THE NAIROBI STOCK EXCHANGE

The Stock Exchange is a market that deals in the exchange of securities issued by public quoted companies and the Government.

The major role that the stock exchange has played, and continues to play in many economies is that it promotes a culture of saving. The very fact that institutions exist where savers can safely invest their money and in addition earn a return, is an incentive to people to consume less and save more.

Secondly, the stock exchange assists in the transfer of savings to investment in productive enterprises as an alternative to keeping the savings idle. It should be appreciated that in as much as an economy can have savings, the lack of established mechanisms for channeling those savings into activities that create wealth would lead to misallocation or waste of those savings. Therefore, even if a culture of saving were to be encouraged, the lack of developed financial markets may lead to economic stagnation.

Thirdly, a robust stock market assists in the rational and efficient allocation of capital, which is a scarce resource. The fact that capital is scarce means systems have to be developed where capital goes to the most deserving user. An efficient stock market sector will have the expertise, the institutions and the means to prioritise access to capital by competing users so that an economy manages to realise maximum output at least cost. This is what economists refer to as the optimum production level. If an economy does not have efficient financial markets, there is always the risk that scarce capital could be channeled to non-productive investments as opposed to productive ones, leading to wastage of resources and economic decline.

Fourthly, stock markets promote higher standards of accounting, resource management and transparency in the management of business. This is because financial markets encourage the separation of owners of capital, on the one hand, from managers of capital, on the other. This separation is important because we recognise that people who have the money may not necessarily have the best business ideas, and people with the best ideas may not have the money. And because the two need each other, the stock exchange becomes the all-important link. To give a practical example, if an entrepreneur has a bright business idea and lacks the money, he can approach the Nairobi Stock Exchange, float shares and raise the capital he needs to turn his idea into a business. The shareholders will then appoint directors and management to run the company on their behalf. This arrangement benefits both parties because the manager of capital, who is the entrepreneur, gets access to capital to turn his idea into a reality, while the owners of capital, who are the shareholders, get a return on their investment without having to report for work at that company.

Fifthly, the stock exchange improves the access to finance of different types of users by providing the flexibility for customisation. This is made possible as the financial sector allows the different users of capital to raise capital in ways that are suited to meeting their specific needs. For example, established companies can raise short term finance through commercial paper; small companies can raise long term capital by selling shares; the Government and even municipal councils can raise funds by floating various types of bonds as an alternative to foreign borrowing.

Sixthly, and very important, is that the stock exchange provides investors with an efficient mechanism to liquidate their investments in securities. The very fact that investors are certain of the possibility of selling out what they hold, as and when they want, is a major incentive for investment as it guarantees mobility of capital in the purchase of assets.

There are many other less general benefits which stock exchanges afford individuals, corporations and even the Government. These include:

1. The growth of related financial services sector e.g. insurance, pension and provident fund schemes which nurture the spirit of savings.
2. The check against flight of capital which takes place because of local inflation and currency depreciation.
3. Encouragement of the divorcement of the owners of capital from the managers of capital; a very important process because owners may not necessarily have the expertise to manage capital investment efficiently.
4. Encouragement of higher standards of accounting, resource management and public disclosure which in turn affords greater efficiency in the process of capital growth.
5. Facilitation of equity financing as opposed to debt financing. Debt financing has been the undoing of many enterprises in both developed and developing countries especially in recessionary periods.
6. Improvement of access to finance for new and smaller companies. This is now possible on the Alternative Investments Market Segment (AIMS). This can also be realized through Venture Capital institutions which are fast becoming key players in financing small businesses.
7. Encouragement of public floatation of private companies which in turn allows greater growth and increase of the supply of assets available for long-term investment.
8. The establishment of an efficient stock market is, therefore, indispensable for any economy that is keen on using scarce capital resources to achieve economic growth.