The participants and their behavior passed the following stages of evolution:
Stage 1: In the beginning there were just management/owners and investors. Stock exchange was invented with one goal in mind: to raise money for enterprises. To this end management/owners would sell shares of their companies. In return the buyers would get a share of their profits.
Stage 2. The first pertinent laws were introduced. E.g. managers/owners influenced lawmakers to pass various laws that would preserve their control as long as they hold the largest portion of shares.
Stage 3. Shares became valuables on their own. They started to be exchanged/traded between investors themselves. Mild speculation took off. The dominant purpose of buying shares still remained tapping into profits of enterprises rather than speculation. But from time to time opportunities presented themselves to make fortunes by sheer speculation. These were rare moments, however (as was the case with Rothschild, for example).
Stage 4. Over time it was discovered that shares of good companies always grow in price after some time lapse. Another goal of investing emerged: the long term investing with eventual sale at a much higher price after holding onto the shares for many years. Long term investing and receiving dividends remained main purposes of buying stocks for more than a century.
Stage 5. But then rampant speculation was added to them and soon tapping into profits (dividend) became secondary. The management became more preoccupied with propelling stock prices of their companies than maintaining their profitability.
Stage 6. Before long most publicly traded companies became chronically unprofitable and stopped paying dividend 1. Thereby the original purpose of owning shares disappeared.
Stage 7. With profits sagging, buying stocks started resembling investing into sweets wrappers. Indeed, what is the value of the share of an enterprise which is unprofitable ? Recall that the reason of why shares became valuables was that they were backed by the share of profit. If profits dwindled to zero the value of shares turned out to be backed by nothing. Well, that was the common sense. But at this point theoreticians emerged as new players on Stock Exchange. The theory emerged that shares are backed not as much by the current profits but rather by the future profits. Investors were recommended to buy stocks in anticipation thereof 2.
Stage 8. In order to anticipate profits the theory of leading indicators was developed. It is about tale-tell signs of future profits behavior. For example, if sales grew it is more likely than not that profits will follow suit. If jobless claims dropped, it is also more likely than not that profits will grow. Etc. Hence, buy on these news. Some leading indicators were enshrined into economics theories. Others remained just empirical rules.
Stage 9. Mass media started disseminating these theories and thereby "educating" investors. Most investors started playing by the "rules".
Stage 10. Another group of players emerged looking for loopholes in the rules and making advantage of people playing by them. For example, the following scheme of deluding investors playing by the rule "buy on sales growth" was reported in the media:
Companies needlessly buy from each other on the equal amount of money. Say, I buy from you on $10 and you buy from me on $10. This does not affect our balance sheets and profitability. But now we both have increase in sales to report. Our stocks naturally go up !
To falsely trigger "buy on jobless claims drop" rule the following scheme is employed. Companies increasingly hire workers not directly but through placement agencies which treat them as self-employed. When economy sours and companies let people go stocks surprisingly go up because the laid off "self-employed" workers cannot file jobless claims, which naturally drop in numbers.
(To counter this scheme a law has to be passed that would prohibit placement agencies to treat people that they place as self-employed.)
This brief analysis of evolution of the behavior of various players on Stock Exchange reveals the following trends:
To correct the situation profits should regain the first priority of the companies rather than their stocks valuation. It can be done by introducing a proper taxation. E.g., by applying a very high tax (say 90%) to all gains from stocks sale which are in excess of the maximum profit per share over the last year times number of shares sold:
Tax = K x (sale price of a share - (maximum profit)/(number of shares outstanding)) x (number of shares sold),
where K is close to 1 (e.g. K=0.9) and maximum profit is calculated over the interval [the date of sale - 6 month, the date of sale + 6 month]. The tax is due one year after stock sale.
It is easy to see that such a tax would guarantee that the ratio (share price)/(earnings per share) would not significantly deviate from 1.
1:According to Eugene Fama of the University of Chicago, the portion of publicly traded companies in the US that pay dividend fell to a bare 20.8% by 1999.
2: Some economists started even arguing that "profits no longer mattered to stock prices".