What is the point of the equity market?
Stock markets were traditionally a venue for companies to raise money to finance growth. But the number of listed companies has collapsed in many parts of the western world, suggesting 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. There has also been a collapse in the number of companies choosing to IPO from an average of over 300 a year in the 1980-2000 period to only 108 a year since (Figure 2). The U market has experienced a similar fall from grace.
This is not just of philosophical interest. A thriving public equity market brings a number of benefits, not least the fact that it is the most accessible and cheapest way for ordinary savers to participate in the growth of the corporate sector. The transparency provided by a public market is also a double-edged sword. While companies may find it burdensome, it enables management and corporate practices to be held to account more readily, with wider social and economic benefits. Regulators are not blind to these features. The UK financial Conduct Authority (FCA) has singled out primary markets as playing a “crucial role in supporting prosperity and providing investment opportunities”1. Regulators around the world, including in the US, UK and EU, have all conducted studies aimed at identifying the barriers to effective primary markets.
However, if fewer companies value a stock market listing, this leads to the provocative question which titles this paper: what is the point of the equity market? We focus on the US and UK but also contrast them with elsewhere. Some markets have experienced similar trends to the US and UK but others have been diametrically opposed. We unpick some of the potential explanations why and find that, even in the US and UK, the equity market continues to serve a purpose, albeit not exactly the same as originally envisaged.