Chapter 4 The Share Market and the Corporation Websites: www.asic.gov.au www.asx.com.au www.nyse.com Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a McGrath’s Financial Institutions, Instruments and Markets 5e by Viney Slides prepared by Anthony Stanger 4-

The Share Market

and the Corporation

Websites:

www.asic.gov.au

www.asx.com.au

www.nyse.com

Learning Objectives Understand the nature of corporations and reasons for public listing Discuss the role of primary and secondary markets in equity financing Explain the derivatives and interest rate roles of a stock exchange Understand the electronic trading and settlement systems for share market transactions Explain the importance of information flows for share market efficiency Identify the main regulators of the share market Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a McGrath’s Financial Institutions, Instruments and Markets 5e by Viney Slides prepared by Anthony Stanger 4-

Understand the nature of corporations and reasons for public listing

Discuss the role of primary and secondary markets in equity financing

Explain the derivatives and interest rate roles of a stock exchange

Understand the electronic trading and settlement systems for share market transactions

Explain the importance of information flows for share market efficiency

Identify the main regulators of the share market

Chapter Organisation 4.1 The Nature of a Corporation 4.2 The Stock Exchange 4.3 Summary Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a McGrath’s Financial Institutions, Instruments and Markets 5e by Viney Slides prepared by Anthony Stanger 4-

4.1 The Nature of a Corporation

4.2 The Stock Exchange

4.3 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 (SX) Ordinary share The principal form of equity issued by a corporation, which bestows a claim to residual cash flows and ownership and voting rights Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a McGrath’s Financial Institutions, Instruments and Markets 5e by Viney Slides prepared by Anthony Stanger 4-

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 (SX)

Ordinary share

The principal form of equity issued by a corporation, which bestows a claim to residual cash flows and ownership and voting rights

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 T he issue price of shares of a limited liability company Any partly paid portion of shares of a no-liability company Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a McGrath’s Financial Institutions, Instruments and Markets 5e by Viney Slides prepared by Anthony Stanger 4-

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

T he issue price of shares of a limited liability company

Any partly paid portion of shares of a no-liability company

4.1 The Nature of a Corporation (cont.) Advantages of the corporate form Can obtain large amounts of finance for 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 s pecialised management Greater effectiveness in the planning and implementation of strategic decisions Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a McGrath’s Financial Institutions, Instruments and Markets 5e by Viney Slides prepared by Anthony Stanger 4-

Advantages of the corporate form

Can obtain large amounts of finance for 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 s pecialised management

Greater effectiveness in the planning and implementation of strategic decisions

4.1 The Nature of a Corporation (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 Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a McGrath’s Financial Institutions, Instruments and Markets 5e by Viney Slides prepared by Anthony Stanger 4-

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

4.1 The Nature of a Corporation (cont.) Disadvantages of the corporate form Main disadvantage arises due to 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) Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a McGrath’s Financial Institutions, Instruments and Markets 5e by Viney Slides prepared by Anthony Stanger 4-

Disadvantages of the corporate form

Main disadvantage arises due to 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)

4.1 The Nature of a Corporation (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 Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a McGrath’s Financial Institutions, Instruments and Markets 5e by Viney Slides prepared by Anthony Stanger 4-

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

Chapter Organisation 4.1 The Nature of a Corporation 4.2 The Stock Exchange 4.3 Summary Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a McGrath’s Financial Institutions, Instruments and Markets 5e by Viney Slides prepared by Anthony Stanger 4-

4.1 The Nature of a Corporation

4.2 The Stock Exchange

4.3 Summary

4.2 The Stock Exchange (SX) Primary market role Secondary market role Derivative market role Interest rate market role Trading and settlement roles Information role Regulatory role Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a McGrath’s Financial Institutions, Instruments and Markets 5e by Viney Slides prepared by Anthony Stanger 4-

Primary market role

Secondary market role

Derivative market role

Interest rate market role

Trading and settlement roles

Information role

Regulatory role

Primary market role The SX f acilitates the efficient and orderly sale of new financial securities New floats/initial public offerings (IPOs) Initial listing of a corporation on the SX 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 Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a McGrath’s Financial Institutions, Instruments and Markets 5e by Viney Slides prepared by Anthony Stanger 4-

The SX f acilitates the efficient and orderly sale of new financial securities

New floats/initial public offerings (IPOs)

Initial listing of a corporation on the SX

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

Primary market role (cont.) Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a McGrath’s Financial Institutions, Instruments and Markets 5e by Viney Slides prepared by Anthony Stanger 4-

Primary market role (cont.) Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a McGrath’s Financial Institutions, Instruments and Markets 5e by Viney Slides prepared by Anthony Stanger 4-

Secondary market role The SX f acilitates 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 Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a McGrath’s Financial Institutions, Instruments and Markets 5e by Viney Slides prepared by Anthony Stanger 4-

The SX f acilitates 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

Secondary market role (cont.) Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a McGrath’s Financial Institutions, Instruments and Markets 5e by Viney Slides prepared by Anthony Stanger 4-

Derivative market role The SX provide s a m arket for trading 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. Fosters 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 Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a McGrath’s Financial Institutions, Instruments and Markets 5e by Viney Slides prepared by Anthony Stanger 4-

The SX provide s a m arket for trading 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. Fosters 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

Derivative market role (cont.) The SX provide s a m arket for trading equity -related derivative products (cont.) Derivatives serve as a R isk management tool (hedge) S peculative instrument Derivatives traded on a SX include Options Warrants Futures contracts Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a McGrath’s Financial Institutions, Instruments and Markets 5e by Viney Slides prepared by Anthony Stanger 4-

The SX provide s a m arket for trading equity -related derivative products (cont.)

Derivatives serve as a

R isk management tool (hedge)

S peculative instrument

Derivatives traded on a SX include

Options

Warrants

Futures contracts

Interest rate market role The listing, quotation and trading of typically longer-term debt instruments on a SX Straight corporate bonds Floating rate notes (FRNs) Convertible notes Preference shares Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a McGrath’s Financial Institutions, Instruments and Markets 5e by Viney Slides prepared by Anthony Stanger 4-

The listing, quotation and trading of typically longer-term debt instruments on a SX

Straight corporate bonds

Floating rate notes (FRNs)

Convertible notes

Preference shares

Interest rate market role (cont.) This role adds value to a debt issue due 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 SX provides access to a wider market Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a McGrath’s Financial Institutions, Instruments and Markets 5e by Viney Slides prepared by Anthony Stanger 4-

This role adds value to a debt issue due 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 SX provides access to a wider market

Trading and settlement roles The ASX uses CLICK XT, an integrated computer-based trading system to trade all listed securities Clients’ orders are executed via computer from the broker’s office Orders are executed in order of time recei ved and the buy/sell price Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a McGrath’s Financial Institutions, Instruments and Markets 5e by Viney Slides prepared by Anthony Stanger 4-

The ASX uses CLICK XT, an integrated computer-based trading system to trade all listed securities

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

Orders are executed in order of time recei ved and the buy/sell price

Trading and settlement roles (cont.) The ASX uses CHESS (Clearing House Electronic Sub - register System) Facilitates the settlement of transactions conducted through CLICK XT S ettlement of t ransactions within 3 days (T + 3) Provides an electronic sub-register that records the ownership of listed securities Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a McGrath’s Financial Institutions, Instruments and Markets 5e by Viney Slides prepared by Anthony Stanger 4-

The ASX uses CHESS (Clearing House Electronic Sub - register System)

Facilitates the settlement of transactions conducted through CLICK XT

S ettlement of t ransactions within 3 days (T + 3)

Provides an electronic sub-register that records the ownership of listed securities

Trading and settlement roles (cont.) CDI ( CHESS Depositary Interest) Electronic depositary receipts issued by the ASX representing uncertificated (scriptless) securities CUFS (CHESS Unit Foreign Securities) for equity securities DI (Depositary Interest) for debt and bearer securities Overcomes problems of countries not recognising uncertificated holdings or the electronic transfer of legal title Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a McGrath’s Financial Institutions, Instruments and Markets 5e by Viney Slides prepared by Anthony Stanger 4-

CDI ( CHESS Depositary Interest)

Electronic depositary receipts issued by the ASX representing uncertificated (scriptless) securities

CUFS (CHESS Unit Foreign Securities) for equity securities

DI (Depositary Interest) for debt and bearer securities

Overcomes problems of countries not recognising uncertificated holdings or the electronic transfer of legal title

Information role Investor confidence in the Australian Stock Exchange (ASX) relies on informational efficiency The current share prices should reflect all information available in the market The ASX has a critical role in facilitating the flow of information to the market Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a McGrath’s Financial Institutions, Instruments and Markets 5e by Viney Slides prepared by Anthony Stanger 4-

Investor confidence in the Australian Stock Exchange (ASX) relies on informational efficiency

The current share prices should reflect all information available in the market

The ASX has a critical role in facilitating the flow of information to the market

Information role (cont.) Listing rules are SX 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 Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a McGrath’s Financial Institutions, Instruments and Markets 5e by Viney Slides prepared by Anthony Stanger 4-

Listing rules are SX 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 r egulation is to ensure market participants have confidence in the integrity of market operations Two main supervisors in Australia Australian Stock Exchange ( ASX ) Australian Securities and Investment Commission ( ASIC ) Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a McGrath’s Financial Institutions, Instruments and Markets 5e by Viney Slides prepared by Anthony Stanger 4-

The aim of r egulation is to ensure market participants have confidence in the integrity of market operations

Two main supervisors in Australia

Australian Stock Exchange ( ASX )

Australian Securities and Investment Commission ( ASIC )

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 Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a McGrath’s Financial Institutions, Instruments and Markets 5e by Viney Slides prepared by Anthony Stanger 4-

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

Regulatory role (cont.) ASX (cont.) Electronic surveillance systems to monitor trading behaviour of market participants Detect trades that fall outside certain limits C ross-references all trades against information on the relevant company, directors and associated parties The National Guarantee Fund (NFG) compensates investors in the event of failure or misconduct by a stockbroker Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a McGrath’s Financial Institutions, Instruments and Markets 5e by Viney Slides prepared by Anthony Stanger 4-

ASX (cont.)

Electronic surveillance systems to monitor trading behaviour of market participants

Detect trades that fall outside certain limits

C ross-references all trades against information on the relevant company, directors and associated parties

The National Guarantee Fund (NFG) compensates investors in the event of failure or misconduct by a stockbroker

Regulatory role (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 the potential conflict of interests as a publicly listed corporation Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a McGrath’s Financial Institutions, Instruments and Markets 5e by Viney Slides prepared by Anthony Stanger 4-

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 the potential conflict of interests as a publicly listed corporation

Chapter Organisation 4.1 The Nature of a Corporation 4.2 The Stock Exchange 4.3 Summary Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a McGrath’s Financial Institutions, Instruments and Markets 5e by Viney Slides prepared by Anthony Stanger 4-

4.1 The Nature of a Corporation

4.2 The Stock Exchange

4.3 Summary

4.3 Summary Corporate form of organisation has advantages (fundraising and management) and disadvantage of separation of ownership and control The SX 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 Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a McGrath’s Financial Institutions, Instruments and Markets 5e by Viney Slides prepared by Anthony Stanger 4-

Corporate form of organisation has advantages (fundraising and management) and disadvantage of separation of ownership and control

The SX 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