Adam Smith long before, in 1776, argued that joint stock companies deal with other people's money and therefore negligence and profusion will always prevail. Jensen (1989), another celebrated financial economist, therefore, predicted 'eclipse of modern corporations'. Small firms, on the contrary, are owned and managed by owners who know their self-interest better than others know it and therefore will protect their interests better than others will do for them.
DEBT VS EQUITY CAPITAL: Pecking order theory of finance suggested that firms always preferred internal to external finance and if they had to use external finance, they would prefer debt and only as a last resort equity finance. Internal source is the least costly, next comes debt capital for its tax advantage, and equity is the last to free it from cash problem.
Over time UK and USA firms have relied less and less on market sources of finance. Contrary to theory and practice around the world, Bangladeshi public limited companies (PLCs) are raising more equity and less debt capital.
DEVELOPMENT BANKS: Development banks have been the key institutions for industrial development and structural change. In 2013, gross loan as a percentage of Gross Domestic Product (GDP) was 13 per cent for China Development Bank (CDB), 10.7 per cent for Brazil's BNDES and 7.0 per cent for Korean Development Bank (KDB). Industrial Development Bank of India (IDBI) became an apex lending institution starting as subsidiary of the Reserve Bank of India (UN 2016). The Bangladesh Development Bank Limited (BDBL) extends financial assistance for setting up industries and provides all kinds of commercial banking services to its customers. Its long-term loans and advances to industries was 55 per cent to 64 per cent of total loans and advances during 2014-15.
STOCK MARKET VOLATILITY: Stock exchange is a company like other companies but its difference with others is that, while other companies deal with products and services, stock exchange deals with shares and papers. Products and services are relatively easier to evaluate but evaluating papers require information, knowledge, competitiveness and transparency, and good national and corporate governance. At the present level of national and corporate governance and market competitiveness, investing in shares and securities is risky. Volatility of share price is very high compared to the volatility of prices of other products and services. NASDAQ Stock Exchange had its index 5063 in 2000 but decreased to 1335 in 2001-2003. Nikkei Stock Exchange's index in mid-1980s was 38000, 25 years later it was less than half of 1980s value. UK's mid-1950s index could not recover the pre-great depression index value. In the developing countries, share prices are more volatile than in the developed countries as their firms do not have a long track record. Price of Dhaka Stock Exchange shares increased 974 per cent from 2005 to 2010.
DOMESTIC MARKET AND SMALL BUSINESSES: In general, countries will have to work towards making their domestic markets more viable and also work on reducing inequalities in their own societies. Only then will they have a social buy-in for global integration.
Global trade is growing less than global growth. Historically, the volume of world merchandise trade has tended to grow about 1.5 times faster than world output, although in the 1990s it grew more than twice as fast. Last year marked the first time since 2001 when this ratio dropped below 1, to a ratio of 0.6:1 (WTO Secretariat). There are high-income countries characterised by small population, less stock market and even with small exports. Many European high-income countries with GDP per capita more than $25,000, have only around 40 stock exchange-listed companies. French big firms are emulating German Mittelstand (small and medium enterprises) for growth, jobs, and exports. Mittelstand has become an ambition (The Economist, October 20, 2012, p.56). The origin of Mittelstand is artisans who flourished in the 19 century. Private firms were in basic industries and capital goods while State built up national champions in nuclear power and aerospace. Medium is beautiful; these firms outperformed small and big firms creating new jobs. USA has 1,97,000 medium-sized firms which earn $10 million to $1.0 billion revenue, employ 40 million people in the country and account for one-third of private-sector GDP. Some 82 per cent of these firms survived the dark years of 2007-10 compared with 57 per cent of small firms. Although the survival rate among the 2100 big firms was 97 per cent they shed 3.7 million jobs during these years, whereas mid-size companies added 2.2 million jobs. Mediums increased employment by 3.8 per cent compared to 2.5 per cent by small and 0.8 per cent by big firms.
DELISTING: Companies evaluate the costs and benefits of listing. Legal fees, accounting and other fees have increased dramatically. There is also less autonomy in conducting business in the sense that sometimes institutional shareholders cut managers' freedom in business decisions. Another factor is the compliance of corporate governance required by the market and regulations which may involve significant costs for a smaller company. Delisting removes the expenses of complying with terms and conditions of listing on the stock exchange. One research studied 380 delisted firms in 1995-2009 of which 155 are voluntarily delisted firms. Owners maintain significant control and probably did not want to keep their firms public indefinitely. In USA, voluntarily delisted firms increased from 23 in 1998 to 436 in 2004.
INVESTMENT IN STOCK MARKET: Employee provident fund's composition of portfolio in 2011 in Sri Lanka was 90.8 per cent in government securities and 9.2 per cent in corporate equity (Central Bank of Sri Lanka, EPF Department). The picture is similar in South Asia. Investment in shares is less than 20 per cent in Denmark (The Telegraph, May 30, 2017). Global pension statistics show that pension fund investments in equity during 2013 were 14 per cent in Thailand, 30 per cent in Australia and Canada, 20 per cent in UK and Netherland, 40 per cent in USA (OECD 2013). In Bangladesh, banks and insurance companies invest in stock market. Bank's investment in stock market can restrict growth of credit to the private sector. Insurance companies invest an average of 20 per cent of total investments in the listed companies whereas the average of UK, USA, Canada and China is 50 per cent.
DEMOCRACY, COMPETITIVE ENVIRONMENT AND STOCK MARKET: Stock market developed more in democracies and competitive environment. The top ten countries with democracy scores of more than 9.01 out of 10 have market capitalisation to GDP ratio higher than 50 whereas the bottom ten countries with democracy scores of 2.07 and less do not have a stock market. Other countries with democracy scores of 2 to 3 have very small stock market - around 5 per cent of GDP, according to Democracy Index 2016 from The Economist Intelligence Unit. The index is based on 60 indicators grouped in five different categories measuring pluralism, civil liberties, and political culture.
Dr. Dhiman Chowdhury is Professor of Accounting at the University of Dhaka.
