Just as businesses fund their activities by taking out bank loans and selling bonds, they also issue shares of stock. Stocks are shares of ownership in a corporation. Owners have a claim to the firm’s profits, but remember that profit is revenue minus costs. In other words, profit is what is left over after everyone else—creditors, bond holders, suppliers, and employees—have been paid. If profits are high, shareholders benefit. They benefit directly if the firm pays out its profits in dividends or indirectly if the firm reinvests its profits in a way that increases the value of the stock. But if profits are low or negative, shareholders suffer losses.

Stocks are traded on organized markets called stock exchanges. The New York Stock Exchange (NYSE) is the largest in the world. When new stocks are issued, that is called an initial public offering or an IPO. An IPO is the first time a stock is sold to the public.

You’ll recall from the beginning of this chapter that simply buying and selling existing shares of stock does not increase net investment in the economy. But when a firm sells new shares to the public, it typically uses the proceeds to fund investment, that is, to buy new capital goods. In addition, the possibility of offering equity or ownership in a firm opens the door to many business ventures that might never get off the ground, or might not be able to expand rapidly.

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Consider Google. Google is today a household word, but when the company began in September 1998, it was headquartered in a garage. Yet in August 2004, Google founders Sergei Brin and Larry Page sold $1.67 billion worth of stock in an IPO. The money helped Google to fund new investments and pay for research and development. In addition, Google’s IPO turned the founders and the early investors into millionaires and billionaires. This big payoff was a reward for creating the company and making the early and risky investments that were necessary to get Google off the ground. Stock markets help people with great ideas become rich and that encourages innovation. It is no accident that the United States—one of the most innovative countries in the world—also has the best developed stock and capital markets.

Selling part of Google to the public also let the founders diversify. If someday another search service bests Google, Brin and Page will not become paupers. This added safety also encourages innovation. People who come up with new ideas know that their wealth will not be locked into one firm.

We’ll have a lot more to say about stock markets in the stock markets chapter, but for now what you need to know is that stock markets encourage investment and growth.