Why Stock Markets Exist

Fortunes have been made and lost in trading the stock markets, and there are literally trillions of dollars worldwide tied up in securities and trading portfolios. As such, the stock markets are a handy invention for those looking to earn money, and provide a means for pension funds and insurers to generate returns sufficient to keep them in business. But aside from the benefits the stock markets bring to traders, what is their actual purpose, and why do the stock markets even exist in the first place?

The core and utmost function of the stock markets is to provide businesses with a ready source of capital for expansion and inward investment. At the initial issue stage, large companies can raise billions from the markets by selling off equity in the form of shares, supplying it with the funding it needs to finance particular projects or strengthen the company’s books. In times to trouble, companies can turn initially to the stock markets to raise money, even in circumstances where banks and traditional lenders may be unwilling to offer a helping hand. The markets, by virtue of being comprised of a countless number of investors and larger funds, provide the finance in the form of share purchases in the hope that share prices will rise – when they do, shares can be sold to other investors with the difference being locked in as a profit.

In terms of the wider economic benefits of the markets, having such a ready source of capital is a major contributor to the state coffers, encouraging entrepreneurship and providing government with increased resources with which they can reinvest in the form of rising corporate tax receipts as businesses grow in line with their expansion funded by share issues. This can have a dramatic impact on the amount of money a government has to spend, in addition to increasing the capacity for employment within a particular economy (which in turn boosts gross income tax receipts).

Without this vital role played by the markets, Western economies would be far less developed, individuals would be significantly less wealthy than at present and global standards of living would be significantly reduced.

Likewise, the markets also allow governments at a more direct level to raise capital in the form of debentures, which pay a specified rate of return at a specified future date. For governments with vast borrowing requirements, this facility is vital in ensuring schools can afford to open their doors, hospitals can afford to treat new patients, and the state can continue to support those on welfare. Without at all overplaying the role of the markets, the existence of such a facility for raising finance is absolutely critical to the success of government, society and business, and without it life as we know it would be very different.

Aside from their primary capital functions, the stock markets also act as a safeguard for employees, suppliers and other stakeholders in publicly traded companies. The stock market, as a result of listing rules and regulations and in facilitating share trading, permits external, independent corporate governance, effectively ensuring that companies behave in a sensible and positive way, and that the management are kept in check.

Because public companies have to adhere to strict requirements imposed by the stock markets to participate in share trading (read more about share trading), and by virtue of opening up shares to the public (rather than keeping company ownership within a particular clique), businesses have no choice but to run themselves legitimately, to the indirect benefit of those with an interest in their management. That means suppliers can rely moreso on getting paid, employees can rely moreso on fair working conditions, and society can rely on big business to behave itself, or face the wrath of the shareholders at the next AGM.

In addition to simply providing a convenient way for willing traders and large corporations to make money, the markets also play a vital role in business and government, both directly and indirectly, affording ordinary citizens with a good standard of living and having a positive impact on society as a whole – both through acting as a check against unruly corporate behaviour and through providing the investment vital to economic growth and prosperity.