The benefits of a smooth-running stock exchange

Why is it that stock exchanges are considered so important? Why do most national news bulletins conclude by telling their audience what the local stock exchanges have done that day?

Most developed stock exchanges around the world are considered “liquid”, and shareholders are able to sell their shares quickly, at a fair price and at a low cost. In addition, shareholders know at any given point that they can sell their shares, and even if they don't wish to sell they know the value of their holdings. Because of this enhanced liquidity and transparency in pricing, shareholders are willing to supply capital to the stock market. In economics we typically solve the “scarcity” problem by allowing the market to decide what will be produced and which firms will produce it. An efficiently functioning stock market, similarly, helps allocate scarce investment capital. If the market was poorly regulated and operationally inefficient, then it is likely that we would face an inefficient allocation of capital.

In order to induce investors to provide capital to the stock market, they need to know that there is a level playing field and that the market is not skewed in the direction of investors with privileged information. If investors do not hold this view, then they will be unwilling to supply capital to the market and this will inhibit economic growth.

When a company makes the decision to go public, there is a recognition that the consequent reporting requirements are much more stringent than when it was privately owned. A privately owned company is required to publish annual reports, but when a company goes public the extent of the information that is required to be made known is increased. In the US, this is referred to as the 10K form. In addition to this, companies are required to submit a 10Q form to the Securities and Exchange Commission (SEC). There are also numerous other forms that may need to be submitted, depending on the firm's activities. Forms 3, 4 and 13D, for example, are commonly used, as they detail changes in ownership. As a result of this scrutiny, potential suppliers of capital view the firm with enhanced confidence and are more likely to invest.