Why would the rich care about the poor's overinvestment in riskier investments?

Question

Glasbeek, Harry. BA, LLB (Melbourne), JD (Chicago).
Class Privilege: How Law Shelters Shareholders and Coddles Capitalism (2017). p. 196 Bottom.

  Also, from an investor's point of view, limited liability frees investment shareholders from the burden of involving themselves in the daily operation of the corporation. The contributed capital is transferred to the corporation where a board of directors and executives are to take charge of it. The corporation is duty-bound to chase profits, that is, the very efforts the would have made on their own account will still be made. But the contribu-tors of capital do not have to expend any effort of their own. In other words, limited liability is good because shareholders do not have to do anything.
  Two further arguments are made in favour of limited liability. The first arises directly from the fact we are supposed to like the idea of a thriving

p. 197

market in which shares can be sold and bought. Limited liability helps that cause by eliminating some of the volatility that might otherwise prevail. In the absence of limited liability, less-well-off investors might invest in higher-risk investments than would wealthier ones, because they have less non-invested assets to lose. Wealthier investors would then have a different appraisal of what makes a share's price affordable than their less wealthy comrades would. This could lead to unpredictability in the valuation of shares and, therefore, to less attractive stock markets.2 Here the assumption is that robust stock markets are a plus for the economy—a highly contestable assumption.

I know that the rich are more likely to be able to afford investment advisors who can help them appraise share prices differently (e.g. more accurately), and who don't cater to the poor.

But can someone please expound the emboldened sentence? How does the poor's larger investment in riskier investments, affect wealthier investors' appraisal of what makes a share's price affordable?

Answer 1

How does the poor's larger investment in riskier investments, affect wealthier investors' appraisal of what makes a share's price affordable?

It does not. The author purportedly (and mistakenly) thinks that tolerance to risk is governed solely by the investor's wealth.

Your question mistakenly conveys that a wealthy investor's method of valuation of share's price consists of merely reading (or as your question portrays, is "affect[ed]" by) the non-wealthy investor's assessment. But that reading significantly differs from what the author wrote.

The excerpts you reproduce reflect the author's cluelessness about basic concepts in finance. The end of the first excerpt seems to be inaccurately transcribed: The poor grammar in "The first arises directly from the fact are supposed to like the idea of a thriving" do not allow us to grasp the point the author is trying to make. More important, the second excerpt is nonsense.

The author wrote:

less-well-off investors might invest in higher-risk investments than would wealthier ones, because they have less non-invested assets to lose.

Causation as purported by the author is wrong. It is true that some non-affluent investors might be more tolerant to risk, but that tolerance is not solely determined by their non-affluence. Their expertise (or lack thereof, as you later point out), and/or their ambitions (meaning a person's legitimate sake of wealth) influence the levels of risk each individual investor is willing to incur.

As a counterexample to refute the author's point, Nathan Rothschild and James de Rothschild continued getting into high-risk investments even after they had made fortunes, and much to the dismay of the next generation in the family.

Next, the author alleges that:

Wealthier investors would then have a different appraisal of what makes a share's price affordable than their less wealthy comrades would.

If a share's price is affordable to a non-affluent investor, then it obviously is affordable to the wealthier investor as well. The author might have meant a more appropriate term such as risk-worthiness as a function of expected profit, which brings us back to my previous comment on being more (or less) risk-tolerant than other investors.

An investor buys stock because he has the expectation that the share price will go up. The fact that different investors have different appraisals on the future price of a stock has little or nothing to do with each investor's wealth. Of course, there is a phenomenon known as herd mentality where a multitude of agents are influenced by a contagious and/or blind belief that a share price will continue certain trend. That leads to price bubbles or collapse, accordingly, but that mechanism of affecting each investor's appraisals is unrelated to what the author and your question portray.

Unpredictability and difference of appraisals are precisely what allow the price of some stocks to fulfill some investors' expectations of profit. If everybody were able to predict the future value of an asset, for instance \$90 per share (for simplicity, assume a risk-free interest rate of 0%), nobody would be willing to sell his share for less than \$90, and nobody would be willing to buy a share for more than \$90. Consequently, the share price would stay at \$90, thereby failing every shareholder's expectation of profit.

The author does not substantiate, at least in those excerpts, why the assumption that "robust stock markets are a plus for the economy" is highly contestable.

I understand how hedge fund managers with PhDs in Finance (who serve only the rich) can help the rich to appraise share prices differently (e.g. more accurately)

That is unsubstantiated, highly debatable, and very opinion-based. But I don't vote down questions (or answers) merely for a difference of opinions.

Edited on July 5, 2018, to address OP's follow-up comment, and to add last paragraph

(1) Edited, although see "the fact are supposed to like" in the excerpt. I assume the author meant to type something like "the fact that people|investors are supposed to like the idea of a thriving market". But the whole sentence is still unclear: Is it a fact that they like the idea of a thriving market? or are they supposed to like that idea? Saying "the fact that something is supposed" is rather meaningless for his argumentation.

More important, the author's inaccuracies and gaps reflect he does not handle some financial concepts well, and yet he tries to premise on those flawed arguments his proposition about a limited liability schema. I am not knowledgeable enough to support or criticize the author's conclusion(s) about LLCs/LLPs, but he should definitely rework his arguments away from engendering unwarranted confusion & controversy about "classes".

(2) You ask whether the following would change the sense of my answer:

I know that the rich are more likely to be able to afford investment advisors who can help them appraise share prices differently (e.g. more accurately), and who don't cater to the poor.

There are two reasons why it wouldn't lead to a different answer. First: Paying an expensive financial advisor does not guarantee that the investor will obtain competent --let alone accurate-- advice. An advisor's certifications or designations certainly, and only, signal that he has demonstrated (typically via exams) standard knowledge of some prerequisite syllabi. However, the advisor remains subject to the aforementioned unpredictability of markets, and to internal policy at his employer agency.

Second: An advisor might recommend the same to wealthy and poor investors, yet the wealthy respond with "I hear you, advisor, but I still want you to do xyz with my funds" based on that investor's risk profile, scrutiny, fiscal planning, expertise, or moral/religious considerations.

I should have added yesterday that, even if the wealthy investor cared about the appraisals made by the poor investor, such reading of appraisals is impossible in today's stock markets because these involve so many buyers and sellers. The author "highly contests" (albeit without substantiating why) that "robust stock markets are a plus for the economy", but it is precisely that inability (in today's markets) to cross-read investments what strikes the author's insinuation that appraisals vary by "class".

Answer 2

Liability applies whether your assets are in cash, stock, real estate or other. For example, if a company goes bankrupt, it may have to liquidate to pay creditors. Limited liability which prevents shareholders from being liable for additional debts that cannot be paid from such a liquidation would tend to benefit those whose liability is limited, i.e., those with assets to invest, but that is a separate question from whether the perceived marginal benefit associated with a risk differs systematically from wealth.