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Policy perspectives paper

Investor Protection and the New Zealand Stock Market

Acknowledgements

Max Dupuy has made a major contribution to earlier drafts.  Peer review was undertaken by John McMillan and also by Roger Procter, Bryan Chapple, Geoff Lewis and Nick Davis. Helpful comments have been provided by Justine Gilliland, Sailesh Khandu, Sid Durbin, Kerryn Fowlie and Peter Martin.

Disclaimer

The views, opinions, findings, and conclusions or recommendations expressed in this Policy Perspectives Paper are strictly those of the authors. They do not necessarily reflect the views of the New Zealand Treasury.  The Treasury takes no responsibility for any errors or omissions in, or for the correctness of, the information contained in these Policy Perspectives Papers. The paper is presented not as policy, but to inform and stimulate wider debate.

 

Summary

Some observers have expressed concern that New Zealand’s stock market appears to be underdeveloped relative to many other OECD countries. John McMillan (2004) has speculated that poor investor protection could be an underlying factor. The purpose of this paper is to evaluate evidence regarding the hypothesis put forward by McMillan about the potential link between weak investor protection and stock market development in New Zealand.

I examine two possible measures of stock market development – market capitalisation and ownership concentration of firms. In relation to the first, New Zealand does have a small market capitalisation by international standards. A range of factors could explain this outcome. The regulatory settings around investor protection are one, but only one possible cause. In relation to the second measure, I present updated data on the concentration of ownership of New Zealand firms. The data show that ownership is not particularly concentrated by international standards.

A set of widely-cited international comparisons, produced by La Porta (and various co-authors) in 2000, reckons that New Zealand has relatively strong private protection – that is, rules for disclosure of information, approval of transactions, and access by minority investors to redress in court. However, La Porta’s evidence suggests that New Zealand has lagged other OECD countries in the area of public protection – ie, the capacity of the Securities Commission and the courts to investigate wrongdoing and impose sanctions.

Since 2000 New Zealand has been moving toward stronger public protection and has been bolstering private protection mechanisms. New Zealand policymakers have also been working toward “harmonising” various slices of investor protection with emerging international standards. There is little empirical evidence about the optimal degree (let alone the optimal details) of private and public protection for stock market development. There may be details that it is important to get right in both private and public protection that are not apparent in the type of cross-country study produced by La Porta.

My conclusion is that the available evidence on investor protection and concentration of ownership tends to allay McMillan’s concerns that they have contributed to underdevelopment of the New Zealand stock market. It is therefore more plausible that other factors have constrained the development of New Zealand’s stock market. These factors include: low savings in the form of financial assets; the tax treatment of savings; trans-Tasman integration of capital markets; and the incidence of co-operative ownership and full or partial state ownership of New Zealand firms.

Introduction

Some observers have expressed concern that New Zealand’s stock market appears to be underdeveloped relative to many other OECD countries. John McMillan (2004) has speculated that poor investor protection could be an underlying factor. The purpose of this paper is to evaluate evidence regarding the hypothesis put forward by McMillan about the potential link between weak investor protection and stock market development in New Zealand.

Poor investor protection could potentially be a factor constraining the development of the New Zealand stock market 

In a review of the flexibility of the New Zealand economy, McMillan (2004) gives provisionally good marks in several areas, including turnover of wealth, labour market flexibility, and barriers to firm birth and growth. However, McMillan expresses concern that existing large firms perform poorly and worries there may be barriers to medium-sized firms becoming large. He offers three possible reasons: scarce managerial talent, “smallness of the NZ market” and “financial-market frictions” (p. 164-5). McMillan places particular emphasis on the last of these. In short, after taking a wide lens to review the flexibility of the New Zealand economy, McMillan raises a particular issue: the possibility that poor investor protection may be constraining the development of the stock market. He speculates that protection of the rights of minority shareholders may not be as strong as it appears on the surface, with the result being a poorly capitalised stock market characterised by concentrated ownership.

Cross country studies have been undertaken by La Porta et al into the development of stock markets as a function of the protection of minority rights

McMillan’s discussion echoes four strands of research pursued by economists in various industrialised countries. One strand examines the decision of firms to “go public” as part of the firm lifecycle and transition from small to large (eg, Pagano et al 1998, Kim and Weisbach 2005). A second strand investigates the importance of large firms to the overall productivity of the economy (eg, Pagano and Schivardi 2003). The third strand looks at the links between financial system development and overall economic development (eg, Levine 2002, Claus et al 2004, de Serres et al 2006). The fourth is concerned with explaining the relative development of stock markets around the world as a function of the protection of minority investors (eg, La Porta et al 1998 and 2006, Leahy et al 2001).

The focus of the current paper is on the fourth strand, examining evidence regarding McMillan’s concerns about the adequacy of investor protection and stock market development in New Zealand and look closely at measures of stock market development.

In particular, this paper examines:

  • Two possible measures of stock market development. Firstly, capitalisation of the New Zealand stock market which appears low by international standards. Secondly, updated data on the concentration of ownership of New Zealand firms – an issue that strikes McMillan as a possible symptom of poor investor protection.
  • International measures of private and public investor protection (produced by La Porta and various co-authors) in order to compare New Zealand with other OECD countries in 2000.
  • Some legislative changes affecting investor protection that have been occurring within New Zealand since 2000.

My overall conclusion is that the available evidence tends to allay McMillan’s concerns that poor investor protection could be contributing to underdevelopment of the New Zealand stock market. It is therefore more plausible that other factors have constrained the development of the stock market.

Capitalisation of the New Zealand stock market

McMillan hints that New Zealand’s low market capitalisation may be a sign that “all is not well” with New Zealand’s otherwise apparently strong protection of minority investors(p. 166). Market capitalisation is often used as an indicator of stock market development.[1] This section takes a closer look at interpretations of stock market capitalisation in the case of New Zealand.

New Zealand has low stock market capitalisation compared to Australia and other OECD countries

Figures 1 and 2 confirm that New Zealand has a fairly low capitalisation (measured against GDP), compared to other OECD countries. Australian market capitalisation is currently much higher than New Zealand’s (151% of GDP versus 42% of GDP) as of 2005. As recently as 1994, New Zealand and Australia had the same level of stock market capitalisation (just under 60% of GDP). However, in the second half of the 1990s, Australian capitalisation surged while New Zealand’s shrank.

Figure 1: Stock market capitalisation: OECD countries (1999-2003 average)
Figure 1: Stock market capitalisation: OECD countries (1999-2003 average).
Source: Djankov and La Porta et al (2006).
Figure 2: Stock Market Capitalisation: Australia and New Zealand
Figure 2: Stock Market Capitalisation: Australia and New Zealand.
Source: Calculations, based on data from Statistics New Zealand, Australian Bureau of Statistics and World Federation of Exchanges.

While weak investor protection could explain low stock market capitalisation it is only one of a number of possible factors. For example, savings policies and the tax treatment of savings can influence household holdings of financial assets and therefore stock market capitalisation. Other factors may also have played a part in New Zealand including the integration of trans-Tasman capital markets.

Differences in savings policy and past tax settings could be contributing to low capitalisation

A recent Treasury project[2] shows that differences in saving policy between New Zealand and Australia could be contributing indirectly to the relatively low capitalisation of the New Zealand stock market. An earlier Treasury study by Claus et al (2004) indicated that New Zealand’s past tax treatment of savings (which was unusual compared with practice in other OECD countries) could have constrained market capitalisation.[3]

Some major changes occurred in the Australian financial system in the 1990s which contributed to the surge in the capitalisation of its stock market. These changes included the privatisation of government owned assets and financial deregulation and the introduction in 1991 of compulsory retirement savings (Gizycki and Lowe, 2000). The first two changes, but not the last, also occurred in New Zealand, although there were timing differences. This leaves compulsory retirement savings as a possible explanation for the difference in stock market development between in the two countries.

The recent introduction by the New Zealand Government of the KiwiSaver scheme and reduction in taxation of collective investment vehicles[4] has the potential over time to lead to a marked increase in household saving held in the form of financial assets, including stocks. This is expected to filter through to the stock market gradually increasing capitalisation over a period of time (Cameron et al, 2007).

Low capitalisation could be a reflection of strong links between the New Zealand and Australian economies

Relatively low capitalisation of the New Zealand stock market could also be a reflection of strong links between the New Zealand and Australian economies. There have been numerous cases of acquisitions and mergers resulting in firms with bi-national operations listing in Australia alone. The banking industry is one example. Nearly all banks in New Zealand have parent companies headquartered in Australia that list on the Australian stock exchange.

According to overseas studies on competition and economies of scale in stock markets (eg, Bördlein 2002, Malkamäki 1999 and Ramos 2003), there are strong global forces toward the centralisation of some stock market activities, but there are also opposing forces toward decentralisation.

There are strong global forces towards the centralisation of some stock market functions

Economies of scale and network effects contribute to liquidity and market depth and are the main centralising forces – these are important particularly in relation to the trading function, where information can be standardised and use made of centralised technology. In addition information spillovers between a larger pool of firms and investors can be an additional benefit for New Zealand firms listing in Australia.

Decentralising forces are at play where local information is important

However, decentralising forces are also at play resulting from market-access costs and the need for local information, particularly for new listings where information is more complex and firm-specific requiring personal relationships and trust for effective communication. These forces are important for small and distant countries.

Market access costs appear fairly low for New Zealand firms listing on the Australian stock exchange. Initial listing fees and ongoing fees are comparable between New Zealand and Australia (du Plessis 2005). According to a trans-Tasman agreement in 2006[5], firms now only need one prospectus to issue securities in both countries. However, the localisation of information appears to be an important factor, influencing the ongoing demand for listings on the New Zealand stock exchange, especially for small and medium sized New Zealand firms.[6]

Liquidity shows a stronger connection to long term growth than capitalisation. New Zealand has similar levels of liquidity to other comparable OECD countries

McMillan was concerned that low capitalisation of the New Zealand stock market, could be a problem if it is a reflection of some distortion in the economy, potentially constraining aggregate productivity and growth. However, stock market capitalisation has some limitations as an indicator of economic development. A study by Levine (1997, p.2-3) shows that market liquidity – the ability to buy and sell securities easily - exhibits a stronger connection to long term growth. Based on aggregate measures of liquidity (CRA, 2003)[7] New Zealand’s stock market appears to be characterised by similar levels of liquidity to other directly comparable OECD countries of similar size and economic development. This tends to allay McMillan’s concerns, although liquidity appears to be concentrated in the stocks of large New Zealand firms, while the stocks of small firms have low liquidity.

Notes

  • [1]Although widely used as an indicator of stock market development, market capitalisation has some limitations. There is no one indicator that provides a comprehensive measure of stock market development. In addition to market capitalisation which is an indicator of size, alternative measures include liquidity and returns
  • [2]Refer Cameron, Chapple, Davis, Kousis and Lewis (2007) “Financial markets, saving and investment”.
  • [3]Claus et al (2004) provide a case study of a particular tax policy issue that may have affected the development of New Zealand’s stock market.
  • [4]These measures have moved New Zealand closer to standard OECD practice for the tax treatment of savings.
  • [5]The Trans-Tasman Mutual Recognition of Offers of Securities and Managed Investment Scheme Interests Regime, February 2006, http://www.med.govt.nz/templates/ContentTopicSummary_6277.aspx
  • [6]According to Bördlein (2002) small local stock exchanges in Germany have maintained their position by finding business niches that are not attractive to the large or global players (i.e. by focussing on private investors and small and medium sized firms).
  • [7]This conclusion is based on two aggregate measures of liquidity: the value of domestic market turnover relative to the size of the economy (GDP); and the value traded relative to the size of the market (market capitalisation).

Concentration of ownership

McMillan also worries that “NZ public companies tend not to be widely held.” In addition to low capitalisation, he is uneasy that concentration of ownership may be a sign that the broad measures of regulation are missing something about minority protection. However, a closer look at ownership of New Zealand public firms allays some of these concerns.

Control of large publicly traded firms

Updated ownership data is presented on the degree to which New Zealand firms are “widely held”

I present updated data on the degree to which New Zealand firms are widely held. Specifically, the update is based on the same La Porta et al (1999) concentration measures that McMillan refers to. La Porta classifies publicly traded firms in 27 countries (including New Zealand) as either “widely held” or ultimately owned by one of the following: “family”, “state”, “widely held financial institution”, “widely held corporation” or miscellaneous. This process requires tracing ownership, sometimes through a chain of firms across national borders. The updated assessment is made using data as of 23 June 2006, based chiefly on information from Investment Research Group (IRG) and annual reports.

Consider New Zealand’s largest publicly-traded firm (by capitalisation), Telecom.[8] The largest single shareholder, as of June 2006, was Brandes Investment Partners LP, with a 6.7% stake. La Porta calls any firm with no single shareholder larger than 20% “widely held”.[9] So, the Telecom case is simple: it is widely held. In contrast, the largest shareholder of another large firm, the Warehouse Group, is an individual, S.R. Tindall, who had a 27.5% stake, as of June 2006.[10] Accordingly, this firm falls under the “family owned” category according to the La Porta classification.[11]

La Porta analyses a sample of publicly traded firms, as of end-1995, for each country: the twenty largest firms (by capitalisation), excluding “foreign affiliates” (firms at least 50% owned by a single overseas firm).[12]

Table 1: Control of twenty largest publicly traded firms
Country / Year Widely Held Family State Widely Held
Financial
Widely Held
Corporation
Misc
Australia 1995 0.65 0.05 0.05 0.00 0.25 0.00
OECD Average 1995 0.42 0.26 0.17 0.05 0.05 0.06
NZ 1995 0.30 0.25 0.25 0.00 0.20 0.00
NZ 2006 0.65 0.15 0.10 0.00 0.10 0.00

Source: The 1995 results are from La Porta et al (1999); the 2006 update is based on the author’s calculations.

In the large firm sample, the ownership of New Zealand’s firms was below the OECD average in 1995, but above average in 2006

Table 1 shows La Porta’s 1995 classification of control for the twenty largest publicly traded firms for Australia, the OECD and New Zealand, as well as the update for New Zealand as of 2006. In 1995, New Zealand was below average in the widely held category. However, the updated figures – as of June 2006 – show that the proportion of NZ firms in the “widely held” category has increased from 30% in 1995 to 65% in 2005.

Control of “similar size” publicly traded firms

Another sample compared “similar sized” firms across countries – this is a more appropriate comparison given the fairly small size of New Zealand’s large firms.

In addition, a closer look at the 1995 results reveals a less concentrated picture of New Zealand firms than McMillan suggests. McMillan refers to La Porta’s “large firm” sample, as described above. But one problem – acknowledged by La Porta – is that this compares fairly small New Zealand firms with larger firms in the United States, United Kingdom, Australia and other countries, simply because each of the largest twenty firms in a small country will tend to be smaller than its counterpart in a larger country. To get around this problem, La Porta presents a second sample of firms for each country: the ten firms with capitalisation just above USD500 million, excluding foreign affiliates, banks and utilities (which they say would otherwise dominate the sample). This may be a better comparison for the purpose of evaluating the New Zealand stock market, because it does a better job of comparing similar-sized firms around the world.[13] La Porta calls these “medium firms” although in the case of New Zealand in 1995, these are the seven largest firms on the New Zealand market (ie, there were not even ten firms that fit the criteria in 1995). For this reason, it is perhaps best to refer to this sample comparing “similar size” firms across countries.

Table 2: Control of “similar size” publicly traded firms
Country / Year Widely Held Family State Widely Held
Financial
Widely Held
Corporation
Misc
Australia 1995 0.30 0.50 0.00 0.00 0.20 0.00
OECD Average 1995 0.26 0.41 0.15 0.05 0.04 0.09
NZ 1995 0.57 0.29 0.14 0.00 0.00 0.00
NZ 2006 0.60 0.20 0.10 0.00 0.10 0.00

Source: The 1995 results are from La Porta et al (1999); the 2006 update is based on the author’s calculations.

In the “similar size” sample New Zealand appears less concentrated than most of the OECD in both 1995 and 2006

In this “similar” sample (see Table 2), according to the 1995 La Porta data, New Zealand has a larger percentage of firms (57%) classified as “widely held” than average for the OECD (26%). The New Zealand figure compares favourably to Australia (30%), Canada (60%), and the United Kingdom (60%). That is, New Zealand appears less concentrated than most of the OECD, even for 1995. Updated New Zealand figures are also presented for 2006.[14] These show that the proportion of firms classified as “widely held” in this “similar” size range has remained fairly constant since 1995.

The La Porta classification system may have some limitations for evaluating the effectiveness of the New Zealand stock market.

More generally, the La Porta classification system may not be appropriate for evaluating the effectiveness of the New Zealand stock market. For example, consider what would happen to the classification of the largest New Zealand firms in Tables 1 and 2 if the government decided to float 10 percent of each state-owned firm that is not currently publicly traded. This would clearly be good for market capitalisation and Dickie (2005b) argues that it would be good for the health of the market. However, according to the La Porta classification, such a move would raise the proportion of largest firms classified as “state” at the expense of the “widely held” category (ie, the market would look more concentrated).

Notes

  • [8]Telecom has maintained its position as New Zealand’s largest publicly-traded firm by capitalisation as of October 2007.
  • [9]They also perform the same analysis using a stricter 10% cut-off for widely held firms. In this paper, we retain the 20% cut-off.
  • [10]S.R. Tindall is still the largest shareholder of the Warehouse Group with a stake of 26.7% as of October 2007.
  • [11]La Porta uses the term “family” to cover firms that are owned by individuals as well as actual families. This is because it is often difficult to distinguish the two in practice.
  • [12]For some countries, the sources that La Porta uses to determine ownership structure significantly pre-date 1995.
  • [13]To some extent, this comparison will bias the results in the other direction – ie, in favour of making the New Zealand stock exchange appear relatively widely held. For example, the US firm sample will all be very close in capitalisation to the cut-off (USD500 million) because the large number of firms means a smoother size distribution. In contrast, the NZ sample contains firms significantly larger than USD500 million because the small number of firms on the NZX means that the size distribution is not as smooth.
  • [14]We use the US consumer price index to maintain a constant cut-off in real terms. Thus, our cut-off for 1996 is USD656 million.

International comparisons of investor protection

Two measures of stock market development discussed so far provide mixed evidence for New Zealand. Although there is low market capitalisation, ownership does not appear to be particularly concentrated by international standards. This section explores existing international measures of investor protection. There is not yet a large body of empirical evidence, but new work by La Porta and co-authors provide useful hints about New Zealand’s investor protection relative to other countries.[15]

La Porta makes a useful distinction between two types of investor protection: private and public.

La Porta makes a useful distinction between two types of investor protection: private and public. Private mechanisms are based on standards for information disclosure and transaction approval – and the ability of minority investors to take court action (typically against firm “insiders”, such as controlling stakeholders and managers or their agents) if these standards are not met. Meanwhile, regulators can serve as public protectors of investor rights by investigating actions contrary to minority interests (again on the part of insiders or their agents), issuing and enforcing remedying orders, and sometimes seeking criminal sanctions in court. This section describes La Porta’s international comparisons of investor protection in each of these broad categories and takes a close look at New Zealand’s relative standing.

Private protection

La Porta constructs an index of private protection for a sample of countries, including New Zealand, using a hypothetical example based on “self-dealing”.

La Porta constructs an index of private protection by asking lawyers in a sample of countries (including New Zealand) about a situation in which a hypothetical "Mr. James" arranges a transaction between two firms in which he has a controlling stake (Djankov and La Porta et al 2006).[16] In this hypothetical situation, there is a clear possibility that the controlling shareholder could arrange the transaction to his personal benefit, at the expense of the minority shareholders of one of the firms – a practice known as "self-dealing". The private protection index reflects the requirements applicable to this transaction in each country:

  • Disclosure: How much information does the controlling shareholder have to reveal before the transaction? Does the law require a review by independent accountants or other experts?
  • Approval requirements: Can the controlling shareholder or the board of directors (which may have been elected by the controller) approve the transaction without consulting minority shareholders?
  • Access to redress in court: How easy is it for minority shareholders to prove wrongdoing in court after the transaction? How easy is it for the minority shareholders to convince the court to void the transaction and hold Mr. James liable for damages?
Figure 3: La Porta’s private protection index: OECD Countries (2003)
Figure 3: La Porta’s private protection index: OECD Countries (2003).
Source: Djankov and La Porta et al (2006), “anti-self-dealing index”.

Public protection

La Porta presents a public protection index based on the powers of the regulatory body with responsibility for overseeing the stock market.

Note that none of the components of the private protection index reflect sanctions that might be imposed by a regulator or court on Mr. James for any wrongdoing; as noted above, these measures fall under the rubric of public protection. In a separate paper, La Porta et al (2006) present a public protection index, also based on a set of questions addressed to lawyers around the world, focusing on the powers of the regulatory body (the “supervisor”) with responsibility for overseeing the stock market:

  • Independence and focus: Are there any restrictions on the ability of the central government to fire or hire the chief officers of the supervisory body? Is the supervisor able to focus on stock market regulation alone or is it also responsible for other issues such as the banking sector?
  • Rule making power: Can the supervisor issue regulations regarding primary offerings or stock exchange listings or does this power reside elsewhere (eg, with Parliament)?
  • Investigative power: Does the supervisor have the power to command documents and testimony from controlling shareholders, accountants or other relevant parties?
  • Orders: Does the supervisor have the power to order market participants to undertake corrective action (eg, for insufficient disclosure)? Does the supervisor have the power to impose non-criminal sanctions (eg, fines)?
Figure 4: La Porta’s public protection index: OECD Countries (2000)
Figure 4: La Porta’s public protection index: OECD Countries (2000).
Source: La Porta et al (2006), “public enforcement index”.

La Porta’s public protection index also reflects the stringency and comprehensiveness of criminal sanctions faced by parties found to have violated laws regarding disclosure and approval of transactions.

New Zealand gets a relatively high private protection score and lower public protection score

Figures 3 and 4 show how New Zealand’s index scores compared to other OECD countries. New Zealand gets the highest score for private protection compared to other countries but ranks near the middle of the pack on the public protection index.

Using the criteria outlined above, we can take a look at why New Zealand scores as it does on La Porta’s public index. Keep in mind that La Porta’s numbers are based on the situation in year 2000. Some significant legislative changes have been launched in New Zealand since then, in particular the 2002 Securities Markets and Institutions Bill; the 2006 Securities Legislation Bill and the Review of the Securities Act of 1978 (currently in progress as part of a broader Review of Financial Products and Providers).[17] It is also important to recognise that La Porta’s criteria are inevitably somewhat ad hoc: a different researcher might have set up slightly different criteria. However, the La Porta data is very useful because it allows for reasonably rigorous international comparisons. With those caveats in mind, I make the following observations about New Zealand’s public protection score:

  • Independence and focus: The New Zealand Securities Commission has, since its inception, been closely focused on stock market issues – ie, it does not have responsibility for banking sector supervision as is the case in some other countries. However, La Porta gives the Commission low marks for independence because the government has broad powers to fire and hire Commission members. (Little has changed in this regard since 2000.) However, this is not necessarily cause for concern and may simply be an artefact of a bias in La Porta’s framework. La Porta also gives low marks on supervisory independence to countries with parliamentary systems – notably Canada, Australia, New Zealand and the United Kingdom – while awarding high scores to countries with greater separation between executive and legislative branches of government (eg, the United States, where commissioners are appointed by the president, but approved by the Senate).
  • Rule making power: Unlike its counterparts in Australia, the United States and United Kingdom, the Commission has no power to issue its own rules. Parliament retains full responsibility for rule making. This also has not changed since 2000. But while La Porta gives the Commission low marks on rule making powers, there could be advantages where Parliament has overall responsibility, as it is charged with considering wider community and economic interests other than purely regulation of the securities markets and institutions.
  • Investigative power: La Porta rates the Securities Commission very highly in this area as of 2000 and the Securities Legislation Bill has since updated the Commission’s powers to summon witnesses.
  • Orders: The Commission had very little power in this area as of 2000. The Securities Market and Institutions Bill proposes to give the Commission the power to make a range of orders including prohibition and disclosure orders. The Securities Legislation Bill introduces a further range of banning orders.
  • Criminal sanctions: As of 2000, accountants and brokers could not be held criminally liable in the case of a prospectus (or accompanying financial statements) that is misleading or omits material information. The Securities Legislation Bill introduced criminal sanctions for insider trading, market manipulation offences, and investment advisers that recommend illegal offers of securities. Substantial civil pecuniary penalties were also introduced for misstatements in a registered prospectus. Previously the only remedy was compensation for those who suffered loss.

Notes

  • [15]See Djankov and La Porta et al (2006) and La Porta (2006).
  • [16]La Porta refers to this index as the “anti-self-dealing index” and also frequently uses the term “private enforcement”; I prefer “private protection”.
  • [17]Several background documents are available on the MED website http://www.med.govt.nz/templates/StandardSummary__190.aspx

Recent legislative changes in New Zealand

New Zealand continues to reform the details underpinning public and private protection measures

Meanwhile, New Zealand continues to reform public and private protection measures under the auspices of the legislative initiatives, focussing on the finer details, which it is important to get right. As outlined above, reforms to public protection measures have strengthened the power of the Securities Commission and the courts to investigate wrongdoing and impose sanctions. In relation to private protection, the Securities Markets and Institutions Bill of 2002 introduces a new set of “continuous disclosure” rules that raise the requirements for timely disclosure on the part of issuers and are in line with international best practice. In addition requirements for substantial security holder disclosure have been simplified and disclosure obligations for investment advisors and brokers have been enhanced.

However, there could be some questions around the capability of market players stemming from the small size of the New Zealand stock market. While New Zealand has a high “level” of disclosure there may still be issues around the quality of the disclosure and the experience and ability of investors to interpret the information and make judgements about the risks, taking into account their individual circumstances. This is being considered as part of the wider Review of Financial Products and Providers which is currently still underway.

Implications of the results for New Zealand

Stepping back from the details of the recent reforms, we can ask what these results mean for New Zealand. La Porta et al (2006) and Djankov and La Porta et al (2006) find that countries that have strong private protection mechanisms also tend to have well-developed stock markets, as measured by capitalisation (relative to GDP), concentration of ownership of public companies, and other variables. In contrast, they find that public protection is not strongly correlated with stock market development, although the rule-making power of the supervisor appears to be somewhat important for stock market development in a sub-sample of “rich” countries.

This appears to support a straightforward story with two parts. First, when rights are better protected, investors are willing to pay more for shares, recognising that more of the firm’s profit is likely to come back to them as dividends (rather than being appropriated by the controller or manager of the firm). Second, the cross-country findings suggest that private protections are more important and effective than public protection measures. It could be that private protection matters more in the absence of good public protection in under developed countries, in which case the “rich” country subset may be a more appropriate comparison for New Zealand than La Porta’s overall results[18].

To sum up, the La Porta data show New Zealand as an outlier that bucks this correlation. That is, New Zealand rates well in terms of the private protection measures that seem to matter for stock market development, but nevertheless has a seemingly underdeveloped stock market.

Notes

  • [18]This analysis compares New Zealand against other OECD countries which are in the “rich” country subset.

Conclusion

My conclusion is that the available evidence on investor protection and concentration of ownership tends to allay McMillan’s concerns that they have contributed to underdevelopment of the New Zealand stock market. It is therefore more plausible that other factors have constrained the development of New Zealand’s stock market.

I examined two possible measures of stock market development – market capitalisation and ownership concentration of firms. In the relation to the first, New Zealand does have a small market capitalisation by international standards. A range of factors could explain this outcome. The regulatory settings around investor protection are one, but only one possible cause. Other possible factors include: low savings in the form of financial assets; the tax treatment of savings; trans-Tasman integration of capital markets; and the incidence of co-operative ownership and full or partial state ownership of New Zealand firms.

In relation to the second measure, the paper brings together updated data on the concentration of ownership of New Zealand firms. My analysis suggests that, contrary to McMillan’s concerns, the ownership concentration of New Zealand’s large publicly traded firms has become less concentrated between 1995 and 2006. In addition, a close look suggests that ownership in 1995 was not particularly concentrated by international standards.

There is little consensus among economists around the world about what the “optimal” regime of investor protection would look like. However, La Porta has produced some evidence that allows for comparisons across countries. A close look at these comparisons and recent changes since 2000 that may affect New Zealand’s relative standing indicates that New Zealand’s investor protection measures rate reasonably well in terms of private protection, although it has lagged some OECD countries in the area of public protection. However, it should be emphasised that these conclusions are based on fairly broad abstractions. There may be details that are important to get right in both public and private protection that are not apparent in this type of cross-country study. Since 2000 New Zealand has been moving toward stronger public protection and has been bolstering private protection mechanisms. New Zealand policymakers have also been working toward “harmonising” various slices of investor protection with emerging international standards.

My analysis suggests further reforms to the regulatory settings around investor protection, beyond those measures already in progress, are unlikely to have a significant impact on the development of the New Zealand stock market. Further research and policy measures might usefully focus on other factors that could be constraining development of the stock market.

References

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