LESSON 2: The Stock Exchange Market: understanding its operations and economic benefits.
In our last lesson, we understood that LIQUIDITY is very important to investors in making their investment decisions. There was the need to create an avenue through which firms can get funds to run their businesses on a long-term basis and at the same time, people who give out their monies to these firms could get the monies back whenever they want. That sounds conflicting if you think about it.
An illustration will help us to understand how the stock market helps to satisfy these conflicting interests.
Assume GHEconomy is a new business that needs capital to implement its ideas. In Ghana, GHEconomy can apply to register as a Public Company limited by shares (henceforth I will simply use the term “pubic company”. Details about the types of companies will be addressed later). This registration will be done at the Registrar General’s Department which is under the Ministry of Justice and Attorney General. The law in Ghana that guides this registration is the Companies Act 1963. (I will not go into the details of the registration now. What we want to understand now is how the stock market works to ensure that the conflicting interest of public companies and investors are met).
Once GHEconomy is registered as a public company it can divide its ownership into units called shares/stocks and present the shares/stocks for sale to the public. There is a slight (not so important) difference between stocks and shares, but for now we will assume they are the same (a reasonable assumption) and use the two terms interchangeably.
Let’s assume GHEconomy divides its ownership into 50 shares, each worth GH₵5. It will then set out to find investors to buy these shares. When a company first sells its shares to the public, Finance experts say the company is doing an Initial Public Offering (IPO).
To make the IPO successful, GHEconomy would contract the services of Investment Bankers who are financial specialists when it comes to issuing new shares (and other securities). The Investment Bankers will help GHEconomy to find quickly, the right individuals and organisations (both individuals and organisations can buy the shares) to buy GHEconomy’s shares.
Now, assume GHEconomy finds five individuals/organisations (namely A, B, C, D, E) to buy their shares, these five entities become the initial shareholders or owners of GHeconomy. The Directors of GHEconomy gives each shareholder a share certificate which is a proof of part-ownership of the company. The extent of their ownership depends on how many shares they bought (Shareholders with larger number of shares have greater ownership rights).
Their purchase of the shares, and hence their ownership, also accords them some rights and privileges which is a discussion in a later section of this series. If the five entities bought all 50 shares, then GHEconomy has GH₵250 worth of share capital which it can use to acquire assets and operate its business.
If you have a good business idea, you could go through this process of registering your business as a public company, marketing the idea to potential investors, and contracting Investment Bankers to help you acquire the needed share capital to activate your idea. Many of the known commercial banks in Ghana have investment banking divisions (just walk to their information desks and make the inquiry).
The share capital GHEconomy accumulates remains with the company forever, so long as the company continues to exist (unless the company decides to buy back its shares from shareholders – another issue for later discussion). The share capital is therefore a long-term capital available to the company to undertake long-term investments.
The question that may pop up at this point is “what happens if any of the initial shareholders wants their money back for an urgent course or are no longer interested in investing in GHEconomy?”. This is where the stock market comes in.
The stock market is a secondary market (the IPO is said to have occurred in the primary market) for trading the shares that GHEconomy (and other companies) have already issued to their very first shareholders. Beyond the fact that trading takes place in a designated location, the stock market is an organization of individuals who come together to provide an institutional setting for the trading of already-issued stocks/shares (in later sections, we will dive into the details of operations on the stock market floor).
For example, if entity “A” (remember “A” is one of the first shareholders of GHEconomy) is no more interested in investing in GHEconomy, he cannot return the shares to GHEconomy and take back his money. His money remains with GHEconomy “forever” to run their business. Instead, what “A” does is to present his shares for sale on the Ghana Stock Exchange (GHEconomy should be listed on the GSE before this can happen – but let’s assume for now that it is listed. We will discuss this in a later section of the series).
All things being equal, “A” can find another entity, say “F”, who is also willing to invest in GHEconomy. “F” buys the shares, pays “A” the value of the shares at that point in time, and “F” becomes the new shareholder in the company after “A” has given “F” the share certificate. “A” ceases to be a shareholder. Whenever “F” wants to end her investment in GHEconomy, she can also go back to the Ghana Stock Exchange to find a buyer and sell the shares she just bought. The ownership or shareholding can therefore keep changing from one person to another but the money for investment remains with the company forever so that it can undertake all the long-term investments which help to develop the economy.
We have presented here, a very basic overview of companies, registration, and stock market operations. We have given simplistic views to some of the issues here in very plain language. Some are easier said than done and some processes involved have been omitted for simplicity. We will be discussing the details in later sections.