post this at Catallarchy)

  Published: April 15, 2004 12:25 PM