Share Market and Corporation

Chapter 4
The share market

and the corporation
Websites:
www.asic.gov.au
www.asx.com.au
www.nyse.com
Copyright  2012 McGraw-Hill Australia Pty Ltd

PPTs to accompany Financial Institutions, Instruments and Markets 7e by Viney and Phillips 4-1
Slides prepared by Peter Phillips
Learning objectives
• Understand the nature of corporations and reasons for
public listing
• Consider the origins and purpose of a stock exchange
• Discuss the role of primary and secondary markets in
equity financing
• Explain the derivatives, managed products and interest
rate market roles of a stock exchange
• Explain the electronic trading and settlement systems
for share market transactions
(cont.)
Learning objectives (cont.)
• Explain the importance of information flows for share
market efficiency
• Identify the main regulators of the share market
• Explain the structure and purpose of the private equity
market

Chapter organisation
4.1 The Nature of a Corporation
4.2 The Stock Exchange
4.3 The Private Equity Market
4.4 Summary

4.1 The nature of a corporation
• Share market
– A formal exchange facilitating the issue, buying and selling
of equity securities
• Publicly listed corporation

– A company whose shares are quoted and traded on a
formal stock exchange
• Ordinary share
– The principal form of equity issued by a corporation, which
bestows a claim to residual cash flows and ownership and
voting rights
(cont.)
4.1 The nature of a corporation (cont.)
• The corporation differs from other business forms
– Ownership claims are widespread and easily transferable
– Owners (shareholders) do not affect the day-to-day affairs of

the company
– Shareholders’ liability is limited to:

▪ the issue price of shares of a limited liability company
▪ any partly paid portion of shares of a no-liability company
(cont.)
• Advantages of the corporate form
– Can obtain large amounts of finance at a relatively cheap

cost
– The liquidity of securities facilitates investor diversification

and encourages investment in corporate securities
– Separation of ownership and control facilitates:

▪ appointment of specialised management
▪ greater effectiveness in the planning and implementation of
strategic decisions
(cont.)
• Advantages of the corporate form (cont.)
– ‘Perpetual succession’—the corporate form is unaffected by

changes in management or ownership
– The corporate form is suited to large-scale operations
(cont.)
• Disadvantages of the corporate form
– Main disadvantage arises from the separation of ownership

and control
▪ Conflict of interest between owners (principals) and managers

(agents) known as the agency problem
▪ Management may try to run business for their own benefit,
rather than that of shareholders, i.e. maximise shareholder
value (share price)
(cont.)
• Disadvantages of the corporate form (cont.)
– Factors moderating conflict of interest between owners and

managers
▪ Investors’ ability to sell shares in a corporation, causing the

share price to fall
▪ Dismissal from the board at AGM by shareholders
▪ Threat of takeover and loss of employment
▪ Use of performance incentives, such as share options
▪ More rigorous corporate governance
(cont.)
• Following the GFC, many corporations were forced to
raise additional capital through the stock market
• This was to ‘sure up’ their balance sheets during the
tough economic environment that followed the crisis
• The advantage of the corporate form is highlighted by
such behaviour
• Smaller firms are not able to access capital as easily
and would normally be expected to pay a higher rate of
return

4.4 Summary

4.2 The stock exchange
• Origins of the modern stock exchange traceable to mid-
16th century England
• Principal functions of a modern and efficient stock
exchange in a globalised market are the provision of:
– markets for a range of financial securities
– securities trading system
– clearing and settlement system
– regulation and monitoring of market integrity
– well-informed market
(cont.)
4.2 The stock exchange (cont.)
• Specifically, the following roles of a stock exchange are
considered:
– Primary market role
– Secondary market role
– Managed Product role
– Derivative market role
– Interest rate market role
– Trading and settlement roles
– Information role
– Regulatory role

Primary market role
• A stock exchange facilitates the efficient and orderly

sale of new financial securities
– New floats/Initial public offerings (IPOs)
▪ Initial listing of a corporation on the stock exchange
– Rights issue
▪ Issue of additional shares to existing shareholders on a pro-
rata basis
– Placements
▪ Issue of new shares to selected institutional investors
– Dividend reinvestment plans
▪ Reinvestment of dividends into corporation for additional
shares
(cont.)
Primary market role (cont.)
(cont.)
Primary market role (cont.)

Secondary market role
• The stock exchange facilitates trading in existing shares

– No new funds are raised by the issuing company
– An active, liquid, well-organised secondary market increases
the appeal of buying new shares in the primary market
– Market liquidity
▪ Ratio of share turnover to market capitalisation
– Market turnover
▪ Number of shares on issue x current share price
(cont.)
Secondary market role (cont.)

Managed product role
• The stock exchange provides a market for trading

managed products
– Equity-based managed products are professionally

managed funds.
– The ‘units’ in these funds are bought and sold on the stock
exchange in the same way as shares in corporations.
– Managed products are described as:

▪ exchange traded funds (ETFs)
▪ real estate investment trusts (REITs)
▪ infrastructure funds

Derivative market role

equity-related derivative products
– A derivative is a financial security that derives its price from

an underlying commodity (e.g. gold) or financial instrument
(e.g. BHP shares)
– Derivative products are described as:

▪ exchange-traded contracts
• standardised financial contracts traded on a formal exchange
▪ over-the-counter contracts
• non-standardised contracts negotiated between writer and buyer
(cont.)
Derivative market role (cont.)

equity-related derivative products (cont.)
– Derivatives serve as a:
▪ risk management tool (hedge)
▪ speculative instrument
– Derivatives traded on a stock exchange include:

▪ options
▪ warrants
▪ futures contracts
▪ Contracts for difference

Interest rate market role
• The listing, quotation and trading of typically longer term

debt instruments on a stock exchange
– Straight corporate bonds

– Floating rate notes (FRNs)
– Convertible notes
– Preference shares
(cont.)
Interest rate market role (cont.)
• This role adds value to a debt issue owing to:
– transparency
▪ information about price, yield, maturity, credit rating of debt
instruments
– ease of entry
▪ electronic trading system facilitates buy and sell orders at
minimum cost and time delay at current market prices
– liquidity
▪ quotation on a stock exchange provides access to a wider
market

Trading and settlement roles
• The Australian Securities Exchange (ASX) uses ASX

Trade and ASX Trade24, which are integrated
computer-based trading systems to trade all listed
securities and derivatives
– Clients’ orders are executed via computer from the broker’s

office
– Orders are executed in order of time received and the

buy/sell price
(cont.)
Trading and settlement roles (cont.)
• The ASX uses CHESS (Clearing House Electronic

Sub-register System)
– Facilitates the settlement of transactions conducted through

ASX Trade
– Settlement of transactions within three days

(T + 3)
– Provides an electronic sub-register that records the

ownership of listed securities
– A CHESS sponsor is a market participant with access to

CHESS, e.g. stockbroker

Information role
• Investor confidence in the ASX relies on informational
efficiency
– The current share prices should reflect all information
available in the market, determined by:
▪ the speed at which new information flows to the market
▪ the speed at which that information is absorbed and reflected in
share prices
• The ASX has a critical role in facilitating the flow of

information to the market
• Corporations Act 2001 (Cwlth) requires information

materially affecting the share price of a listed company
to be immediately given to the ASX
(cont.)
Information role (cont.)
• Listing rules are stock exchange rules with which a

listed entity must comply
• Examples of information disclosures required by ASX

listing rules
– A change in a company’s financial forecasts
– Appointment of a liquidator
– Declaration of a dividend
– Notice of a takeover bid
– Disclosure of directors’ interests

Regulatory role
• The aim of regulation is to ensure market participants

have confidence in the integrity of market operations
• Two main supervisors in Australia
– Australian Securities Exchange (ASX)

– Australian Securities and Investments Commission (ASIC)
(cont.)
Regulatory role (cont.)
• ASX
– Ensures listed companies meet specified limited levels of

performance and standards of information disclosure so
investors can make informed decisions
▪ Continuous disclosure
– Prescribes appropriate behaviour of broker participants on

the exchange
▪ Sanctions include discipline, penalties, loss of licence
(cont.)
• ASX (cont.)
– Electronic surveillance systems to monitor trading behaviour

of market participants
▪ Detect trades that fall outside certain limits
▪ Cross-references all trades against information on the relevant
company, directors and associated parties
(cont.)
• ASIC
– Responsible for the supervision of Corporations Law and

markets in Australia (Corporations Act 2001 (Cwlth))
– Responsible for market integrity and consumer protection

across the financial system, covering investment, insurance
and superannuation products
– Supervises the ASX, addressing potential conflicts of

interest as a publicly listed corporation

4.4 Summary

4.3 The private equity market
• Private equity is an alternative funding source for
companies unable or not wanting to access equity
capital though a public issue
• Source of funds
– Superannuation funds and life insurance offices
• Use of funds
– Startups, business expansion, recovery finance for
distressed companies, management buyouts
– Aim is generally to:
▪ improve profitability sufficiently to realise value though an IPO
▪ break up business to achieve return on investment

4.4 Summary

4.4 Summary
• Corporate form of organisation has advantages
(fundraising and management) and disadvantages
(separation of ownership and control)
• The stock exchange has a number of market roles
– Primary and secondary
– Derivative
– Interest rate
– Trading and settlement
– Information
– Regulatory
• ASX monitors market participants and ASIC supervises
Corporations Law and market integrity


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Chapter 4

The share market

Copyright  2012 McGraw-Hill Australia Pty Ltd

Copyright  2012 McGraw-Hill Australia Pty Ltd

Copyright  2012 McGraw-Hill Australia Pty Ltd

• Publicly listed corporation

– Ownership claims are widespread and easily transferable

– Owners (shareholders) do not affect the day-to-day affairs of

– Shareholders’ liability is limited to:

– Can obtain large amounts of finance at a relatively cheap

– The liquidity of securities facilitates investor diversification

– Separation of ownership and control facilitates:

– ‘Perpetual succession’—the corporate form is unaffected by

– The corporate form is suited to large-scale operations

– Main disadvantage arises from the separation of ownership

▪ Conflict of interest between owners (principals) and managers

– Factors moderating conflict of interest between owners and

▪ Investors’ ability to sell shares in a corporation, causing the

Copyright  2012 McGraw-Hill Australia Pty Ltd

Copyright  2012 McGraw-Hill Australia Pty Ltd

Copyright  2012 McGraw-Hill Australia Pty Ltd

• A stock exchange facilitates the efficient and orderly

Copyright  2012 McGraw-Hill Australia Pty Ltd

• The stock exchange facilitates trading in existing shares

Copyright  2012 McGraw-Hill Australia Pty Ltd

• The stock exchange provides a market for trading

– Equity-based managed products are professionally

– Managed products are described as:

Copyright  2012 McGraw-Hill Australia Pty Ltd

• The stock exchange provides a market for trading

– A derivative is a financial security that derives its price from

– Derivative products are described as:

• The stock exchange provides a market for trading

– Derivatives traded on a stock exchange include:

Copyright  2012 McGraw-Hill Australia Pty Ltd

• The listing, quotation and trading of typically longer term

– Straight corporate bonds

• This role adds value to a debt issue owing to:

Copyright  2012 McGraw-Hill Australia Pty Ltd

• The Australian Securities Exchange (ASX) uses ASX

– Clients’ orders are executed via computer from the broker’s

– Orders are executed in order of time received and the

• The ASX uses CHESS (Clearing House Electronic

– Facilitates the settlement of transactions conducted through

– Settlement of transactions within three days

– Provides an electronic sub-register that records the

– A CHESS sponsor is a market participant with access to

Copyright  2012 McGraw-Hill Australia Pty Ltd

• The ASX has a critical role in facilitating the flow of

• Corporations Act 2001 (Cwlth) requires information

• Listing rules are stock exchange rules with which a

• Examples of information disclosures required by ASX

Copyright  2012 McGraw-Hill Australia Pty Ltd

• The aim of regulation is to ensure market participants

• Two main supervisors in Australia

– Australian Securities Exchange (ASX)

– Ensures listed companies meet specified limited levels of

– Prescribes appropriate behaviour of broker participants on

– Electronic surveillance systems to monitor trading behaviour

– Responsible for the supervision of Corporations Law and

– Responsible for market integrity and consumer protection

– Supervises the ASX, addressing potential conflicts of

Copyright  2012 McGraw-Hill Australia Pty Ltd

Copyright  2012 McGraw-Hill Australia Pty Ltd