MARKET DATA REVIEW: Why stock exchanges are regarded as economic barometers

We have all seen the smiling faces of company owners and executives as they ring the opening bell to officiate the listing of the company in the Dar es Salaam Stock Exchange, which is also a mark of the start of public trading of their shares on the stock market. In often cases these are some of the happy moments for company owners and management, indicating the ultimate goal of smart and dreamer entrepreneurs and business owners — namely, to conquer markets and go beyond the horizon.

As is, upon listing and start of trading of the shares in the public platform, the outcome may be either way — the continued increase of share price and hence the enhancement of wealth for entrepreneurs, anchor shareholders and other shareholders or the decline in share prices and hence the erosion of wealth for shareholders. However, even if the fundamental and sentimental situation will require that the companies shares has to have a downward trend, still the argument for benefit for companies to choose to pursue an initial public offering (IPO) rather than stay private rather are stronger as I will shortly explain. Much as some people who start businesses would want to enjoy the freedom that comes with entrepreneurship and private ownership but the urge to grow further, the need to profile the company and many other sufficient motivations and incentives encourages companies and company owners to opt for IPO and listing into public trading platform as compared to these companies remaining privately closely held.

I will now try to respond to a question: why would companies want to go public via listing into the stock exchange? what is a stock exchange? what are its major functions? how do they relate with listed companies?

So, what is a stock exchange?

A stock exchange is an organised market where shares, bonds (for government, municipalities and corporations), units (for collective investment schemes) and derivatives are listed and regularly transacted. Once a company is listed in the stock exchange, from then on the exchange provides a platform or a place where buyers and sellers of the shares and other securities can trade on prices that are determined by the power of the market (demand and supply).

Stock exchanges are also regarded as barometers of the economy and its performance as it reflects the good or the bad health of economy — investors sentiments and outlook about the economy and sectors within the economy are reflected in the prices of securities traded in the stock exchange. For example if share prices are increasing it is an indication that the country is running on the path of development and prosperity, the vice versa is also true.

So, what are the major functions of stock exchange?

Promotion of capital formation

The stock exchange provides companies with the facility to raise capital for expansion through selling shares to the investing public. Besides the borrowing platform provided to individuals or firms by the banking system, in the form of credit, but there are other forms of capital raising that can be used by companies and entrepreneurs to finance their businesses and enterprises growth. Some of these available forms or options for capital raising might be achieved, directly or indirectly, via the stock exchange — i.e. by issuance of shares or bonds or other such financial instruments. Thus, the stock exchange plays an important role in capital formation in the country.

Mobilising savings for investment

When people draw their savings and invest in shares (sold during an IPO or on the issuance of new company shares of an already listed company), it usually leads to rational allocation of resources because funds, which could have been consumed, or kept in some form of deposits within banks (especially in the short term nature), are mobilized and redirected to help companies finance companies that are performing real productive functions within the economy — functions that leads to creation of employment of factors of production such as people, land, entrepreneurship skills, etc. This may then promote business activity with benefits for several economic sectors, resulting in stronger economic growth and higher productivity levels of firms.

Facilitating company growth

Companies may grow organically or inorganically via acquisition of other companies. In some cases companies view acquisitions as an opportunity to expand to new products and services, to increase their distribution channels, to hedge hedge against volatility, to increase their market share, or to acquire other necessary business assets— all for the growth and expansion of their enterprises. A takeover bid or a merger agreement that can be financed through the stock market is one of the simplest and most common ways for a company to grow. Apart from the merger and acquisition model of growth, even in organic growth model, companies use the stock exchange to raise capital through IPOs and listing of the same.

Increasing government funds for development projects

The government can undertake projects of national importance and social value by raising funds through sale of its securities on stock exchange. At various levels the Government may decide to borrow money to finance infrastructure projects such as sewage and water treatment works or housing estates or building bridges, roads, health facilities, education facilities, etc via selling government bonds or other forms of state guaranteed bonds.These bonds can then be listed in the stock exchange whereby members of the public who buy them, thus lending money to the government can be able to liquidate these financial instruments in the public platform/stock markets on prices that are determined by the markets force of demand and supply.

Providing a ready market

The organization of stock exchange provides a ready market to investors (and speculators) in industrial enterprises. It thus, enables the public to buy and sell securities already in issue. It also makes possible the determination of prices using the forces of supply and demand. The pricing mechanism at the stock exchange and the constant quoting of market price allows investors to always be aware of their investment values, which is basically

Profit sharing and capital gain to Investors

Both casual and professional investors, as large as institutional investors or as small as an ordinary middle-class family, through dividends and stock exchange increases do share in the capital markets, and hence participate in the sharing of the wealth of profitable businesses.

Maintenance of liquidity

The pension funds and insurance companies purchase large number of securities from the stock exchanges. These securities are marketable and can be turned into cash at any moment. Therefore fund managers and institutional investors prefer to keep securities instead of cash in their reserve, this facilitates these institutions to maintain liquidity which may be needed at any time whenever demand arises.

Promotion of the habit of saving and investment for small savers

Stock exchange provides a place for savings and investments to the general public. Thus it creates the habit of saving and investment among members of the public. This habit leads to investment of funds in corporates or government securities. The funds placed at the disposal of companies are used for productive purposes. As opposed to other businesses that require huge capital outlay, investing in shares is open to both the large and small investors because persons are allowed to buy the number of shares they can afford. Therefore the stock exchange provides the opportunity for small investors to own shares of the same companies as large investors do.

Corporate governance and safeguarding activities for investors

The stock exchange renders safeguarding activities for investors, which enable them to make fair judgments of their investments. Thus, directors in listed companies are required to disclose all material facts to their respective shareholders. Thus innocent investors may be safeguarded from clever stock brokers.

By having a wide and varied scope of owners, companies generally tend to improve management standards and efficiency to satisfy the demands of these shareholders, and compliance to the rules for public companies imposed by the stock exchange and the capital markets regulator enhances this perspectives further. Consequently, public companies tend to have better management records than private held companies.

Barometer of the economy

At the stock exchange, share prices rise and fall depending, largely, on economics forces and investors perspective about the current and future outlook of the economy. Share prices tend to rise or remain stable when companies and the economy in general indicate signs of stability and growth. An economic recession depression, or financial crisis could eventually lead to a stock market crash. Therefore the movement of share prices and in general of the stock indexes can be an indicator of the general trend in the country’s economy.