The equity stock market is unique in that it involves ownership. When investing in the bond market, the money market, or other securities issued by an institution to raise funds, the investor does not actually own a piece of the firm they are investing in. Instead, they own the debt, and are entitled to interest payments. With the equity market, investors are not expecting to earn on interest or concerned about repayment of a debt; they are interested in the profits and success of the company for which they own a share in.
Background of Equity Markets
Equities originated as a financing option in Europe during the Renaissance. They provided extra security for investors by offering a stake in the company. Partial ownership was a way to ensure repayment. The first equity markets were short-term; once an enterprise was finished, lenders received their share and were no longer invested in the company. In this way, the first equity investors were only temporary owners, and their involvement in management and making decisions was minimal.
One of the first companies that was owned by shareholders was the Dutch East India Company, started in 1602. The company issued shares to the public, allowing stock investing to fund its business ventures. This started the trend of stock trading and investment, but only on a small scale. The equity stock market became a more practical and universal venture during the Industrial Revolution when companies needed huge amounts of money to build factories and finance needs. Since then, using different equity investment options has been a way for firms to increase their money-raising abilities, and a way for investors to enter into an often high-risk, short-term, and sometimes high-yield market.
Today, with a reputation for being extremely volatile, the equity market is being examined to make sure changes made over the years, as well as in the future, are suited to benefit and attract equity investors. The Security and Exchange Commission is presently reviewing the structure and fairness of the equity market.
The Give and Take in the Equity Market for Firms
Why is the equity market a good thing for businesses? Because it is an alternative to issuing debt. Loans from banks can be expensive, and companies are limited in how much capital they can receive from bank loans. Many investors take advantage of corporate bonds issued by an institution, but the fixed repayment obligation can be tricky for a corporation, especially during down times. Asset-backed securities are also used to raise money, but only so many can be issued depending on available assets. By selling equity, a firm can bring in sufficient capital to fund their needs, without incurring a massive debt. Ultimately, balancing financial needs between debts and equities is ideal.
Although there are many benefits of using the equity market to raise money, there is a negative side as well for firms. With equities, profits are divided among shareholders; the more shareholders own, the more a company has to pay out. Investors who own stock in a company also have some say in how the company is run, and management decisions. This input is minimal, usually reserved to the ability to vote on new directors, but it is a consideration. Also, there is an inherent responsibility of a company to produce short-term earnings for equity investors. This forces a business to focus on the near future, even if looking at the long-term may truly be the smarter method.
The Give and Take for Equity Investors
For equity investors, putting money into the stock market can be a risky investment, but also a lucrative one. As opposed to with bonds or money market instruments, an investor could make a sizable sum overnight. At the same time, great amounts of money can be lost in short periods of time.
An equity investor buys shares of a company, and therefore has a vested interest in the success of that business. They are entitled to dividends, some degree of transparency on the firm’s financial situation, and the ability to vote on directors. There is a huge amount of risk involved in the equity stock market that investors do not have to accept in other markets.
Equities are a tool for investors and businesses to make money, but they are not mediums of guaranteed revenue. Therefore, not only is balance beneficial for firms, but for investors as well. Having a diversified investment strategy is wise for the investor. Harmony between risk, yield, potential, and fixed returns will temper all extremes and improve the likeliness of having a positive investing experience.