What is the point of the equity market?
Stock markets were traditionally a venue for companies to raise money to finance growth. However, although initial public offerings from the likes of Uber and Pinterest are making headlines in 2019, the number of listed companies has collapsed in many parts of the western world over recent decades. This suggests that markets perform this function less and less. Easier access to alternative sources of financing alongside the increased cost and hassle of a public listing are all partly to blame. Savers and policymakers should all be concerned about the implications. All is not lost, however. Equity markets are thriving in some parts of the world and even where they appear not to be, they continue to serve an economic purpose, albeit one that is different to the original blueprints.
We have come a long way since the first financial exchange was established in Antwerp, Belgium, in 1531, although rather than shares, this was a venue where promissory notes, bonds and commodities changed hands. It wasn’t until early the next century, when the Dutch East India Company made the innovation of issuing its backers with paper shares, which investors in turn could trade between each other, that we saw the first signs of something like the modern day stock market. Over the ensuing centuries stock markets have become an integral part of our financial plumbing.
The initial purpose of the stock market from a company’s perspective was to provide it with a means of raising capital to finance its future endeavours. From an investor’s perspective, the market provided liquidity by allowing them to sell their shares to other investors at a transparent price. These primary functions have since expanded and a stock market listing provides many more benefits to companies and investors today (Figure 1). However, it also comes with many more costs for companies and a greater burden than our forbearers could have imagined.
The decision to list or not depends on whether the expected benefits outweigh the costs and for many successful companies, this is no longer a straightforward question to answer. Things have become so bad that in the US, the number of listed companies has declined by almost 50% since 1996. A wave of IPOs from high profile companies such as Lyft, Uber, Pinterest, Tradeweb and Levi Strauss may be hitting the headlines in 2019 but this is set against a backdrop of long term falling appetite to go down this route. Between 1980 and 2000, there were over 300 IPOs a year in the US, on average, but this has collapsed to only 110 a year since. The UK market has experienced a similar fall from grace.
Figure 1: The stock market cost/benefit trade-off – the company perspective
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