There Is a Jungle out There

The Stock Exchange is where small fry get eaten by lions

Listener 17 March, 2001.

Keywords Business & Finance

There is no necessity for a stock exchange. In the early days, people traded shares by personal contact. But shares could not be readily bought or sold, and investors could not readily liquidate their investments. The stock exchange created a common knowledge of prices and availability. It became easier for corporations to raise risk capital, because investors were more willing to put their money in, knowing it was easier to get it out. Businesses could raise equity for a new venture or major extension. Banks provide the additional funds at a lower cost, because the shareholders took the risk.

There is only room for one efficient stock exchange in New Zealand. When the country was highly regionalised there were separate ones in the main centres. They became linked by telephone, and later amalgamated. Thus the stock exchange is a natural monopoly but, unusually, it has always been privately owned, The practice in New Zealand was to have natural monopolies publicly owned. More recently some were privatised (Telecom and ports for instance) but our legislation regulating natural monopolies remains primitive (so consumers can get easily exploited).

Because natural monopolies have economies of scale they seek mergers when it becomes technically feasible. That is why the Australian and New Zealand exchanges were trying to merge. Computer terminals mean a broker can run the business from Golden Bay. Because in practice personal connections are important, any merger must mean that some brokers will move to Sydney, with a loss of jobs in New Zealand.

While the merger is off (temporarily?), the demutualisation of the New Zealand Stock Exchange (which means that the shares in it can be bought and sold) means it is vulnerable to a takeover from, say, the Sydney exchange. Should any merger be allowed? The merits are those of establishing a stock exchange in the first place – it is easier to raise capital for risky ventures The short answer is it will happen anyway. Given the international networks, New Zealand firms will register offshore to get better trading of their stocks. The loss of sovereignty comes not from a merger, but the technological changes which make it possible. Should we worry? This may be the first time that an important natural monopoly will move offshore, so of course we should worry – even more than we should worry about our inadequate treatment of onshore natural monopolies.

Because of the laws which govern shareholding, company control uses a first-past-the-post principle, where ownership of 50 percent plus 1 share gives absolute authority over the business, including the ability to exploit the remaining shareholders. When Douglas Myers, the richest man in New Zealand, remarked ‘a lot of these old farts were encouraged to put their money into things and lost their dough,’ he did not mention is the dough went to others (often equally old farts).

It is clearly not in the interests of the minority shareholders to be ripped off by the majority. If they think the share market is a jungle, in which the small fry get eaten by lions, they are likely to stay out, investing their savings elsewhere, or in overseas share markets which give them greater protection. If your stockbroker can operate electronically in world markets so can you. This may be to the detriment of New Zealand economy, because New Zealand companies will have less access to capital insofar as they are on a backwater stock exchange. Paradoxically there is more potential for medium sized businesses to suffer from a mismanaged stock exchange than small investors.

Stock exchange rules attempt to balance the divergent interests of the big and small investors. The rules differ from exchange to exchange. New Zealand is one of the least regulated, although in July the government will impose a new code giving the small shareholders protections more like they get in other reputable markets.

In the interim, as we saw in the recent Montana takeover, the rules can be clumsy and applied idiosyncratically. Small shareholders may get trapped into the lion’s den, unable to escape. It is a bit like FPP parliaments. Once the control had passed to a small elite, they did what they liked explaining it was in everyone’s best interests. It did not always seem so (as a number of Montana shareholders will mutter). But it was always in the interests of those in control. (Perhaps the difference is that FPP parliaments does not change as the result of dawn raids. That is the prerogative of military dictatorships and share markets.)

But even if small investors are considered fair game for the biggies, it is not obvious that the law of the jungle is in the interest of New Zealand, although that may be the way the beasts want to run it. It comes back to the inadequacy of public regulation of those natural monopolies. Until that is addressed the New Zealand economy will suffer from monopoly inefficiency.

And while the lions ponce around, roaring and shaking their manes, it is the lionesses who hunt and provide the kill. The lions then muscle in. Real production comes from more than share ownership.