A market less efficient

But today things look less rosy. Signs of a crisis are emerging amid claims the biggest stock markets are no longer helping companies raise money efficiently. As turmoil reverberates through the eurozone and beyond,and bank lending to small businesses remains stifled,European and US stock markets also seem unable to mobilise the investment in corporate growth and innovation that has in the past created employment for untold millions.

Around the world,academics,policymakers and industry experts are debating whether an abrupt slowdown in companies choosing to list publicly on stock markets in Europe and the US is tied purely to market turmoil or,rather,a sign of longer-term decline in the usefulness of stock markets in developed economies.

In Europe and the US,the number of fresh companies listing,or floating new shares on stock exchanges in initial public offerings,has dropped sharply in the past five years in London,by more than half.

It is a matter of alarm not just for bankers,fund managers and stock exchanges but also for governments. The IPO is no longer performing its classic function of channelling capital to small start-up companies because of its high costs and the insistence of institutions on high liquidity, says Professor John Coffee of Columbia University Law School. There is a need to design alternative capital raising mechanisms for the smaller company that does not have the prospective capitalisation of a Facebook.

In the US,the Securities and Exchange Commission will host a forum to discuss problems with small business capital formation. In the UK,the government is reviewing how well equity markets are serving the economy by facilitating investment.

Stock markets still fulfil two vital functions,says Professor Paul Marsh of the London Business School. First,on the so-called primary market,they match investors with entrepreneurs to finance successive waves of innovation. Then,by providing a forum for trading shares,known as the secondary market,they let investors diversify risk and uncouple time horizons from those of the companies they invest in,he explains.

Yet deep cracks have appeared as the relationship between investors and companies in the biggest markets has fractured. Problems are also emerging in the secondary markets,as competition between exchanges and rivals has spread trading across multiple venues,to the confusion of investors and issuers.

Record numbers of IPOs have been announced and then delayed or withdrawn before completion,says Deal-ogic,the data provider. In the US,34 per cent of companies have dropped plans to list this year. In Europe,the Middle East and Africa,about 45 per cent of IPOs have been launched but failed to list this year.

Prof Marsh says: There is something wrong in IPO land. I think investors are fed up with paying too much for IPOs. There has been a quiet investor strike on price.

The issue goes beyond the recent financial crisis, agrees Sacha Sadan of Legal amp; General Investment Management,who says distrust has built up between companies,the bankers who advise on share floats,and investors. This follows years of awful IPOs that have performed poorly after launch. The changing role of stock markets has been accompanied by a radical change in the business models and priorities of exchanges,which have evolved from mutually owned clubs into listed companies driven by their own shareholders need for returns. There are fears that some have lost sight of their public utility function as platforms for raising capital and,ultimately,helping with job creation.

For many exchanges,the business of attracting flotations has lost its appeal,bringing in little more than initial listings fees. Instead,exchanges especially large ones are diversifying into derivatives and clearing,where margins are higher; and rolling out new technology to attract high-frequency traders.

This worries emerging market exchanges and some smaller western bourses. Ravi Narain,chief executive of the National Stock Exchange of India,says the ties that have long bound exchanges to underlying economies through their roles in facilitating capital raising are beginning to get frayed around the edges in developed economies. Exchanges in these economies are becoming prisoners of low GDP growth,limits to their ability to cut costs,pressure from shareholders seeking higher and higher returns so where do you go?

Bob Press,founder of Trafalgar Capital Advisors,which advises those hoping to list,says there is a dearth of small businesses coming to market in western economies. Many are put off by the rigours and costs involved. Bankers,meanwhile,focus on winning mandates from larger companies. Bigger is easier. They get more protection and higher fees, he says.

A few companies find alternative sources of capital to tide them over. Groupon,a US coupon marketer that floated this month at 20 a share,had privately placed shares with large institutional investors T. Rowe Price,Fidelity and Morgan Stanley Asset Management. But many small companies needing capital will struggle. Bank of England and European Central Bank reports make clear how reluctant banks are to lend to small businesses. Nor can private equity funds and venture capitalists fill the gap as they have in the past.

Dominic Rossi,global chief investment officer at Fidelity Worldwide Investment,says the IPO market will recover,although it will take years not months. However,he concludes that by the time shareholder demand has revived and companies are prepared to brave the rigours of a public listing,stock markets will have shrunk and concentrated.

If so,it will become increasingly difficult for those in the market to claim as they have done for decades that they form the bedrock of the worlds biggest economies.

2011 The Financial Times Limited