The strength of the American and global economy is helping equity markets recover, says John Thain, but companies need to do more to earn investors’ trust
America’s capital markets are the oxygen of our country’s free market economy. They represent more than 35% of the market capitalization of world stockmarkets. By uniting issuers and investors they provide the financial fuel that powers economic growth.
Recently, American stockmarkets have been supported by reductions in tax rates on labour and capital, which have helped to sustain the long-term growth in our equity culture. The number of American shareholders rose sharply from 30 million in 1980 to more than 84 million in 2002. American investors have also increased the holdings of foreign equities in their portfolios from $200 billion in 1990 to more than $2.1 trillion in 2004. The growth and rising liquidity of US equity markets, in turn, have helped to spur the growth of international companies and equity markets overseas and, with them, the expansion of the global economy.
Today, all the elements that traditionally have favoured rising stockmarkets are in place. The US and global economies are enjoying solid, after-inflation growth of approximately 3.75%. Inflation in America is still under 3%, and interest rates remain low by historical standards. Productivity growth is high, and capital spending and corporate profits have been rising at double-digit rates. And more than 2 million jobs have been created since August 2003.
America’s equity markets have responded to the good news, with the Dow Jones Industrial Average rallying from the lows set in October 2002, following a series of setbacks that led to the loss of over $4.4 trillion of equity value.
I believe that the principal challenge facing US equity markets in 2005 is to strengthen further investor confidence and trust. Achieving that goal begins with the recognition that the real genius, power and potential of US capitalism do not reside on Wall Street, but on Main Street and, above all, with the individual investor and entrepreneur.
Collectively, markets, companies, the financial services industry and government regulators must unite in a commitment to strengthen investor confidence. We must set our sights on better governance, increased transparency and disclosure, advancement of shareholder rights, and management of companies and markets that will inspire greater investor trust.
Those of us in positions of leadership in US equity markets must ensure the equitable treatment of all investors. Every investor, whether buying 100 shares or 1 million shares, must be treated equitably and receive the best price and the best value from a trading venue.
Here’s to Sox
As we focus on better governance, let us acknowledge that Sarbanes-Oxley represents an indispensable first step toward this ideal, and also that the great majority of companies are working hard to abide by the legislation. To be sure, many business leaders with whom I have spoken, both in America and abroad, are concerned about the costs of compliance, and are increasingly insistent about the need for tort reform. I have passed on their concerns to our regulators and political leaders in Washington, and underscored the importance of preventing regulation from becoming an undue burden.
Overall, Sarbanes-Oxley and other disclosure requirements are helping to ensure companies have solid governance structures, that corporate financial performance is well audited, and that all relevant facts about companies are disclosed.
At the New York Stock Exchange (NYSE), we have endeavoured to exemplify the spirit and substance of this landmark legislation through a complete restructuring of our governance structure. Our corporate governance overhaul has been guided by three core principles: independence, separation of key functions and transparency. Even before the passage of Sarbanes-Oxley, NYSE developed and began implementing standards for our more than 2,760 listed companies that are among the highest in the securities industry.
Rather than merely helping listed companies to avoid repeating yesterday’s mistakes, we are pushing them to aim for the highest ethical standards in the eyes of the investing public. Research shows that strong standards of governance and transparency are increasingly important investment criteria that lead to improved equity performances, higher valuations and to stronger brands. These benefits, along with natural advantages inherent in the deepest, most efficient and most liquid markets in the world, enhance the value proposition for non-US companies to list in America. Between 1992 and 2004, non-US companies raised more than $370 billion in American equity capital through public and private offerings.
The cost of compliance
Nevertheless, many non-US companies are now questioning whether they want to deal with the costs of compliance with new standards. At the NYSE, our role is to work closely with our listed companies to ensure that they understand – and have the necessary information to comply with – our own governance requirements, and those of Sarbanes-Oxley.
Many companies have now completed their Sarbanes-Oxley certification, without incurring prohibitive costs, and others can learn from their experience. We bring these companies together, providing a platform for them to interact, enabling listed companies to draw on the expertise of other companies and share best practices.
Nevertheless, the reluctance of American investors to return with greater conviction to our equity markets clearly indicates that, while companies have made a good-faith start, important work remains to be done.
Companies must understand that there is a new breed of investor, with new demands. Today, it is individual investors – putting money into 401(k) pensions and into mutual funds and brokerage accounts – who account for up to 80% of the new money coming into our stockmarkets. Most of these people were caught unawares by the wave of corporate scandals. As a result, many have decided to trust their own judgment and, by taking their own initiatives and becoming more entrepreneurial, to rely less on traditional sources of information.
Today’s investors are smarter and more sophisticated; they assemble their own research, most of it web-based; and they know more and pay closer attention than ever before. In addition, they have been energized by the Securities and Exchange Commission and by the NYSE’s empowering them with new opportunities to vote on shareholder issues and to communicate directly with boards.
Companies need to communicate with these investors in clear creative ways. For example, investors might not understand the fine points of the work of an audit committee, or whether the chairman is a member of the nominating committee. However, they do understand that most corporate failures occurred when boards and managements selfishly put their own interests before those of their shareholders.
Investors today want, first, to be assured that a company’s board is truly independent and is meeting its responsibilities. Second, they want to know about a company’s financial health and prospects, and want that vital information to be communicated in plain English. Third, they want assurances that intermediaries and institutions that trade in markets will not be permitted to line their pockets.
Investors will also judge whether a company is merely complying with the new rules, or sincerely striving to create an all-pervading ethos of good governance. Companies that build these bonds of trust around their operations, people and prospects, and make them central to their culture, will be rewarded by investors.
Finally, as US companies conform to the new regulatory regime, it is heartening to see other countries advancing proposals that reflect the goals of Sarbanes-Oxley. However, as long as the regulatory regimes that govern markets remain fragmented, global capital markets will be marred by inefficiencies that will dampen investor confidence. Our foremost challenge, internationally, is to cooperate and collaborate in creating a seamless global market that satisfies different regulators with common disclosure, accounting standards and the highest quality of corporate governance.
That said, I have never been more optimistic about the future of equity markets. We cannot foresee geopolitical events, but the outlook for the US and global economy is brighter than at any time in the past five years. Capital markets continue to perform superbly in bringing together issuers and investors to fund research and development, new products and the most exciting growth prospects for the 21st-century economy. What’s more, everywhere that I travel, and every leader that I meet, in Latin America, across Europe, to India, China and the Pacific Rim, I hear one conviction repeated again and again: that free markets are the future.
And, since free markets are propelled by investor confidence, we must spare no effort to ensure that such confidence is fully restored and strengthened.
John A Thain is chief executive officer of the New York Stock Exchange and was formerly president and chief operating officer of Goldman Sachs. He is co-chair of the World Economic Forum Annual Meeting 2005.