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Chapter 4 The share market and the corporation Websites: www.asic.gov.au www.asx.com.au www.nyse.com Copyright  2012 McGraw-Hill Australia Pty Ltd PPTs to accompany Financial Institutions, Instruments and Markets 7e by Viney and Phillips Slides prepared by Peter Phillips 4-1 Learning objectives • Understand the nature of corporations and reasons for public listing • Consider the origins and purpose of a stock exchange • Discuss the role of primary and secondary markets in equity financing • Explain the derivatives, managed products and interest rate market roles of a stock exchange • Explain the electronic trading and settlement systems for share market transactions (cont.) Copyright  2012 McGraw-Hill Australia Pty Ltd PPTs to accompany Financial Institutions, Instruments and Markets 7e by Viney and Phillips Slides prepared by Peter Phillips 4-2 Learning objectives (cont.) • Explain the importance of information flows for share market efficiency • Identify the main regulators of the share market • Explain the structure and purpose of the private equity market Copyright  2012 McGraw-Hill Australia Pty Ltd PPTs to accompany Financial Institutions, Instruments and Markets 7e by Viney and Phillips Slides prepared by Peter Phillips 4-3 Chapter organisation 4.1 4.2 4.3 4.4 The Nature of a Corporation The Stock Exchange The Private Equity Market Summary Copyright  2012 McGraw-Hill Australia Pty Ltd PPTs to accompany Financial Institutions, Instruments and Markets 7e by Viney and Phillips Slides prepared by Peter Phillips 4-4 4.1 The nature of a corporation • Share market – A formal exchange facilitating the issue, buying and selling of equity securities • Publicly listed corporation – A company whose shares are quoted and traded on a formal stock exchange • Ordinary share – The principal form of equity issued by a corporation, which bestows a claim to residual cash flows and ownership and voting rights (cont.) Copyright  2012 McGraw-Hill Australia Pty Ltd PPTs to accompany Financial Institutions, Instruments and Markets 7e by Viney and Phillips Slides prepared by Peter Phillips 4-5 4.1 The nature of a corporation (cont.) • The corporation differs from other business forms – Ownership claims are widespread and easily transferable – Owners (shareholders) do not affect the day-to-day affairs of the company – Shareholders’ liability is limited to:  the issue price of shares of a limited liability company  any partly paid portion of shares of a no-liability company (cont.) Copyright  2012 McGraw-Hill Australia Pty Ltd PPTs to accompany Financial Institutions, Instruments and Markets 7e by Viney and Phillips Slides prepared by Peter Phillips 4-6 4.1 The nature of a corporation (cont.) • Advantages of the corporate form – Can obtain large amounts of finance at a relatively cheap cost – The liquidity of securities facilitates investor diversification and encourages investment in corporate securities – Separation of ownership and control facilitates:  appointment of specialised management  greater effectiveness in the planning and implementation of strategic decisions (cont.) Copyright  2012 McGraw-Hill Australia Pty Ltd PPTs to accompany Financial Institutions, Instruments and Markets 7e by Viney and Phillips Slides prepared by Peter Phillips 4-7 4.1 The nature of a corporation (cont.) • Advantages of the corporate form (cont.) – ‘Perpetual succession’—the corporate form is unaffected by changes in management or ownership – The corporate form is suited to large-scale operations (cont.) Copyright  2012 McGraw-Hill Australia Pty Ltd PPTs to accompany Financial Institutions, Instruments and Markets 7e by Viney and Phillips Slides prepared by Peter Phillips 4-8 4.1 The nature of a corporation (cont.) • Disadvantages of the corporate form – Main disadvantage arises from the separation of ownership and control  Conflict of interest between owners (principals) and managers (agents) known as the agency problem  Management may try to run business for their own benefit, rather than that of shareholders, i.e. maximise shareholder value (share price) (cont.) Copyright  2012 McGraw-Hill Australia Pty Ltd PPTs to accompany Financial Institutions, Instruments and Markets 7e by Viney and Phillips Slides prepared by Peter Phillips 4-9 4.1 The nature of a corporation (cont.) • Disadvantages of the corporate form (cont.) – Factors moderating conflict of interest between owners and managers  Investors’ ability to sell shares in a corporation, causing the share price to fall  Dismissal from the board at AGM by shareholders  Threat of takeover and loss of employment  Use of performance incentives, such as share options  More rigorous corporate governance (cont.) Copyright  2012 McGraw-Hill Australia Pty Ltd PPTs to accompany Financial Institutions, Instruments and Markets 7e by Viney and Phillips Slides prepared by Peter Phillips 4-10 4.1 The nature of a corporation (cont.) • Following the GFC, many corporations were forced to raise additional capital through the stock market • This was to ‘sure up’ their balance sheets during the tough economic environment that followed the crisis • The advantage of the corporate form is highlighted by such behaviour • Smaller firms are not able to access capital as easily and would normally be expected to pay a higher rate of return Copyright  2012 McGraw-Hill Australia Pty Ltd PPTs to accompany Financial Institutions, Instruments and Markets 7e by Viney and Phillips Slides prepared by Peter Phillips 4-11 Chapter organisation 4.1 4.2 4.3 4.4 The Nature of a Corporation The Stock Exchange The Private Equity Market Summary Copyright  2012 McGraw-Hill Australia Pty Ltd PPTs to accompany Financial Institutions, Instruments and Markets 7e by Viney and Phillips Slides prepared by Peter Phillips 4-12 4.2 The stock exchange • Origins of the modern stock exchange traceable to mid16th century England • Principal functions of a modern and efficient stock exchange in a globalised market are the provision of: – – – – – markets for a range of financial securities securities trading system clearing and settlement system regulation and monitoring of market integrity well-informed market (cont.) Copyright  2012 McGraw-Hill Australia Pty Ltd PPTs to accompany Financial Institutions, Instruments and Markets 7e by Viney and Phillips Slides prepared by Peter Phillips 4-13 4.2 The stock exchange (cont.) • Specifically, the following roles of a stock exchange are considered: – – – – – – – – Primary market role Secondary market role Managed Product role Derivative market role Interest rate market role Trading and settlement roles Information role Regulatory role Copyright  2012 McGraw-Hill Australia Pty Ltd PPTs to accompany Financial Institutions, Instruments and Markets 7e by Viney and Phillips Slides prepared by Peter Phillips 4-14 Primary market role • A stock exchange facilitates the efficient and orderly sale of new financial securities – New floats/Initial public offerings (IPOs)  Initial listing of a corporation on the stock exchange – Rights issue  Issue of additional shares to existing shareholders on a prorata basis – Placements  Issue of new shares to selected institutional investors – Dividend reinvestment plans  Reinvestment of dividends into corporation for additional shares (cont.) Copyright  2012 McGraw-Hill Australia Pty Ltd PPTs to accompany Financial Institutions, Instruments and Markets 7e by Viney and Phillips Slides prepared by Peter Phillips 4-15 Primary market role (cont.) (cont.) Copyright  2012 McGraw-Hill Australia Pty Ltd PPTs to accompany Financial Institutions, Instruments and Markets 7e by Viney and Phillips Slides prepared by Peter Phillips 4-16 Primary market role (cont.) Copyright  2012 McGraw-Hill Australia Pty Ltd PPTs to accompany Financial Institutions, Instruments and Markets 7e by Viney and Phillips Slides prepared by Peter Phillips 4-17 Secondary market role • The stock exchange facilitates trading in existing shares – No new funds are raised by the issuing company – An active, liquid, well-organised secondary market increases the appeal of buying new shares in the primary market – Market liquidity  Ratio of share turnover to market capitalisation – Market turnover  Number of shares on issue x current share price (cont.) Copyright  2012 McGraw-Hill Australia Pty Ltd PPTs to accompany Financial Institutions, Instruments and Markets 7e by Viney and Phillips Slides prepared by Peter Phillips 4-18 Secondary market role (cont.) Copyright  2012 McGraw-Hill Australia Pty Ltd PPTs to accompany Financial Institutions, Instruments and Markets 7e by Viney and Phillips Slides prepared by Peter Phillips 4-19 Managed product role • The stock exchange provides a market for trading managed products – Equity-based managed products are professionally managed funds. – The ‘units’ in these funds are bought and sold on the stock exchange in the same way as shares in corporations. – Managed products are described as:  exchange traded funds (ETFs)  real estate investment trusts (REITs)  infrastructure funds Copyright  2012 McGraw-Hill Australia Pty Ltd PPTs to accompany Financial Institutions, Instruments and Markets 7e by Viney and Phillips Slides prepared by Peter Phillips 4-20 Derivative market role • The stock exchange provides a market for trading equity-related derivative products – A derivative is a financial security that derives its price from an underlying commodity (e.g. gold) or financial instrument (e.g. BHP shares) – Derivative products are described as:  exchange-traded contracts • standardised financial contracts traded on a formal exchange  over-the-counter contracts • non-standardised contracts negotiated between writer and buyer (cont.) Copyright  2012 McGraw-Hill Australia Pty Ltd PPTs to accompany Financial Institutions, Instruments and Markets 7e by Viney and Phillips Slides prepared by Peter Phillips 4-21 Derivative market role (cont.) • The stock exchange provides a market for trading equity-related derivative products (cont.) – Derivatives serve as a:  risk management tool (hedge)  speculative instrument – Derivatives traded on a stock exchange include:     options warrants futures contracts Contracts for difference Copyright  2012 McGraw-Hill Australia Pty Ltd PPTs to accompany Financial Institutions, Instruments and Markets 7e by Viney and Phillips Slides prepared by Peter Phillips 4-22 Interest rate market role • The listing, quotation and trading of typically longer term debt instruments on a stock exchange – – – – Straight corporate bonds Floating rate notes (FRNs) Convertible notes Preference shares (cont.) Copyright  2012 McGraw-Hill Australia Pty Ltd PPTs to accompany Financial Institutions, Instruments and Markets 7e by Viney and Phillips Slides prepared by Peter Phillips 4-23 Interest rate market role (cont.) • This role adds value to a debt issue owing to: – transparency  information about price, yield, maturity, credit rating of debt instruments – ease of entry  electronic trading system facilitates buy and sell orders at minimum cost and time delay at current market prices – liquidity  quotation on a stock exchange provides access to a wider market Copyright  2012 McGraw-Hill Australia Pty Ltd PPTs to accompany Financial Institutions, Instruments and Markets 7e by Viney and Phillips Slides prepared by Peter Phillips 4-24 Trading and settlement roles • The Australian Securities Exchange (ASX) uses ASX Trade and ASX Trade24, which are integrated computer-based trading systems to trade all listed securities and derivatives – Clients’ orders are executed via computer from the broker’s office – Orders are executed in order of time received and the buy/sell price (cont.) Copyright  2012 McGraw-Hill Australia Pty Ltd PPTs to accompany Financial Institutions, Instruments and Markets 7e by Viney and Phillips Slides prepared by Peter Phillips 4-25 Trading and settlement roles (cont.) • The ASX uses CHESS (Clearing House Electronic Subregister System) – Facilitates the settlement of transactions conducted through ASX Trade – Settlement of transactions within three days (T + 3) – Provides an electronic sub-register that records the ownership of listed securities – A CHESS sponsor is a market participant with access to CHESS, e.g. stockbroker Copyright  2012 McGraw-Hill Australia Pty Ltd PPTs to accompany Financial Institutions, Instruments and Markets 7e by Viney and Phillips Slides prepared by Peter Phillips 4-26 Information role • Investor confidence in the ASX relies on informational efficiency – The current share prices should reflect all information available in the market, determined by:  the speed at which new information flows to the market  the speed at which that information is absorbed and reflected in share prices • The ASX has a critical role in facilitating the flow of information to the market • Corporations Act 2001 (Cwlth) requires information materially affecting the share price of a listed company to be immediately given to the ASX (cont.) Copyright  2012 McGraw-Hill Australia Pty Ltd PPTs to accompany Financial Institutions, Instruments and Markets 7e by Viney and Phillips Slides prepared by Peter Phillips 4-27 Information role (cont.) • Listing rules are stock exchange rules with which a listed entity must comply • Examples of information disclosures required by ASX listing rules – – – – – A change in a company’s financial forecasts Appointment of a liquidator Declaration of a dividend Notice of a takeover bid Disclosure of directors’ interests Copyright  2012 McGraw-Hill Australia Pty Ltd PPTs to accompany Financial Institutions, Instruments and Markets 7e by Viney and Phillips Slides prepared by Peter Phillips 4-28 Regulatory role • The aim of regulation is to ensure market participants have confidence in the integrity of market operations • Two main supervisors in Australia – Australian Securities Exchange (ASX) – Australian Securities and Investments Commission (ASIC) (cont.) Copyright  2012 McGraw-Hill Australia Pty Ltd PPTs to accompany Financial Institutions, Instruments and Markets 7e by Viney and Phillips Slides prepared by Peter Phillips 4-29 Regulatory role (cont.) • ASX – Ensures listed companies meet specified limited levels of performance and standards of information disclosure so investors can make informed decisions  Continuous disclosure – Prescribes appropriate behaviour of broker participants on the exchange  Sanctions include discipline, penalties, loss of licence (cont.) Copyright  2012 McGraw-Hill Australia Pty Ltd PPTs to accompany Financial Institutions, Instruments and Markets 7e by Viney and Phillips Slides prepared by Peter Phillips 4-30 Regulatory role (cont.) • ASX (cont.) – Electronic surveillance systems to monitor trading behaviour of market participants  Detect trades that fall outside certain limits  Cross-references all trades against information on the relevant company, directors and associated parties (cont.) Copyright  2012 McGraw-Hill Australia Pty Ltd PPTs to accompany Financial Institutions, Instruments and Markets 7e by Viney and Phillips Slides prepared by Peter Phillips 4-31 Regulatory role (cont.) • ASIC – Responsible for the supervision of Corporations Law and markets in Australia (Corporations Act 2001 (Cwlth)) – Responsible for market integrity and consumer protection across the financial system, covering investment, insurance and superannuation products – Supervises the ASX, addressing potential conflicts of interest as a publicly listed corporation Copyright  2012 McGraw-Hill Australia Pty Ltd PPTs to accompany Financial Institutions, Instruments and Markets 7e by Viney and Phillips Slides prepared by Peter Phillips 4-32 Chapter organisation 4.1 4.2 4.3 4.4 The Nature of a Corporation The Stock Exchange The Private Equity Market Summary Copyright  2012 McGraw-Hill Australia Pty Ltd PPTs to accompany Financial Institutions, Instruments and Markets 7e by Viney and Phillips Slides prepared by Peter Phillips 4-33 4.3 The private equity market • Private equity is an alternative funding source for companies unable or not wanting to access equity capital though a public issue • Source of funds – Superannuation funds and life insurance offices • Use of funds – Startups, business expansion, recovery finance for distressed companies, management buyouts – Aim is generally to:  improve profitability sufficiently to realise value though an IPO  break up business to achieve return on investment Copyright  2012 McGraw-Hill Australia Pty Ltd PPTs to accompany Financial Institutions, Instruments and Markets 7e by Viney and Phillips Slides prepared by Peter Phillips 4-34 Chapter organisation 4.1 4.2 4.3 4.4 The Nature of a Corporation The Stock Exchange The Private Equity Market Summary Copyright  2012 McGraw-Hill Australia Pty Ltd PPTs to accompany Financial Institutions, Instruments and Markets 7e by Viney and Phillips Slides prepared by Peter Phillips 4-35 4.4 Summary • Corporate form of organisation has advantages (fundraising and management) and disadvantages (separation of ownership and control) • The stock exchange has a number of market roles – – – – – – Primary and secondary Derivative Interest rate Trading and settlement Information Regulatory • ASX monitors market participants and ASIC supervises Corporations Law and market integrity Copyright  2012 McGraw-Hill Australia Pty Ltd PPTs to accompany Financial Institutions, Instruments and Markets 7e by Viney and Phillips Slides prepared by Peter Phillips 4-36