The Growth of Equity Markets - Corporate Governance and Business Ethics

A vital dimension of the increasing initialization of the world economy is the growth of capital markets, and especially the vast growth of equity markets, where volatility has been experienced at its furthest extremities. The American zone equity markets (entirely dominated by the NYSE and NASDAQ) were propelled from a total market capitalization of $4, 000 billion in 1990 to $24, 320 billion in 2007. This onward progress was violently punctuated by the market collapse of 2001/2002, with a fall from $16, 450 billion in 2000 to $11, 931 in 2002.



The European zone markets grew from just over $2, 000 billion in 1990 to $18, 634 in 2007, experiencing a similar shock with the fall from $9, 588 billion in 2000 to $6, 465 billion in 2002. Finally market capitalization in the Asia Pacific zone grew slowly from just under $4, 000 billion in 1990 to $4, 918 billion in 2000, and after the 2001 fall exploded to $17, 920 billion dollars in 2007 (World Federation of Exchanges 2007, ).

Traditionally the Anglo-American world has revealed a greater enthusiasm for share trading, but in recent years this enthusiasm has been taken up in both European and Asian markets. In the Americas share trading reached a peak of $34, 070 billion in 2000, collapsing to $17, 899 billion in 2003, before recovering and once again taking off to $48, 363 billion in 2007.



In the European zone, trading reached a peak of $17, 430 billion in 2000, collapsed to $9, 884 billion in 2002, and quickly trebled to $31, 366 billion in 2007. In the Asia-Pacific, trading was more modest until 2003 when it quadrupled to $21, 460 by 2007 (World Federation of Exchanges 2005, ). Because they have adopted regional time zones which fit their trading patterns over the 24 oh of each day opening with the Asia Pacific markets, followed by the European, and closing with the US markets, the World Federation of Exchanges has to an extent concealed the enormous concentration of equity markets by including South America in with the United States, Africa and the Middle East in with Europe, and South Asia in with Southeast Asia, Japan, and Australia. A more accurate picture of the paucity of equity markets in the developing world is highlighted for example by the 2002 inflows of total portfolio investment into low income countries which amounted to 0. 009% of the world total, and into middle income countries (excluding China) that amounted to 4. 2% of the world total, while the high income countries claimed almost 90% of the total inflows of portfolio investment (Gunter and van dethronement 2004).

In the past, the supremacy of the NYSE was unchallenged. The Anglo-American exchanges, comprising the NYSE, NASDAQ, London, Toronto, and Sydney stock exchanges, have played a dominant role in equity markets, but more recently Euro next and the Deutsche Bores have become significant players. More startlingly, there are now five Asian stock exchanges in the largest 12 including Tokyo, Shanghai, Hong Kong, Bombay, and the National Stock Exchange of India. In recent years, the substantial growth of the regional stock exchanges in Europe and Asia has threatened the dominant position of the NYSE, and this explains the interest of the NYSE in the merger with Euro next which was completed in 2007.

This concentration of equity market activity is more apparent in share trading With the NYSE, NASDAQ, and London having a combined total of share trading of $55, 563 billion in 2007 (World Federation of Exchanges 2007, ) (perhaps further compounded by the NYSE merger with Euro next, and LSE merger with Boras Italian). However, share trading has increased significantly in European markets, and dramatically in the Shanghai, Shenzhen, and Hong Kong exchanges. There remains a predominance of Anglo-American institutions and activity in world equity markets, though not as great as in the past, and to an extent these markets continue to reflect Anglo-American investment interests. Yet much of the rest of the world is adopting a greater use of equity markets rather than more traditional sources of finance. However this increasing global pre-eminence of equity markets is a very recent phenomenon.



Historically, the primary way most businesses throughout the world (including in the Anglo-American region) have financed the growth of their companies is internally through retained earnings. In most parts of the world until recently, this was a far more dependable source of finance rather then relying on equity markets. Equity finance has proved useful at the time of public listing when entrepreneurs and venture capitalists cash in their original investment, as a means of acquiring other companies or providing rewards for executives through stock options. Equity finance is used much less frequently during restructuring or to finance new product or project development. In Europe and the Asia-Pacific however, this finance was in the past provided by majority shareholders, banks, or other related companies (to the extent it was needed by companies committed to organic growth rather than through acquisition, and where executives traditionally were content with more modest personal material rewards than their American counterparts).



The euphoria of the US equity markets did reach across the Atlantic with a flurry of new listings, which formed part of a sustained growth in the market capitalization of European stock exchanges as a percentage of GDP. This substantial development of the equity markets of France, the Netherlands, Germany, Spain, Belgium, and other countries began to influence the corporate landscape of Europe, and was further propelled by the formation of Euro next. Indeed, as the regulatory implications of Sarbanes Oxley emerged in the United States from 2003 onwards, the market for initial public offerings (IPO’s) moved emphatically towards London, Hong Kong, and other exchanges. Concerned about the impact of Sarbanes Oxley on the US economy, a group of authorities formed the Committee on Capital Markets Regulation (CCMR) and highlighted the damage being caused to what for many years was recognized as “the largest, most liquid, and most competitive public equity capital markets in the world” (CCMR 2006, ). However, after the 2001/2002 NASDAQ fall, this picture began to change with Europe and then the Asia Pacific raising more new equity capital than NASDAQ and the NYSE.

Though the US total share of global stock market activity remained at 50% in 2005, as Figure demonstrates, the IPO activity had collapsed: A better measure of competitiveness is where new equity capital is being raised – that is, in which markets initial public offerings (‘IPO’s’) are being done. These companies do have a choice of where to trade. In the late 1990s, the U. S. exchange listed capital markets were attracting 48% of all global IPO’s. Since then, the United States has seen its market share of all global IPO’s drop to 6% in 2005 and is estimated, year to date, to be only 8% in 2006. This loss of market share exists in both the high-tech and non-high tech sectors and is not restricted to firms from China or Russia, whose companies have been a major source of IPO’s in recent years. The headline numbers most often quoted are that last year, 24 of the 25 largest IPO’s were done in markets outside the United States and 9 of the 10 largest IPO’s in 2006 to date took place outside the United States.




This greater vibrancy in European markets partly explains the NYSE’s interest in merging with Euro next and the NASDAQ’s courtship with the LSE. It is likely any such mergers will represent a further US bridgehead into the equity markets of Europe, rather than the converse. Along with the growth in market capitalization in European exchanges occurred a gradual increase also in trading value. It appears that contemporary equity markets inevitably will be associated with high levels of trading activity.

The important role of equity markets in fostering further international financial integration is recognized by the European Commission (2005): Globally, portfolio investment is the largest asset category held cross-border; global portfolios (equity and debt securities) amounted to 19 trillion US dollars at the end of 2003 (IMF CPIS, preliminary data). Turnover in international financial centers is very substantial. At the London Stock Exchange, 7. 6 ban euro worth of foreign equity was traded on a daily basis in May 2005. That represents 45% of the total London trading volume. The part of turnover of foreign equity in the New York and Frankfurt stock exchanges stands at 8% and 7%, respectively. Currently, 235 EU firms are listed in US stock exchanges and 140 US firms in London, Frankfurt or at Euro next. Moreover, an agreement on equivalence of accounting standards has been reached, in April 2005, between the US Securities and Exchange Commission and the European Commission.

As equity markets come to play a more powerful role in corporate life in Europe, Japan, and other parts of the world, a set of assumptions and practices are also disseminated which may confront long standing values and ideals in the economies and societies concerned. Specifically, the ascendancy of shareholder value as the single legitimate objective of corporations and their executives usually accompanies increasing dependence upon equity markets. Do re cites a Goldman Sachs study of manufacturing value added in the United States, Germany, and Europe in general, which concluded that [t]he share of gross value added going to wages and salaries has declined on trend in the US since the early 1980s. In fact, for the US, this appears to be an extension of a trend that has been in place since the early 1970s We believe that the pressures of competition for the returns on capital available in the emerging economies have forced US industry to produce higher returns on equity capital and that their response to this has been to reserve an increasingly large share of output for the owners of capital. This insistent pressure to drive increases in capital’s returns at the expense of labor inherent in Anglo-American conceptions of the nature of equity finance is roundly condemned by Do re (2000) as the negation of essential values previously considered central to economic good in both Europe and Japan:

Multiple voices are urging Japanese managers to go in the same direction. The transformation on the agenda may be variously described – from employee sovereignty to shareholder sovereignty: from the employee-favoring firm to the shareholder-favoring firm; from pseudo-capitalism to genuine capitalism. They all mean the same thing: the transformation of firms run primarily for the benefits of their employees into firms run primarily, even exclusively, for the benefit of their shareholders. It means an economy centered on the stock market as the measure of corporate success and on the stock market index as a measure of national well-being, as opposed to an economy which has other, better, more pluralistic criteria of human welfare for measuring progress towards the good society.

The euphoric enthusiasm for the power of equity markets was severely dented by the Enron/World Com series of corporate collapses in the US (and the reverberations in the Ah old, Parmalat, and other failures in Europe) (Clarke 2007). With about seven trillion dollars wiped off the NYSE in 2001/2002, and the executives of many leading corporations facing criminal prosecution, the recovery in equity markets came sooner and more robustly than expected. However, part of the price of restoring confidence to the markets was the hasty passage of the Sarbanes Oxley legislation and increased regulation of corporate governance. One reaction to these developments was increased interest in the investment potential or largely unregulated hedge funds that quickly grew from assets of $50 billion in 1993 to $1. 18 trillion in 2006. Hedge funds presented the opportunity to acquire corporate assets quickly (and often very briefly) in stealthy interventions, without the usual standards of disclosure and transparency. More recently, private equity has grown in significance from $100 billion in assets in 1993 to $900 billion by 2005, on the way morphing from venture capital and MBO's to highly leveraged, debt fueled takeovers.

These activist interventions into equity markets proved even more short-lived than the junk-bond takeover era of the 1980s; however, they do indicate the impatience of capital with any regulation or limitation of its powers and the resentment attached to the continuous disclosure regime now introduced in equity markets and corporate governance in many parts of the world. The sub prime mortgage crisis, and the elaborate financial instruments developed to pass on risk by investment banks, that has caused a prolonged implosion of financial institutions in 2007/2008 is an indication of the dangers presented by the increasing initialization of economic activity, and the hazardous context for corporate governance in market oriented economies. Nonetheless, the strength and vigor of capital markets seems destined to continue to advance globally without adequate regulation or oversight.

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