Do stock markets serve investors?

One reason for the empire's longevity is its ability to adapt to changing conditions and to have an objective feedback mechanism.

Whenever the government got into trouble, it would establish a Royal Commission made of experts or simply invite a prominent person to head a committee to review what has happened and make recommendations for change.

This was normally independent of the civil service and vested interests.

The best part about such royal or independent inquiry is that there is official deniability — the recommendations are those of the experts and not necessarily those of the government.

If the public liked the recommendations, the government could adopt these and act quickly, whereas if the public did not like the recommendations, the report would quickly be shelved and not acted upon.

In the wake of the current crisis, the British government invited LSE professor John Kay to review the UK equity market and its impact on the governance of UK listed companies.

The report was published on July 23 and has many lessons on the theory and practice of Asian stock markets.

Stock markets play an important role in the economy, by enabling listed companies to raise capital, improve the price discovery of shares, help in risk management at the corporate and national level and also exercise discipline on the corporate governance and performance of listed companies.

The series of crises in stock markets in Asia from 1997-1999, the tech bubble in 2000 and the current crisis from 2007-2011 all questioned whether stock markets perform well in practice.

In advanced markets like London, UK companies hardly raise primary capital through IPOs, since most of the established companies have become cash rich.

Stock market volatility remains very high — with prices crashing up to 50-60 percent from peak to trough in the recent crisis.

The impact on corporate governance has been questionable, because it was discovered that retail investors are too small to influence corporate behavior, and large institutional investors tend to sell out rather than exercise their voting power to change corporate behavior.

Kay's study suggested that short-termism is a fundamental problem in UK equity markets and that the principal reasons are a decline in trust and the misalignment of incentives throughout the equity investment chain.

These underlying trends are reflected in the UK equity market data. British companies are investing less in the real economy, their investments falling from over 13 percent of GDP to less than 10 percent of GDP and their R&D is the lowest compared with U.S., Germany and France.

In fact, new net equity issuance by British listed companies has been negative in the last decade, with IPO new capital offset by share buybacks and acquisition of listed companies by cash.

This is not only because listing costs are high, but also because the total return on listed shares have been disappointing — the FTSE all-share index returned 4.5 percent per annum in the last decade.

The structure of ownership of shares has also changed drastically.

In 2010, the share of retail investors in total UK equity market ownership was only 11.5 percent, compared to 54 percent in 1963.

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