The largest share market in Australia is the Australian Stock Exchange (ASX). The ASX was formed in 1987 when the six largest individual exchanges spread around Australia were combined. The ASX provides a regulated environment for investors to buy and sell shares.
Broadly speaking, the role of the share market can be considered from three main perspectives: shareholders, companies and the economy as a whole.
The main reasons for investors to purchase shares are to gain a stake in any company profits and to make capital gains from increases in share prices. As owners of the company, shareholders are entitled to share in the successes of the company. If the company returns a profit, a proportion of these profits will be returned to shareholders. These payments are known as dividends, and are awarded on a per share basis. In addition, as the company grows, the value of the company increases and its share price will also increase. When this occurs, shareholders may decide to sell their share as they will make a profit because they will sell their shares for more than they paid ft them. Such profits are called capital gains. In the decade to June 2007, the total share market value of Australian companies listed on the ASX grew by an average 13 per cent per year to $1.6 trillion.
The share market also allows companies to sell new shares to the public. When a company decides to list itself on the stock exchange it must set about offering its shares to the public for the first time. This process is called a float, or an initial public offering (IPO). Whenever people purchase shares in a float they are actually investing in that company. It is often beneficial for a company to float itself to access funds for investment without having to earn these funds as profits or having to borrow them from a financial institution. Additionally, once a company has listed, it can access further equity funds at any time by issuing an approved prospectus for the release of new shares.
Share market values are often an indicator of a country’s economic conditions. Because market prices rise in accordance with new and better economic prospects for companies, rising share prices will generally suggest that the economy is enjoying good conditions. By contrast, an economy that is moving towards recession will have fewer economic opportunities for companies, leading to lower share prices. A downturn or upturn in the share market can be measures by the All Ordinaries Index, which measures changes in the overall value of companies listed on the ASX. In 2007, the Australian share market had recorded several years of consecutive strong growth in share prices, led by mining, energy and finance companies.
The share market has a significant impact on economic activity. We must consider how the share market is likely to affect the overall structure of investment, borrowing and debt across the economy.
One of the most important benefits of the share market is that it encourages more efficient investment in the economy. A healthy share market will encourage individuals to purchase shares with their additional income, as these offer the potential for higher returns, rather than putting money into a bank. A healthy share market also ensures that shares have a much higher liquidity (which means that they can more easily be exchanged for cash), which makes them more desirable. As a result, companies wishing to raise funds can float on the share market, or sell further shares in the company, allowing them to gain access to funds without the prospect of having to pay interest costs on borrowing. In return, investors gain part ownership of the company and the potential for making large financial gains if the company is successful.
Just as the share market gives firms the possibility of raising funds through a float, it also has an impact on the economy by influencing how companies manage their debt. Companies can finance (or pay off) the gap between the funds they have and the funds they need in one of two ways. Debt financing involves borrowing money with the obligation to repay that money (such as a bank loan or issuing a company bond). Alternatively, equity financing involves selling ownership in the company in order to raise funds. When a company is floated, it is engaging in equity financing.
At any given time there are a range of assets in which an investor can invest. These include property, bonds, shares, commodities (like gold and silver) or even cash. Because investors only have a limited amount of funds, they will choose to invest in those assets that appear likely to provide the greatest rewards in the future. When one type of asset is performing well, demand for that asset is likely to increase, raising its price compared with other assets. By contrast, when an asset does not perform well, demand for that asset with fall, lowering its price compared with other asset. Investors often participate in the share market for speculative reasons and shares may be sold quickly after their market price rises. This creates a speculative bubble, in which shares prices are driven by speculation rather than financial performance. In Australia, the bursting of the ‘dot.com’ share price bubble in 2000 saw the Stock Exchange’s IT Index fall by around 60%.
The performance of the share market is closely associated with the business cycle. Despite the similar trends between the level of economic growth and the share price, the relationship between the two is neither simple, nor direct. Rather, it is a two-way relationship: economic conditions influence share prices, but share prices also influence economic conditions. In fact, the share market often amplifies changes in the business cycle. When the market experiences a downturn, it is likely that shareholders will feel less confident about their economic prospects (as their wealth has fallen).
The share market has become an increasingly important part of the operation of the market economy. The share market is an efficient way for companies to raise funds needed for growth, and for individuals or other businesses to gain returns on their surplus funds.
