Stock Price Increases in 1990s Case Study Example | Topics and Well Written Essays - 2000 words

Stock Price Increases in 1990s - Case Study Example However the sharp price increases in the stocks might have been the result of factors like irrational over-enthusiasm on the part of the investors, lower interest rates and higher level of savings by the middle-class and the consequent increase in their investment in stocks. Apart from these reasons, the relationship between the earnings increase and the stock price increase was negligible. Hence the expectations of the large investors in their setting higher target levels on the return on capital employed from those firms in which they held the investments on the assumption that the share price increases would automatically increase the earnings would hold no ground. While the factors responsible for the share price increase are totally different from the performance of these companies it would be illogical to expect the managements of the large companies to service their shareholders with larger returns on the capital employed based on the share price performances. With this backgr ound this paper examines the rationale behind the statement that during the 1990s, nearly all FTSE 100 and S&P 500 companies failed to reach pre and post-tax return on capital employed targets set by large investors and the managements of the giant firms during 1990s should be considered responsible for the mediocre return of capital employed as well as the moderate growth of sales of their firm in spite of the higher stock prices. 2.0 Reasons for Stock Price Increases: As outlined earlier the stock price increases during the 1990s were caused by factors like "Irrational Exuberance' on the part of the investors, declining interest rates and higher level of stock market investments out of savings by the middle classes. The signs of greater economic stability prevalent during the period convinced both the business managers and the investors to take extra risks which later resulted in both positive and negative consequences. Let us analyse the reasons for the increase in the share prices. 1. Irrational Exuberance on the part of the investors: Coined and used by the Federal Reserve Board Chairman Alan Greenspan as a word of caution against the repercussions of the stock market boom, denotes a warning that the market might have been overvalued and a natural consequence, slumps in the prices of the stock was inevitable. "The term "irrational exuberance" is often used to describe a heightened state of speculative fervor." (Robert J Shiller 2000) Irrational exuberance is defined by Shiller (2000) as the psychological basis of a speculative bubble. The speculative bubble on the other hand is the situation where the potential investors are lured by stories justifying the share price increases, who irrespective of their doubts about the real value of the assets continue to invest in the stocks. This luring is also partly due to the excitement created by such investments which resemble gambling and partly owing to the envy of the investors on the others' successes. This might be the main reason for the stock market boom that the world witnessed during the 1990s. 2. Declining Interest Rates: One of the other reasons, though not major, that was attributed to the share