Corporate Finance

The capital market

A capital market is a financial market in which long-term capital is bought and sold, or lent and borrowed. A stock market is a capital market for stocks and shares. A financial market where short term capital is borrowed and lent is a money market.

The role of a stock market for companies is to bring companies and investors together, whereby investors put new long term funds into a company and a company can raise capital for investing in its business. The stock market also has a role of providing a ‘second hand’ market for stocks and shares, whereby investors can sell their stocks or shares if and when they wish to do so. It also makes it possible for other investors to acquire existing stocks or shares in a company.

A readily available ‘second hand’ market gives existing stocks and shares greater liquidity, which makes them very much more attractive as investments
Other roles of a stock market are to enable the owners of a company to realize some of their investment by bringing their hitherto private company to the market; allow companies to take over other companies by issuing new shares as the purchase consideration. Stock market companies can therefore use their market status to finance expansion through acquisitions.

Not all companies seek a stock market quotation for their shares. The reasons for ‘remaining private’ might be:

• insufficient size
• insufficient past trading record
• no requirement for extra capital or rapid growth; adequate private funding
• to avoid burdens of stock market regulations
• to avoid pressures of stock market investors’ expectations for earnings and dividend growth
• to avoid widespread share ownership; to retain ownership in the hands of a few individuals; to avoid takeover threats.

A company can bring its shares to the market for the first time (in a ‘floating’) by means of
(1) an offer for sale
(2) a placing
(3) a prospectus issue
(4) a Stock Exchange introduction.

A company that already has a stock market listing and that now wishes to issue new shares must either

(1) make the issue a rights issue, whereby existing shareholders are invited to sub scribe for all the new shares in proportion to their existing shareholdings; or
(2) obtain prior approval from shareholders for any other method of share issue (for example, to finance a takeover with a share-for-share exchange as the method of compensation)

Rights issues will be unpopular with investors when there are poor prospects for high returns.