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The South Sea Bubble - Business Ethics


The South Sea Bubble (1720)


Famous for...

The dramatic rise and collapse in the London share price of the South Sea Company

The price was:

£100 (in January 1720)

£1,000 (its peak in early August)

£100 (in December).



What were its effects?


1. Other companies going bust

The dramatic rise in the South Sea Company's share price encouraged other companies to form which also went bust.


2. Miserable investorsThe South Sea Bubble - Business Ethics

Lots of people lost lots of money including the famous scientist, Isaac Newton (pictured right), who lost £20,000 (then a small fortune).



Why did it happen?


1. Investment fever

People were greedy and wanted a quick profit.


2. Government debt

The South Sea Company agreed to finance the British government’s debt (more than a half of it by 1720) in return for the company receiving exclusive trading rights in Spanish South America.


3. The Mississippi Bubble (also in 1720)

This was an even bigger share price collapse in France which had a downward effect on the English stock market.



What did the South Sea Company do?

Founded in 1711, its main money making activity was slave trading.

The slave trade was triangular, because it happened in three stages:


1. Britain to Africa

Low quality goods sent from Britain (particularly Glasgow, Liverpool and Bristol) were sold in West Africa for slaves.


2. Africa to America

The slaves were then packed into slave ships and taken to North and South America

Many slaves died in the atrocious conditions.


3. America to Britain

The slaves were sold to buy goods (particularly sugar and cotton) which were then brought back for sale in Britain.



Lessons for business ethics


1. Greed isn’t good

Money corrupts - the South Sea Company’s activities involved:

  • bribery.
  • corrupt government ministers. The South Sea Bubble - Business Ethics 
  • insider trading (buying shares on information inside the company).

King George I’s (pictured right) reputation was badly damaged by his association with the company.

People were ruined because they were tempted by a quick profit.



2. Don’t follow the crowdThe South Sea Bubble - Business Ethics

Invest in a company because it has good prospects, not because everybody else is doing it.

As the American share investor, Warren Buffett (pictured right), said:

“Be fearful when others are greedy”.



3. Companies must have customers

The South Sea Company’s shares crashed, because it didn’t make enough profit from its customers.

When it was doing well, fraudulent and useless companies were formed to cash in on the soaring share prices.

One company famously advertised itself as:

“a company for carrying out an undertaking of great advantage, but nobody to know what it is”.



4. Not all companies are bad

Limited (or joint stock) companies are a great way of financing expansion and innovation, because the losses of shareholders are limited to the value of their shares.

But the South Sea Company lobbied for the 1720 Bubble Act that banned all joint stock companies (except all those approved by royal charter).



5. Integrity improves decision makingThe South Sea Bubble - Business Ethics

Bribes and quick profits persuaded the government to choose the South Sea Company, not the Bank of England, to finance the government’s debt.

Only Robert Walpole (pictured right):

  • supported the Bank of England in the House of Commons.
  • attacked the wild speculation that led to the South Sea Bubble

This led to Walpole's appointment as the first British prime minister in 1721.



6. Regulation is necessary but don’t stifle innovation

The South Sea Bubble:

  • showed that government must prevent fraud and financial crises.
  • made people disastrously hostile to change, innovation and investment in new businesses.


Key quote

I can calculate the movement of the stars, but not the madness of men.

- Isaac Newton (talking about the South Sea Bubble).


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