Historical Overview of the World Equity Market:

Growth, Decline, and Rebirth

Dr. William Barclay,World Equity Market Structure

Fin 594 – Fall 2011

04/09/23 Fin 594 - Fall 2011 2

Some Basic Concepts: I• Stock (share, equity, common stock) – an ownership claim on a company

that issues the shares – Issued to raise capital– May or may not pay dividend– Normally carries voting rights to elect Board of Directors– Stocks are sold on an initial public offering (IPO) or secondary offering

• IPO – the first sale of stock to the public by a company (raises capital and allows existing owners to take equity out of the company)

• Corporate Bonds – debt issued by a company to raise capital– Carries preset interest rate – Has priority over stock and preferred stock in bankruptcy proceedings

• Preferred Stock – hybrid between stock and bonds– Has specified dividend rate– May be cumulative or non-cumulative – Behind bond holders but ahead of common stock holders in bankruptcy

• Derivative – an asset that is priced on the basis of another product, e.g. stock index futures are priced based on the prices of the stocks in the index

04/09/23 Fin 594 - Fall 2011 3

Some Basic Concepts: II

• Bid (buy price) – price that someone is willing to pay for a share of stock

• Offer (ask, selling price) - price at which someone is willing to sell a share of stock

• Order book (central limit order book, CLOB) – all the bids and offers ranked from best to worst– Best bid: highest price available– Best offer: lowest price available

04/09/23 Fin 594 - Fall 2011 4

Other Terms: I

• Long, go long, long position – to buy and thus own an asset– If you buy Bank of Beijing shares you are long the

Bank – You can be long by buying the asset itself or, often, a

derivative product that is priced from the asset, e.g. stock index futures or options

• Short, go short, short position – to sell an asset that you do not own – May occur by selling short (we will talk about this later

in the course) or by selling a derivative product such as a futures or option contract

04/09/23 Fin 594 - Fall 2011 5

Other Terms: II• Bull – a person who believes that price of an asset such as stocks

will rise– Bulls like bull markets

• Bear – a person who believes that the price of an asset will decline– Bears like bear markets

• Exchange traded fund – a fund (e.g. a bundle of stocks) that tracks the prices of its components– The SPY is an ETF that contains all of the stocks in the Standard &

Poor’s 500 Index and thus tracks the index• Mutual Fund – a fund that contains a large number of components

such as stocks, bonds, etc – Unlike ETFs, (almost all) mutual funds cannot be traded during the day

but only on the basis of closing prices of the components• Secondary offering – an issue of new stock by a company that is

already listed for trading (and previously had an IPO); raises new capital and dilutes existing ownership

04/09/23 Fin 594 - Fall 2011 6

!. Do you own stocks?If yes, approximately how frequently to you trade: 1/wk, 1/month, 1/year

2. Do you think you own more stocks than your parents did at your age?

3. At age 35, what proportion of your assets would you like to have invested in stocks – <10%, 10 – 25%, >25%

Why did you choose this amount?

4. What proportion of the population in your country do you think owns stocks – <10%, 10 – 25%, >25%

5 Over the coming 10 year period, what level of return do expect an investment in stocks to achieve?

Negative, 0 – 5%/year, 5 – 10%/year, 10 – 20%/year, >20%/year

6. Which stock exchange (SE) is larger: the Tokyo Stock Exchange, the Taiwan Stock Exchange, or the Shanghai Stock Exchange?

On what basis did you answer this question?

04/09/23 Fin 594 - Fall 2011 7

History of the World Equity Market: An Overview

• The Origins in Antiquity?• The Rise and Decline of Stock Exchanges

– From the 1600s to WWII– Key Characteristics of SEs

• Post WWII: The Rebirth of SEs – The Established Markets– The “New” Markets

• Stock Exchanges Today – Size

• Trading value • Capitalization • IPO values

• Another method of Comparing Sizes – Turnover Ratios• Stock Exchanges: Wealth, Equitization and Stock Ownership

04/09/23 Fin 594 - Fall 2011 8

Rome: The Origins of Equity Markets?

• Smith: first entities that look like equity markets appeared in Rome more than 2200 years ago

• May overstate the reality but the three conditions described are important:– Freely transferable (tradable) capital as a result of wealth accumulation– Credit availability (lending of money at interest), use of bank drafts for

financing of trade– Risk/reward trade off by investors

• Was also international in scope – non-Roman citizens could participate

• Fall of Rome ended this early, and limited, development of equity markets– Next 1000 – 1200 years saw a different type of economy in Europe:

capital was fixed (land, livestock, implements), credit little used, no class of investors in part because of Christian religious opposition to buying and selling for profit (doctrine of “fair” price)

• Evidence from early Asia - ??

04/09/23 Fin 594 - Fall 2011 9

The Emergence of Stock Exchanges

• Modern form of tock exchanges (SE) first appeared in the 1600s– Established first in countries leading the European exploration and

conquest of the Americas, Africa and Asia – Netherlands probably had the first functioning SE in Amsterdam;

London also an early entry; first in Asia probably Japan– Developed in other European countries and European settled

colonies• SEs had the same dual function in 1600s and 1700s as today:

– Capital raising and allocation, e.g. Br East India CO, Bk of Eng, Hudson’s Bay Co, etc)

– Limited liability for share owners– Speculation/investment (and people trying to define the difference)

• These early SEs were of limited importance to their economies and citizenry– Financial assets not yet a significant form of wealth – Commodity exchanges more common

04/09/23 Fin 594 - Fall 2011 10

The Rise of SEs: 19th Century to the 1930s

• By WWI SEs were central to an emerging world financial market:– World wide: 20 million investors held L32.6 billion

of public companies (approx 3 trillion in current $)– Equity market participation very concentrated

• UK 24%, US 21%, France, 18%, Germany 16%, all other 21%

– Internationalization of investment already a feature• In UK, France and Germany over 20% of the listings

were foreign, often from “developing” economies (UK>50%)

– Two leaders established• London initially the largest SE• However, by end of WWI, NYSE larger than London but

primarily a market for domestic issues

04/09/23 Fin 594 - Fall 2011 11

Key Features of the Stock Exchanges as Financial Markets

• Despite early limited economic role, key features of SEs already apparent (1) Equitization

• Conversion of ownership in commercial ventures into interests (equities or shares) that could be bought and sold

– Dutch East India Company – organized as a joint stock company• Previously partnerships were the mode of merchant operations

– Limits to capital that can be raised– No limits to potential losses

• Investors are no longer partners – and have only limited risk• Form of wealth holding begins to change• Today initial public offerings (IPOs) equitize a business

(2) Centralization • Information flows to and is acted on at one location (physical/virtual)

– What are the advantages of a centralized market?(3) The importance of information (e.g. N. Rothschild & Battle of Waterloo)

• Physical location for purchase and sale of shares when information and communication technology creates geographical constraints

04/09/23 Fin 594 - Fall 2011 12

Key Features of Stock Exchanges as an Organization

(4) Organized, run and governed by members– More like a private club than a business

(5) Time and place advantage of membership– What does this mean?

(60 Not profit maximizing organizations – Why?

04/09/23 Fin 594 - Fall 2011 13

“Stocks have reached what looks like a permanently high plateau.” - Irving Fisher, leading US economist, Oct 15, 1929

04/09/23 Fin 594 - Fall 2011 14

The Great Crash of 1929 – and its Aftermath

04/09/23 Fin 594 - Fall 2011 15

The Crash of 1929

• US market dropped 25% in two days (Oct 24 & 25, 1929

• Did the value of stocks drop 25% in two days – or the price of stocks?

• What questions do crashes raise about financial markets?– Are financial markets actually self correcting?– Do they reflect rational economic calculations – or

herd mentality?• Crashes impact the rest of the economy (the

“real” economy) and in turn are impacted by it

04/09/23 Fin 594 - Fall 2011 16

The Decline of Stock Exchanges:The Great Depression/WWII Cycle

• DJIA rose >400% from 1921 low to 1929 high– DJIA fell >25% on Oct 24/25 on a then record vol of almost 13 million shares

despite NYSE organized bankers pool to support prices– By 1932 bottom, DJIA lost 87% of value– Not just the US - a world wide bear market:

• E.g.Canada’s stock market lost almost 80% of pre-crash value, German stock market lost 74% of pre-crash value

• World stock market as measured by Europe, Australia and Far East Index (EAFE) lost 63%

• The 1929 Crash and the Great Depression ended this first wave of SE globalization

• The impact was global and long lasting– In 1939 NYSE ADV <1,000,000 – first time since early 1920s– Foreign listings in London dropped to less than 10% of the total– The command economy of Nazi Germany and Fascist Italy allocated a minor role

to SE; Japan’s SEs closed– In 1928 17% of Harvard Business School grads entered the investment bus – in

1940 only 4.4 % did so – DJIA net gain 1900 – 1941: 57% (<2%/yr)

04/09/23 Fin 594 - Fall 2011 17

The Real Economy Impact

• In US:– Unemployment went from <3.5% to 25% (1929 – 1932)

– GPD dropped over 40% (1929 – 1932)– 9000 banks closed by early 1933

• Internationally:– Unemployment jumped and GDP fell (similar to US levels in

many cases)– Many countries sought to restart economies by creating tariff

walls to protect their economy– Countries went off gold standard– Countries defaulted on sovereign debts

• Was the 1930s Great Depression unique, or part of a pattern – return to this later

04/09/23 Fin 594 - Fall 2011 18

Dow Jones Industrial Average, Yearly Close, 1900 - 1941

0

50

100

150

200

250

300

350

19001903

19061909

19121915

19201923

19261929

19321935

19381941

DJI

A

DJIA 12/31 CLOSE

04/09/23 Fin 594 - Fall 2011 19

Post WWII: The Re-emergence of SEs

• In the past 60 years, SEs have reemerged – SEs became a core element in financial systems, both at the national

and the global level– SEs as business in their own right with much recent M&A activity (e.g.

NYSE/Euronext, London SE/Italien Borse)• Size of SEs is one simple and impressive measure of this

increased importance – One common size measurement is simply volume of trading, i.e. the

number of shares that change hands • What are problems of comparison?

– SE comparative size is usually measured in two ways• Capitalization of listed companies (shares outstanding * price/share)• Value of trading (sum of shares traded * price at time of execution)

• By any measure the growth of stock exchanges in the past 35 years have been phenomenal – Capitalization of SE listed companies has increased 18 fold since 1975– However, turnover – the value stocks traded – has increased 100 fold in

the same time period

04/09/23 Fin 594 - Fall 2011 20

Listed Share Volume, 10 Largest Stock Exchanges, 2010

0

500,000

1,000,000

1,500,000

2,000,000

2,500,000

NASDAQ SE

NYSE

Shanghai SE

Nat'l SE - India

Shenzhen SE

Korea SE

Bombay SE

London SE

Millions of Shares

04/09/23 Fin 594 - Fall 2011 21

The World’s Largest SEs, 2010 by Market Capitalization of Listed Issues

0

2000

4000

6000

8000

10000

12000

14000

16000

Market Cap

NYSE

NASDAQ

Tokyo SE

London SE

EuroNext

Shanghai

Hong Kong

TSX

Bombay

BM/Fbovespa

Nat't SE - India

ASX

$US billions

04/09/23 Fin 594 - Fall 2011 22

The World’s Largest SEs, 2010, by Value of Trading of Listed Issues

$0

$2,000

$4,000

$6,000

$8,000

$10,000

$12,000

$14,000

$16,000

$18,000

$20,000

Value Traded

$US

Bil

lio

ns

NYSE

NASDAQ

Shanghai

Tokyo SE

Shenzhen

London SE

EuroNext

Deutsche Borse

Korea SE

Hong Kong SE

$US billions

04/09/23 Fin 594 - Fall 2011 23

Other Approaches to Measuring Growth of SEs

• An original function of SEs was to raise capital for new ventures beyond that which individual or groups of entrepreneurs could aggregate – continues to day

• Therefore one comparative measurement can be capital raised through initial public offerings (IPOs)

– Over time the growth rate of capital raised via IPOs is similar to that of market capitalization

• However, the total IPO capital raised is only a fraction of total traded value – Increasing reliance on equity capital vs debt

• Growth in number of listed companies (over 40,000 listed companies word wide)

• SEs vs size of economy (national and world comparisons)• SEs increased role is also evident via new prominence given to the stock

market in news reporting – “What did the market due today?” – always about the stock market

• Result has been proliferation of measures of market performance, i.e. stock indexes • Both third parties and SEs seek to establish their index as the reference benchmark

– Dow Jones, FTSE, CAC, Nikkei, DAX have become household names

04/09/23 Fin 594 - Fall 2011 24

Capital Raised by IPOs, Largest SEs, 2006, 2007, 2008, 2009 and 2010

$0$100,000$200,000$300,000$400,000$500,000$600,000$700,000$800,000

NYSE

London

SE

Hong Kong

SE

Austra

lian S

E

BM/F

bove

spa

BME (S

pain)

NASDAQ

Shangh

ai S

E

$US

Mil

lio

ns 2006

2007

2008

2009

2010

04/09/23 Fin 594 - Fall 2011 25

Days to Raise IPO Capital, 2010

0

0.5

1

1.5

2

2.5

3

3.5

4

Day

s to

Rai

se I

PO

Cap

ital

NYSE

NASDAQ

Shanghai

London

BME

04/09/23 Fin 594 - Fall 2011 26

World’s Largest SEs, 2010by # of Listed Companies

0

1000

2000

3000

4000

5000

6000

Bombay SE*

TSX Grp

BMA (Spain)

London

NASDAQ

NYSETokyo

Australia

Korea SE

Nat'l SE (India)

Listings

*Dual with NSE

04/09/23 Fin 594 - Fall 2011 27

Comparing Equity Market and Economic Growth

• Figures for growth of capitalization – one measure of equitization – are impressive as are figures on value of trading (turnover)

• However, world economy has also grown during this 30 year period

• Is growth in stock market activity simply a reflection of the increase in economic activity?

• How can we compare?• Use World GDP as base and compare to stock market

activity– Early 1990s vs a decade later

• Why has the latter exceeded the former?

04/09/23 Fin 594 - Fall 2011 28

Growth in the World Equity Market vs Growth in World GDP, 1975 - 2009

Market Cap and Value Traded vs GDP

020000400006000080000

100000120000

1975

1980

1985

1990

1995

1997

2002

2005

2006

2007

2008

2009

Year

Value Traded & Mkt Cap ($ billions)

Market Cap Value Traded World GDP

04/09/23 Fin 594 - Fall 2011 29

Analyzing the Re-Emergence of Stock Exchanges:I

• The re-emergence of SEs can be divided into two parts:– The first trend is a return to importance of older,

established equity markets • US, UK, Germany, France and Japan that were leaders in

shareholding by WWI– NYSE and NASDAQ, LSE, Euronext, Deutsche Borse, and Tokyo SE

• These are the largest SEs and account for much of the total world equity market capitalization and value of trading

• Also leaders in IPO issuance to raise additional capital – In addition, these SEs are increasingly reorganizing as for

profit entities and acting as for profit businesses seeking growth

• Mergers of SEs in Europe to create EUREX, NOREX and EuroNext, • NYSE/Euronext merger, NASDAQ’s failed bid London SE, Dhubai

SE bid to acquire part of NASDAQ, etc.– Return to SE M&A later in the course

04/09/23 Fin 594 - Fall 2011 30

Growth in Market Capitalization, Six Established World Markets

(1980 - 2010)

$0.0

$2.0

$4.0$6.0

$8.0

$10.0

$12.0$14.0

$16.0

$18.0

$ T

rill

ions

NYSENASDAQTSELondonDBEuroNext

04/09/23 Fin 594 - Fall 2011 31

Growth in Annual Value of Trading, Six Established World Markets

(1980 – 2010)

$0.0

$5.0

$10.0

$15.0

$20.0

$25.0

$30.0

$35.0

$ T

rill

ions

NYSENASDAQTSELondonDBEuroNext

04/09/23 Fin 594 - Fall 2011 32

Established Markets – Changing Share of World Equity Market

• These markets are largely the same as those cited in our analysis of early 20th century equity market participation– A long history of equity trading and equitization

• Is this simply a recreation of that earlier pattern or has equitization and thus stock market activity spread to other areas of the world?

• Examine “established market” share of world equity market over time – points to the second trend that accounts for growth in the post-WW II world equity market

• Dispersion of equity market cap and trading share out of “established markets” is primarily a trend of the past 25 years

04/09/23 Fin 594 - Fall 2011 33

World Equity Market Share, Top 6 Established Markets

50%

60%

70%

80%

90%

100%

1975 1980 1985 1990 1997 2002 2006 2009 2010

Mkt Cap Share Traded value Share

04/09/23 Fin 594 - Fall 2011 34

The Re-Emergence of Stock Exchanges:II

• The second trend is the founding and growth of SEs in new equity markets– Many new SEs established in 20th century and

especially after WWII – Include: Shanghai, Taiwan, S. Korea,

Thailand, Indonesia in Asia as well as Mexico, Chile and Brazil in Latin America

– These markets are smaller as measured by capitalization and value traded than the older SEs but many are growing rapidly

04/09/23 Fin 594 - Fall 2011 35

Leading “New” Markets

Exchange Founded Trading Value, 2006 ($USb)

Capitalization (2006, $USb)

Istanbul SE 1929/1986 $224.6 $182.3

Bombay SE 1875 $215.0 $818.8

Mexican Bolsa 1985 $96.3 $348.3

National SE (India) 1992 $424.5 $774.1

Korea SE 1956 $1,339.6 $834.4

Shanghai SE 1890s/1990 $738.8 $917.1

Shenzhen 1990 $423.7 $277.9

Taiwan SE 1962 $737.7 $594.5

Stock Ex of Thailand

1962/1975 $100.6 $140.2

04/09/23 Fin 594 - Fall 2011 36

Leading “New” Markets

Exchange Founded Trading Value, 2010 ($USb)

Capitalization (2010, $USb)

Instanbul SE 1929/1986 $411.5 $307.0

Bombay SE 1875 $258.7 $1,631.8

Mexican Bolsa 1985 $119.1 $454.3

National SE (India) 1992 801.0 $1,596.6

Korea SE 1956 $1,607.2 $1091.9

Shanghai SE 1890s/1990 $4496.2 $2,716.5

Shenzhen 1990 $3572.5 $1,311.4

Taiwan SE 1962 $903.1 $597.2

Johannesburg Stock Ex

1962/1975 $340.0 $925.0

04/09/23 Fin 594 - Fall 2011 37

“Emerging Markets”

• There is also a third group of markets that have developed in the past 3 decades – “emerging markets”– These include Eastern Europe: Poland, Hungary,

Czech Republic – Also Africa: Egypt, Malta, Iran

• A large number of new SEs in emerging markets but still a small portion of market capitalization and traded value – Future growth? Impact of 2008 world market

collapse?

04/09/23 Fin 594 - Fall 2011 38

Change in Market Capitalization Rankings, 1999 – 2009

20 Largest Markets based on 2009 Mkt Cap1999 2009

US 1 1

UK 3 2

Japan 2 3

France 5 4

Canada 8 5

Australia 13 6

Germany 4 7

Switzerland 6 8

China 43 9

Brazil 19 10

Spain 11 11

S. Korea 15 12

Italy 9 13

Taiwan 17 14

Netherlands 7 15

Swede 12 16

India 21 17

Hong Kong 14 18

S, Africa 18 19

Russia 32 20

04/09/23 Fin 594 - Fall 2011 39

Comparing SEs: Turnover Ratio (Combines Market Capitalization and Value Traded)

• Our different measures of exchange size produce different rankings. This is true of the most widely used measures, market cap and trading value. – Can we combine these measures to compare stock exchanges? – What would a combined measure mean?

• Traded value and market cap can be combined to create a measure of market activity called the “turnover ratio”

• How to calculate turnover ratio: traded value divided by market capitalization (TV/MCap)– Traded value usually an annual measure– Market Cap usually as of close of the year

04/09/23 Fin 594 - Fall 2011 40

Turnover Ratios: Comparing Exchanges

• Calculation examples:– In 2009, total traded value on Shanghai SE

was $5,062 billion while year end market capitalization was $2,705 billion

• What was the turnover ratio for the Shanghai SE in 2009?

– In 2009, total traded value on the Shenzhen SE was $2,774 billion while year end market capitalization was $868 billion

• What was the turnover ration for the Shenzhen SE in 2009?

04/09/23 Fin 594 - Fall 2011 41

What does the Turnover Ratio Measure?

• Turnover ratio – frequency with which the average share trades – Turnover ratio of >1 means the average share is traded at more than

___ per year;– Turnover ratio of <1 means the average share is traded less than _____

per year • Can be used to compare activity levels in markets of different sizes

– A first insight into “equity culture” in a particular country– High overlap between exchanges in top 10 by market cap and traded

value – less overlap with turnover ratio • 4 SEs ranked in top 10 on this measure are not in top 10 on either of the

other two measures (Istanbul, Oslo, Borsa Italiana, Taiwan SE)– On a world wide basis this same calculation can be made over time to

assess shift in activity

04/09/23 Fin 594 - Fall 2011 42

Ten “Most Active” SEs, 2005 – 2009 (listed issues, 2005 as benchmark)

050

100150200250300350400450

NASDAQ*

Shenzhen SE

Korea SE

Deutsche Borse

Oslo Borse

Borsa Italiana

BME Spain)

NYSE

Istanbul SE

Taiwan SE

Tu

rno

ver

%

2005 Turnover Ratio 2006 Turnover Ratio 2007 Turnover Ratio

2008 Turnover Ratio 2009 Turnover Ratio

*In 2008 & 2009 NASDAQ included trades in non-NASDAQ listed stocks; the actual turnover ratios are estimates

04/09/23 Fin 594 - Fall 2011 43

Growth of the World Equity Market, 1975 – 2010

$0

$20,000

$40,000

$60,000

$80,000

$100,000

$120,000

1975

1980

1985

1990

1995

1997

2002

2005

2006

2007

2008

2009

2010

Market Cap Value Traded

Billions of $US

Stock Exchanges: Wealth and Financialization

The Changing Structure of Wealth Holding

04/09/23 Fin 594 - Fall 2011 45

Equities and Wealth

• What is Wealth?

• What is net wealth?

• How does wealth differ from Income?

• What are some forms of wealth?

04/09/23 Fin 594 - Fall 2011 46

Equities as Wealth

• What are the advantages of holding wealth in the form of equities?

• What are the disadvantages of holding wealth in the form of equities?

04/09/23 Fin 594 - Fall 2011 47

Financialization: The Holding of Wealth Transformed

• Re-Emergence of SEs part of a larger process of financialization:– Increased importance of financial markets, financial institutions, financial modes

of thinking and financial elites in larger economy– Financialization transforms future streams of income (profits, dividends, interest

payments) into tradable assets • E.g. future earnings of business transformed into equities that may be bought and sold• E.g. loans, whether private or government, transformed into bonds that may be bought

and sold– Process of this transformation requires larger finance sector to structure and

securitize assets into financial assets• Can financialization

– May be one problem revealed by 2008 financial crisis

• Measures of financialization in the US:• Ratio of equity assets to total GDP on a per capita basis• Total US debt (government, households, and business) rose from 1.6 times GDP in

1973 to 3.5 times GDP in 2007– Debt of financial sector was the fastest growing component

• Profits of financial sector were only 14% total corporate profits in 1981 vs 40 - 45% in 2000 – 05

– Similar trends occurred in other nations: outcome is increased holding of wealth in the form of financial assets including stocks

04/09/23 Fin 594 - Fall 2011 48

Direct and Indirect Ownership

• What is direct ownership (participation) in equity markets?– Individual invests via a broker-dealer, choosing

(perhaps with advice) stocks and/or equity funds– Increased orientation to stock market – “what did the

market do today?” has a meaning

• What is indirect ownership?– Via an institutional intermediary – E.g. mutual fund, pension fund, trust

04/09/23 Fin 594 - Fall 2011 49

Equities and Household Financial Wealth

• Financial wealth excludes real estate, including primary residence • Household wealth has shifted towards financial wealth• Within financial wealth, trend is towards growth in percent of

household wealth in equities– Increases in the order of 25 - 50% during the 1990s were not

uncommon – UK exception – 1980s privatizations already distributed shares widely

• These are maximum figure because may include some bond mutual fund holdings

– US & Europe from different data sources – comparability vs trend

– We will analyze the impetus behind this shift later in the course • These are average figures for all households

– Distribution of wealth among households is uneven; wealthy households (top 20 – 35% by wealth) hold a disproportionate share of total financial wealth

– These top wealth holding households are more likely to hold equities• Discuss in greater detail when we examine equity culture

04/09/23 Fin 594 - Fall 2011 50

Share Owning Population, Selected Countries

Percent of Population Owning Shares, ca 2000-2005

0%10%20%30%40%50%60%

Australia

S. Korea

Canada

France

Germany

Japan

New Zealand

Hong Kong

Sweden

Taiwan

UKUS

Direct Ownership Total Ownership

04/09/23 Fin 594 - Fall 2011 51

Equitization: US as a Case Study

• What is equitization? • How can we measure equitization?

– Growth in number of listings• An indication of commercial participation in equity market • Problem of counting all listings as equivalent

– Growth in market capitalization • Good measure of market growth • Problems: population growth could increase market cap• Economic growth should increase market cap

• Control for population and economic growth by comparing market cap to GDP on a per capita basis– US: growth in GDP/capita and market cap/capita parallel until

early 1990s – new pattern emerges as equity market becomes more important mechanism for wealth holding and creation

04/09/23 Fin 594 - Fall 2011 52

US Equitization: Per capita GDP vs Per Capita Market Cap, 1980 - 2008

$0

$10,000

$20,000

$30,000

$40,000

$50,000

$60,000

$70,000

19801982

19841986

19881990

19921994

19961998

20002002

20042006

2008

GDP Per Capita Per Capita Market Cap

04/09/23 Fin 594 - Fall 2011 53

Equitization: Another Measure

• A broader measure of equitization may help us in comparing markets– Market capitalization:GDP ratio– Suggests:

• Range that is found in world equity market today• Possible trends in markets over the next few decades

• Broadly, older markets have higher ratio but this is not universal– E.g. Taiwan very high ratio– Germany and Japan lower ratios– May reflect differences in equity cultures – to be

discussed later in the course

04/09/23 Fin 594 - Fall 2011 54

Comparing Market Capitalization to Gross Domestic Product: 2009

0

0.2

0.4

0.6

0.8

1

1.2

1.4

1.6

1.8

2

2009 Ratio

Mkt

Cap

/GD

P

Germany

Japan

Thailand

China

Spain

S. Korea

India

US

France

Australia

Canada

UK

Taiwan

04/09/23 Fin 594 - Fall 2011 55

SEs and the Investing Public• A major reason for, and result of, increased prominence of SEs is the

increase in equity market participation by populations around the world – Until more than a decade after WWII, only a small percentage of individuals n

any country owned stocks (e.g. WW I figures)– Wealth was primarily in real estate, small business, bank accounts and bonds – In the last 4 – 5 decades this has changed dramatically: SEs have become

important, directly or indirectly, to the financial well being of most people• This fact alone, the growth in the (direct and indirect) investing population,

would be reason to study the structure and operation of SEs • A growing percentage of the accumulated wealth of individuals and

institutions (these are often proxies for individuals) is now in the form of equity assets

– Current well being and future life style– Driving continued equitization and benefiting from this process– However, holding wealth in the form of equities is still available to only half (or

often less) of the population in most counties

04/09/23 Fin 594 - Fall 2011 56

Evolution of Equities as a Percent of Household Financial Wealth, US and Selected European Countries

0%

5%

10%

15%

20%

25%

30%

35%

France

Germany

ItalyNetherlands*

UKUS

1990 1998

*Netherlands date are 1995 and 1998

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What do we, as Investors/traders/wealth accumulators Expect from SEs?

• The stock exchange should be neutral – what does this mean?– Neutral: No preference for any participant in the

operation of the market• Neutrality essential for confidence/trust of investors• Neutrality essential for role as regulator

– Neutral: the SE should not participate in the core activity of trading

• Differs from banks, brokerage houses, etc.• SE revenues cannot be derived from direct participation in

their core activity

– Analogy: a referee in a sports contest

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Terms• Equitization

• Stock Market Capitalization

• Value of trading

• IPO

• Turnover Ratio

• Direct vs indirect stock ownership

• Wealth and Net Wealth

• Other basic concepts appear on the following slides – please be familiar with them