Nature and Function of the Stock Exchange of India - Interdisciplinary issues in Indian Commerce | Interdisciplinary Issues in Indian Commerce - B Com PDF Download

Nature and Function of the Stock Exchange of India

There is an extraordinary amount of ignorance and of prejudice born out of ignorance with regard to the nature and functions of stock exchange. As economic development proceeds, the scope for acquisition and ownership of capital by private individuals also grows.

Along with it, the opportunity for stock exchange to render the service of stimulating private savings and channelling such savings into productive investment exists on a vastly great scale. These are services which the stock exchange alone can render efficiently. It is no exaggeration to say that in a modern industrialist society, which recognises the rights of private ownership of capital, stock exchanges are not simply a convenience, they are essential.

In fact, they are the markets which exist to facilitate purchase and sale of securities of companies and the securities or bonds issued by the government in the course of its borrowing operation. As India moves towards globalisation, this tendency is certain to be strengthened.

The task facing the stock exchanges is to devise the means to reach down to the masses, to draw the savings of the man in the street into productive investment, to create conditions in which many millions of little investors in cities, towns and villages will find it possible to make use of the facilities, which have so far been limited to the privileged few. This calls for far-reaching changes, institutional as well as operational.

The stock exchanges in India, thus, have an important role to play in the building of a real shareholders’ democracy. Aim of the stock exchange authorities is to make it as nearly perfect in the social and ethical sense as it is in the economic.

To protect the interests of the investing public, the authorities of the stock exchanges have been increasingly subjecting not only its members to a high degree of discipline, but also those who use its facilities joint stock companies and other bodies in whose stocks and shares it deals.

There are stringent regulations to ensure that directors of joint stock companies keep their shareholders fully informed of the affairs of the company. In fact, some of the conditions that the stock exchange imposes upon companies before their shares are listed are more rigorous and wholesome than the statutory provisions such as those contained in the Companies Act.

Apart from providing a market that mobilises and distributes the nation’s savings, the stock exchange ensures that the flow of savings is utilised for the best purpose from the community’s point of view. ‘Free’ markets are not simply a matter of many buyers and sellers.

If the prices at which stocks and shares change hands are to be ‘fair’ prices, many important conditions must be satisfied. It is the whole vast company of investors, competing with one another as buyers and sellers that decide what the level of security prices shall be.

But the public is prone to sudden swings of hope and fear. If left entirely to itself, it would produce needlessly violent and often quite irrational fluctuations. The professional dealers inside the stock exchange, and those outside who depend upon them, absorb a large part of the stock of these movements. These are valuable activities.

So as to ensure that the investors reap the full benefit of them, they (dealers as well as investors) need to be regulated by a recognised code of conduct. Fair prices and free markets require, above all things, clean dealings both by professionals and by the investors and dealings based upon up- to-date and reliable information, easily accessible to all.

In case the investment markets are not active and free or adequate information were not available promptly and widely, the unscrupulous people would be able to manipulate particular prices for their own ends.

In any of these contingencies, the relative values of securities would no longer be ‘true’ values, so that the relative yields obtainable from them would be mutually distorted. The signposts which, in a well regulated market show the way along which savings ought to move, would point in the wrong directions.

Good businesses would get less, and indifferent or bad businesses more finance than they deserved. The savings of the community would be misdirected and wasted. In addition, some investors would incur losses which they might otherwise have avoided, and others might reap profits which not otherwise could have been made.

Any such unfairness as between one investor and another is obviously undesirable. Not for a moment, however, should it be supposed that this is the most important evil that may flow from distortion of the security markets.

Much more far reaching is the fact that any misdirection of savings forces the whole society to accept a lower standard of living than it could have enjoyed had its resources been rightly used.

Thus a free and active market in stock and shares has become a pre-requisite for the mobilisation and distribution of the nation’s savings on the scale needed to support modern business. The stock exchange by a process of prolonged trial and error, which is by no means complete, has been continuously streamlining its structure to meet these wide and ever growing responsibilities to the public.

The activities of the stock exchange are governed by a recognised code of conduct apart from statutory regulations. Investors, both actual and potential, are provided, through the daily stock exchange price quotations, with an up-to-the minute approval of the present worth of their holdings, in the light of all the influences that affect the position and prospectus of the companies in question.

But the stock market does not determine the health of one company, it merely reflects it. It is thermometer, not the fever. The prices are sometimes distorted by excessive speculation but, by and large, they provide a continuous assessment of the current value of assets, not available to those who invest in houses or land or other assets, not traded on the stock exchange.

In fact, whether the demand for a stock is motivated by income or profits, so long as it is related to a corporation, the prices of the securities markets will play a realistic part in determining the corporation’s ability to raise funds. For those enterprises that must finance externally, the receptivity of the market to their offerings establishes both the volume and cost of capital raised.

For those companies that finance the bulk of their requirements through reinvested earnings, the willingness of stock holders to defer dividends in the expectation of a higher return through capital gains, establishes both the volume and cost of the capital raised.

If a company’s outlook is very promising and buyers bid up the security’s market value, new financing becomes easier whether through external or internal sources the earnings price ratio is reduced, and the cost of capital becomes correspondingly low.

However, the capacity of a business to raise fresh capital for approved purposes by selling shares to the public, and the cost of capital to the borrower, do not depend simply or even mainly, upon the intrinsic merits of the business.

They depend upon the public’s estimate of the investment merits of its shares in comparison with those of other comparable securities. But these relative investment merits are measured very largely by the prices at which the new securities are offered and the comparable existing securities quoted in the market.

More precisely, they are determined by the relative yields, actual or prospective, that can be obtained in interest or dividends on the capital sum that these market prices represent. The cost of a company of raising new capital is not the price at which the new shares are sold to investors, but the effective rate of interest that investors obtain by buying at that.

The ‘price’ of new capital is the interest yield that has to be offered in order to secure it. Other things being equal, investors will readily accept a lower interest yield for a progressive and promising company than they will demand from a slow moving and inefficient one.

Sometimes, to secure the working capital from the banks, individual businessmen, partnerships and corporations provide the stocks and shares of companies as collateral.

Securities which are listed and for which published quotations are readily available make the satisfactory collateral for such short-term loan taken by the industries to serve the purpose of working capital. Industries are therefore, particularly appreciative of the usefulness of collateral value of listed securities. In this respect the stock exchange indirectly helps the industries to secure working capital from the banks.

Expanded business needed permanent finance and could not expand without it. Investors needed ‘liquidity’ the ability to turn their investment into cash at any time and would not invest without it. It was this dilemma that brought the stock exchange into being.

As business (and governments, too, for that matter) could not ordinarily return invested capital, an investor could not get cash for his investment unless he found somebody else who was ready to buy it from him to take over his share in the company’s ‘Joint Stock’, or his holdings of government securities. What was needed was a market for investments. The job of the stock exchange and its members is to satisfy that need to bring the buyers and sellers of investments together, and to make the ‘exchange’ of stock between them as simple and fair a process as possible.

The tremendous important and socially useful service that the stock exchange renders to the industries is with regard to the shifting of the burden of financing from the management to those of the investors. It will be realised more so from the fact that there is always a conflict of motives between the industries and the investors. Industries require long-term finance with the end in view of locking it up in land, buildings, plants, etc.

Investors, on the other hand, have liquidity preference, that is to say they want to get back the money as and when they would need it. In other words, while the industries require permanent finance, the investors can lend it only for a while because the money that they lend to the industries comes from their savings (part of the income not spent presently) which are made for future spending over contingencies. It is not merely the individual investors alone who suffer from the ‘liquidity preference’ complex, institutional investors too have the same motive.

It is generally thought that a stock exchange serves only those who have money to invest and securities to sell. But a stock benefits the whole community in a variety of ways. By enabling producers to raise capital, it indirectly gives employment to millions of people and helps consumers to get the goods needed by them.

Again, all those who save and put their money either in banks or in life insurance, invest in buying shares and securities, are also helped by stock exchanges, because the institutions with which they place their savings avail themselves of the services of the exchanges to invest the money collected by them.

It is evident from the foregoing analysis that the ready liquidity and constant evaluation of assets, together with the wide range of available investments act as a powerful inducement to save and invest and draw the savings of the community into the channels which are expected to be most productive. It would be difficult to find a more effective method of doing this.

In addition, the overall trend of prices and volume of business on the stock exchange serve as an economic barometer which faithfully registers the changing events and opinion about the investment outlook.

Even allowing for the aberrations of speculation, this mirror of the investment scene is one that neither economists nor businessmen nor the government, charged with the formulation of economic policy, can afford to ignore.