TOC
1. Voting rights and cash-flow rights
The ownership and control of companies are separated. Those who own a company do not necessarily control the company. The shareholder exercises their ownership by electing the board and the board appoints the CEO and senior executives.
equal monetary contribution to a company means equal cash flow rights but not necessarily equal contrl rights.
Companies can have dual class share structure:
- A company has two classes of shares, one is a superior class with more than one votes per share. The other is the inferior class of share with one share one vote.
- Insiders or controlling shareholders control the firm through holding the superior class of shares, while making a small proportion of monetary contribution.
Companies’ share structure can be pyramidal. The ultimate parent company control the subsidiaries through a chain of owenrship, for example
2. Ordinary shares and preference shares
Ordinary shares
Ordinary shares are the basic voting shares of a company’s. Companies issue ordinary shares and preference shares to raise long-term funds. Funds raised by ordinary shares cannot be withdrawn from the company. A shareholder can sell the shares to exit the investment. The secondary market for ordinary shares is important. Ordinary shareholders are the owners of a company who have both the cash-flow rights and the voting rights.
- Voting rights: ordinary shareholders vote on important company issues, e.g. merges and acquisitions, change of company charter, appointing directors, etc.
- Residual claimants: They are entitled to all the profits after paying off all liabilities and preference share dividends.
- They are entitled to receiving dividends. But the amount of dividends is not pre determined. It depends on the board decisions according to the company’s performance and growth.
- They share the upside (price movement) potentials of a company.
Besides, shareholders have limited liabilities to the company’s creditors. They are liable for the company’s debts up to the amount they invested in the company. Limited liabilities encourage investment while unlimited liabilities (in nineteenth century) discourages investment.
Preference shares
Preference shares are long-term equity claims whose dividend payment take priority over the dividend to ordinary shareholders. Preference shareholders usually receive fixed dividends (unlike ordinary shares), but the dividends are not guaranteed (unlike bonds).
Dividends on preference shares are after the payments to creditors and before the dividends to ordinary shareholders. Preference shareholders do not participate in the upside potential of a company and they do not have voting rights.
Comparisons between Ordinary shares and Preference shares
Similarities: they are both issued to raise long-term funds; share holders are both residual claimants; they both can be traded but cannot be withdrawn.
Differences:
- Ordinary shares: Have voting rights; Dividends payment not prioritised and the amount fluctuates.
- Preference shares: Fixed but un-guaranteed dividends (unlike bonds); Dividends paid before the dividends to ordinary shareholders (but after the payments to creditors); Usually do not have voting rights.
3. Overview of global stock markets
Stock market is a market place where companies raise capital and investors trade. It can be organized (stock exchange) or over-the-counter market place.
There is a trend of globalization among the stock exchanges through merges and acquisitions. NASDAQ merged in 2007 with OMX stock exchange, Boston exchange, and Philadelphia exchange. The NYSE merged in 2006 with the Euronext group, and, in 2008, with the American Stock Exchange (AMEX). The London Stock Exchange merged with the Borsa Italiana in 2007.
The London Stock Exchange
London Stock Exchange (LSE) is one of the most active and most established stock exchanges in the world. There were 15 stock exchanges in England and 5 in Scotland in the 19th century. In the 20th century, modern communication technology made distant trading possible, and all stock exchanges consolidated into London.
At the outset, the LSE was membership based. Companies subscribe to membership of the LSE and only members can act as brokers and market makers. The brokers and market makers charge high commission rates and spreads. Foreign companies had no way to become a member of the LSE.
In 1986, the LSE went through a set of dramatic reforms called “The big bang”. During the reform, the LSE began to allow foreign companies to be members, introduced competition among brokers and introduced lower and flexible commission rates. Besides, LSE introduced a screen-based computer trading system. In 2007, LSE listed its shares on the London Stock Exchange. LSE transformed from a membership based organization to a publicly owned firm.
There are a variety of securities traded on the LSE, including Equities UK/International, Exchange traded funds, Investment trusts, Warrants and covered warrants, Eurobonds, Corporate bonds, Local authority bonds, Foreign government bonds, Global depositary receipts, etc.
The LSE has two market sections: The main market (MM) is for the established companies who are usually large and medium sized. The Alternative Investment Market (AIM) is for younger companies who are usually small firms.
4. Primary and Secondary Market
Primary market is where the first time a security is sold while Secondary market is the trading place of existing stocks.
Quote-driven market
The main trading mechanism on the LSE is quote-driven. It is oriented with market maker. There are Bid price, the price at which the market maker is willing to buy. And the Ask price, the price at which the market maker is willing to sell. Generally bid price is lower than ask price and the difference is the bid-ask spread.
Market makers play roles of provide liquidity and set buy and sell prices.
Order-driven market
Nowadays, most stock exchanges also operate order-driven markets, which supplement the quote-driven markets. On order-driven markets, buyers (sellers) input buying (selling) orders into the computer trading system from their terminals. All orders are pooled by a central computer system (called Matched-bargain System or Order Book trading system).
A transaction occurs when a buying price matches selling price. The orders are matched by the central trading system. There is no bid-ask spread in an order-driven market. Therefore, the transaction cost is low. But liquidity can be low compared to a quote-driven market since a market maker is obliged to make a market for a security while on a quote-driven market, no one is obliged.
The Stock Exchange Electronic Trading System (SETs) on LSE is an order-driven system. SETs is the order-driven system for the liquid shares on both the Main Market and the AIM. A typical SETs screen is shown as below
The LSE also operate a number of other trading systems:
- The Stock Exchange Electronic Trading Service-Quotes and Crosses (SETSqx) is for the less liquid shares on both the Main Market and AIM. It combines the order driven mechanism and quote-driven mechanism.
- Stock Exchange Automated Quotation (SEAQ) system. For a number of fixed interest securities on AIM. These securities are normally issued by small, less liquid companies on AIM. A quote-driven non-electrically executable system.
5. Clearing and Settlement
Apart from trading, a stock exchange also performs clearing and settlement.
By clearing, the stock exchange confirms that all parties agree on the number and price of the securities in the transactions. It checks to ensure the buyers have the cash for payment and to ensure the sellers have the securities to deliver. Notify the company registrar of the change of ownership.
Settlement is the official transfer of ownership, it is done at , is the date on which the trading occurs.
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