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Comment by wcoenen | Hacker News Reader

> If your mental model is that the stock market is a tool to allow people to trade a fixed number of concrete objects back and forth, this probably seems odd, but since that's not really a good model of how the stock market works or is intended to work, it's not clear that means much.

I'm pretty sure that's how the stock market is actually intended to work. This should be obvious if you consider things like dividends. There needs to be a fixed number of shares, each with a clear owner for that to work.

The reason it's a bit more complicated in practice, is because historically the technology wasn't there to do realtime gross settlement. So to limit the number of transactions that the central database had to handle, layers of delayed net settlement were set up instead.

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This isn't really true. Let's say a company has 100 shares and they decide to issue a $1 dividend. If there is no shorting, the company just pays out $100 and everything is done.

But let's say there is shorting. Someone loans out 10 shares to a short who then sells them to someone else. All of a sudden there are 110 shares out there. So when the company pays out the $100 it's $10 short of what is required for each stockholder to get the dividend.

So where does the required $10 come from? From the party shorting the stock of course! Anyone short a stock is required to pay out, in cash, any dividends issues while they hold a short position. So it all works out.

So a company could discourage shorting of its stock by arranging dividends to be spread over the year? Paying out to 1/365th of shareholders each day for example.

You can't issues dividends to different shareholders differently (unless they have different classes of stock). All shares have identical rights.

> Someone loans out 10 shares to a short who then sells them to someone else. All of a sudden there are 110 shares out there.

No there isn't - there are 100 shares total at all times, and every time those 10 shares you mention change hands, the cap table is updated (or should be) to reflect this. First they are owned by the original owner. Then they are owned by the shorter (and a contract is in place to return the same amount of shares and any dividends to the original owner). Then they are owned by the person the shorter sells to. At no point are shares duplicated.

There are 110 long shares worth of economic interest in the company - the original owner will still report the shares they have lent out when looking at their current position.

As you point out, an IOU for a share doesn't pay out a dividend from the company, so it is not the same as an actual share. We seem to be in violent agreement that shares are not created out of thin air (but IOUs for shares can be).

> As you point out, an IOU for a share doesn't pay out a dividend from the company

Huh? They most definitely do. That's actually one of the simplest non-objections to naked shorting; in the system we have, the short seller must pay the dividend to the person who loaned them the stock. In a naked short, the short seller would pay the dividend to the person who bought the stock.

Voting rights don't transfer so cleanly; in the current system, a stock lender can't vote the loaned shares. The most natural system of naked shorting would prevent the purchaser from voting a share that was sold short, which would produce a difference between shares sold short and other shares.

Note that I said "from the company". My point was that the company only pays dividend to real shares, and the stock market intends to track ownership of those real shares. This does not prevent lenders and short sellers to replicate dividends from IOUs of shares via contractual agreements, but it is not the same thing.

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