Date: 19.04.16 Category: Ethics & Professionalism
Historically, the primary equity markets have been used to source capital to fund growth but stakeholders believe that this function has declined in recent years, though they note that corporate bond issuance has increased (even if that hasn’t fed through to an increase in overall business investment)6. In recent times, there has been a shift away from growth capital funding through public equity markets.
Stakeholders attribute this to the direct cost of listing, combined with the ongoing regulatory and compliance costs (and the availability of attractive funding elsewhere). While the public equity markets may now be a less frequent provider of growth capital, stakeholders observe that they continue to provide a valuable venue for the recycling of risk capital investment. In addition, they provide companies of sufficient size with access to larger pools of capital and, through secondary markets, with liquidity and a continuous valuation of their outstanding capital.
The secondary markets are many multiples of the size of the primary markets. For instance, while $1.5 trillion of new corporate debt was issued in the US in 2015, outstandings totalled $8.2 trillion7. Capital trading in secondary markets has already been allocated to its end-users – there is no fresh capital raised by companies or governments in secondary markets – but the value of the securities representing the capital can change continuously as investment managers seek to exit or enter and increase or decrease the size of their holdings.
Securities’ prices are set by the supply and demand present in the market at any time in a process called ‘price discovery’. Price discovery matters because it impounds new information into prices, indicating investors’ views on the outlook for the issuer. Companies whose prospects are worsening – either as a result of poor management or a more difficult trading environment – will likely see the price of their securities fall as investment managers sell them to mitigate against poor future earnings streams and creditworthiness.
The converse is true for those companies whose prospects improve. Price discovery acts to discipline companies so that they are encouraged to operate efficiently and generate an adequate return on their capital. Initially, a declining share price is a warning to a company’s owners and managers. Ultimately, a fall in the price of the securities of a struggling company may encourage another company to purchase the struggling company’s shares taking ownership of the company to effect a change of management with the intention of restoring the value of the assets.
Read more in our report.