Financial Market and The Corporation
Financial markets: Markets in which financial assets are traded.
Financial markets function as both primary and secondary markets for debt and equity securities. The term primary market refers to the original sale of securities by governments and corporations. The secondary markets are those in which these securities are bought and sold after the original sale. Equities are, of course, issued solely by corporations. Debt securities are issued by both governments and corporations. In the discussion that follows, we focus on corporate securities only.
Primary Markets Corporations engage in two types of primary market transactions: public offerings and private placements. A public offering, as the name suggests, involves selling securities to the general public, whereas a private placement is a negotiated sale involving a specific buyer.
By law, public offerings of debt and equity must be registered with the Securities and Exchange Commission (SEC). Registration requires the firm to disclose a great deal of information before selling any securities. The accounting, legal, and selling costs of public offerings can be considerable.
Partly to avoid the various regulatory requirements and the expense of public offerings, debt and equity are often sold privately to large financial institutions such as life insurance companies or mutual funds. Such private placements do not have to be registered with the SEC and do not require the involvement of underwriters (investment banks that specialize in selling securities to the public).
secondary market: There are two kinds of secondary markets: auction markets and dealer markets. Generally speaking, dealers buy and sell for themselves, at their own risk. A car dealer, for example, buys and sells automobiles. In contrast, brokers and agents match buyers and sellers, but they do not actually own the commodity that is bought or sold.
Dealer markets in stocks and long-term debt are called over-the-counter (OTC) markets. OTC is securities market in which trading is almost exclusively done through dealers who buy and sell for their own inventories. Today, a significant fraction of the market for stocks and almost all of the market for long-term debt have no central location; the many dealers are connected electronically.
Auction markets differ from dealer markets in two ways. First, an auction market or exchange has a physical location (like Wall Street). Second, in a dealer market, most of the buying and selling is done by the dealer. The primary purpose of an auction market, on the other hand, is to match those who wish to sell with those who wish to buy.
Trading in Corporate Securities : The equity shares of most of the large firms in the United States trade in organized auction markets. The largest such market is the New York Stock Exchange (NYSE), which accounts for more than 85 percent of all the shares traded in auction markets. Second and third size are the Chicago Stock Exchange (CHX) and the American Stock Exchange (AMEX), respectively.
These are followed by four regional exchanges: the Boston Stock Exchange (BSE), the Cincinnati Stock Exchange (CSE) (which is actually located in Chicago!), the Pacific Stock Exchange (PSE) in Los Angeles, and the Philadelphia Stock Exchange (PHLX).
In addition to the stock exchanges, there is a large OTC market for stocks. In 1971, the National Association of Securities Dealers (NASD) made available to dealers and brokers an electronic quotation system called NASDAQ (NASD Automated Quotation system, pronounced “naz-dak” and now spelled “Nasdaq”). In 1998, NASDAQ and AMEX merged to form a single company, but the two organizations retained their original features.
There are many large and important financial markets outside the United States, of course, and U.S. corporations are increasingly looking to these markets to raise cash. The Tokyo Stock Exchange and the London Stock Exchange (TSE and LSE, respectively) are two well-known examples.
NYSE-Listed Stock: U.S. companies that wish to have their stock listed for trading on the Big Board must apply for the privilege. If the application is approved, the company must pay an initial listing fee. In 2005, this fee was $36,800, plus a per-share change that ranged from $14,750 per million shares for the first 2 million shares, to $1,900 for each million shares above 300 million.
In addition to an initial listing fee, the NYSE assesses an annual listing fee. In 2005, the annual listing fee was $930 per million (subject to a $35,000 minimum fee).
The NYSE has minimum requirements for companies wishing to apply for listing on the Big Board, although the requirements might change form time to time, some example minimum requirements in effect in 2005 included:
- The company’s total number of shareholders must be at least 2,200, and stock trading in the previous six months must have been at least 100,000 shares a month on average.
- At least 1.1 million stock shares must be held in public hands.
- Publicly held shares must have at least $100 million in market value ($60 million for IPOs)
- The company must have aggregate earnings of $10 million before taxes in the previous three years and $2 million pretax earnings in each of the preceding two years.
In the practice, most companies with stock listed on the NYSE easily exceed these minimum listing requirements.
We’ve seen that the primary advantages of the corporate form of organization are that ownership can be transferred more quickly and easily than with other forms and that money can be raised more readily. Both of these advantages are significantly enhanced by the existence of financial markets, and financial markets play an extremely important role in corporate finance.