SHARES IN PEOPLE
April 13, 2006
One of the most likely uses of personal equity issuance is to finance education. The idea is simple: a student entering university pays for his education by selling some portion of his future income to the market, says Joseph Clark of the Center for Independent Studies.
Exactly how much he receives for this share depends on the student, the training undertaken, and the market's willingness to pay.
According to Clark:
- One advantage of this type of financing is that whereas a debt contract only requires the lender to take on the risk of default, an equity contract requires the lender to take on the risk of the performance of an asset; this sharing of risk benefits the borrower, who no longer faces the risk of losing his assets if his income cannot support his debt repayment, and it benefits the lender who can demand a premium for taking on the extra risk.
- The second advantage is that equity serves as an information revelation mechanism; the price of equity in an asset represents the market's consensus on the value of that asset in the future.
There are major problems associated with personal equity: adverse selection (people with poor income prospects will want to sell more of their income on the market), moral hazard (once a person has issued shares, he has a reduced incentive to work hard and earn money), and uncertainty (the market might consider the equity too risky and demand an unreasonable risk premium or simply not buy it).
The idea of personal equity is not new. An employment contract is equity, so are many insurance contracts, so is marriage. By imitating the structure of this more developed equity market, the market for personal equity has a good chance of achieving success, says Clark.
Source: Joseph Clark, "Shares In People," Center for Independent Studies, Autumn 2006.
Browse more articles on Economic Issues