THE IMPORTANCE OF STOCK EXCHANGES

Stock exchanges perform important roles in national economies. Most importantly, they encourage investment by providing places for buyers and sellers to trade securities. This investment, in turn, enables corporations to obtain funds to expand their businesses.

Corporations issue new securities in what is known as the primary market, usually with the help of investment bankers. The investment bank acquires the initial issue of the new securities from the corporation at a negotiated price and then makes the securities available for its clients and other investors in an initial public offering (IPO). In this primary market, corporations receive the proceeds of security sales. After this initial offering the securities are bought and sold in the secondary market. The corporation is not usually involved in the trading of its stock in the secondary market. Stock exchanges essentially function as secondary markets. By providing investors the opportunity to trade financial instruments, the stock exchanges support the performance of the primary markets. This arrangement makes it easier for corporations to raise the funds that they need to build and expand their businesses.

Although corporations do not directly benefit from secondary market transactions, the managers of a corporation closely monitor the price of the corporation’s stock in secondary markets. One reason for this concern involves the cost of raising new funds for further business expansion. The price of a company’s stock in the secondary market influences the amount of funds that can be raised by issuing additional stock in the primary market.

Corporate managers also pay attention to the price of the company’s stock in secondary markets because it affects the financial wealth of the corporation’s owners—the stockholders. If the price of the stock rises, then the stockholders become wealthier. This is likely to make them happy with the company’s management. Typically, managers own only small amounts of a corporation’s outstanding shares. If the price of the stock declines, the shareholders become less wealthy and are likely to be unhappy with management. If enough shareholders become unhappy, they may move to replace the corporation’s managers. Most corporate managers also receive options to buy company stock at a selected price, so they are motivated to increase the value of the stock in the secondary market.

Stock exchanges encourage investment by providing this secondary market. Stock exchanges also encourage investment in other ways. They protect investors by upholding rules and regulations that ensure buyers will be treated fairly and receive exactly what they pay for. Exchanges also support state-of-the-art technology and the business of brokering. This support helps traders buy and sell securities quickly and efficiently. Of course, being able to sell a security in the secondary market increases the relative safety of investing because investors can unload a stock that may be on the decline or that faces an uncertain future.