Last week marked the 30th anniversary of the explosion of the Space Shuttle Challenger, a shared national tragedy which unfolded on live television.  The tragedy reminded us of the dangers of space travel, which had been obscured by NASA’s great safety record.

The Challenger disaster also produced a stock market reaction which illustrates the remarkable role of markets in our economy.  It turns out that the New York Stock Exchange (NYSE) quickly and accurately identified the responsible party.

The Challenger explosion occurred at 11:39AM Eastern on January 28, 1986, just 73 seconds after launch from Cape Canaveral.  The NYSE was open as events unfolded.  As economists Michael Maloney and Harold Mulherin explain in an event study, four major space shuttle contractors stood as potentially responsible parties, in addition to NASA.  The contractors were Rockwell International, makers of the shuttle and its engines, Lockheed, with ground support management, Martin Marietta, makers of the external fuel tank, and Morton Thiokol, who made the solid fuel booster.

President Reagan appointed a distinguished panel to investigate the disaster’s cause.  William Rogers, a former U.S. Secretary of State, chaired a panel including astronaut Neil Armstrong, test pilot Chuck Yeager, and physicist Richard Feynman.  The Rogers Commission placed blame on a failure of the O-ring seal of the booster rocket in the subfreezing temperatures on the morning of the launch.  The report provides an independent source of truth against which to compare the stock market response.  Morton Thiokol manufactured the O-ring.

What happened on the stock exchange?  As we might expect, all four contractors’ stock prices fell immediately.  After twenty minutes, Martin Marietta was down 3%, Lockheed was down 5%, and Rockwell was down 6%.  But trading of Morton Thiokol stock had been halted due to excessive sell orders.  By day’s end, Thiokol was down 12%, while the other contractors had regained much of their losses.

The stock market engaged in social learning that day.  No one investor possessed all of the information needed to demonstrate Thiokol’s responsibility, and economists Maloney and Mulherin found no evidence of insider trading during the event.  And yet the stock market put the pieces together before the close of business January 28.

Social learning occurs in markets due to the nature of knowledge in economics.  The information relevant for the economy, or running a profitable business, is all about details, which vary from place to place and over time, as economist Friedrich Hayek first recognized.  Information of this type is dispersed across the economy, and not the type of knowledge uncovered by economists.  We possess the bits of information that determine if investments, say in electric cars or the new Publix grocery store in Troy, will be profitable.  Markets are amazingly efficient at assembling economic information, and putting it in a form to guide decisions by entrepreneurs and investors.

The stock market assembles information by providing people an opportunity to profit from what they know.  The price of each stock each day provides a lightning summary assessment of the company’s prospects.  Anyone with information suggesting that a company is either over- or under-valued can speculate, and will make money if they are right.  A person’s speculation adds their information into the mix.

The Challenger case further demonstrates how markets help ensure the quality of goods and services.  The average quality of a firm’s products is usually hard to observe, but sometimes a highly visible event will signal a problem with product quality or safety.  A swift, strong stock market reaction typically ensues.  Economists have documented stock price declines after product recalls, airline crashes, and even the fabrication of news stories.

People often fear that cost cutting by businesses will compromise product quality and safety.  But the linking of stock prices to quality provides even greedy CEOs a reason to care about quality.  If cost cutting produces a product recall, crash, or other epic fail, the company’s stock price will tumble.  The CEO will then have to answer to the board of directors, stock holders, and stock analysts, and may even lose his job.

Daniel Sutter is the Charles G. Koch Professor of Economics with the Manuel H. Johnson Center for Political Economy at Troy University and host of Econversations on TrojanVision.  Respond to him at dsutter@troy.edu and like the Johnson Center on Facebook.