When we think of capital, a few things come to mind. We think of a one-off investment, the means of production, or high finance such as Wall Street. We think of the capitalist, who in today’s economy is seen as the suited extractor of wealth.
Stock markets, underpinned by international exchanges, are good examples of open capital markets. Capital markets implies that buyers and sellers trade to determine a market price for a security. The openness of markets is important in attracting capital from outside of geographic locations, providing better information to investors, and allowing investors to instantly value their shares.
We don’t often think of the value created by open markets. We take it for granted in this day and age that the medium of exchange is in and of itself a tool of wealth creation.
Investment Capital is a Closed Marketplace
Closed markets rely on different mechanisms to arrive at a firm’s value. In closed markets, such as traditional venture capital, investors evaluate firms on a one-off basis that requires the disclosure of all information about the company.
Closed markets encourage risk aversion. Investors choose deals with indicators of a sure return i.e. the founder has already successfully exited a firm, a customer base has been procured, or the firm has other risk mitigating measures in place.
Subsequently in today’s venture capital climate, venture capital is moving to later stage deals to mitigate risk.
Investment capital is a market. Firms seek equity and debt investment. Investment groups evaluate deals, but only invest in a few. The marketplace for capital can seem more complex than other markets i.e. the grocery store, but at heart, it is a marketplace for exchange.
Investment into firms that are considered “privately held” is a closed marketplace. The marketplace of firms accessible by investors spans professional networks or applications for funding submitted in a one-off fashion.
Access to investments across space and time shrinks considerably. The intervals for investment are not regular and anticipated by conducted in a closed manner by firms. The geography of investment is largely based off social networks rather than ongoing information about the firm’s performance.
Inefficiencies of a Closed Marketplace
It is hard to value the efficiencies created by open capital markets at the level of the stock market. While there are certainly improvements needed with respect to Corporate America in terms of management, equality, and nonfinancial measures of value, open capital markets provide transparency and liquidity to the world’s largest firms. We offer a few areas of wealth creation captured by open markets:
- Pricing occurs instantaneously when new information enters the exchange. Information asymmetry plays a large part in risk. If the information is provided regularly in an open and transparent manner, investor risk can be substantially mitigated. Just as successful new investments create wealth, bad investment destroys it. The wealth creation of transparency can be seen as the elimination of unnecessarily bad investments where information asymmetry plays a leading factor in investment loss.
- Investors cannot benefit from the success of open due diligence and analysis strategies. Closed markets also close analyst information exchange about investment strategy.
- Capital flows based on social networks instead of opportunity. Closed capital markets fund white males and subsequently closed markets suffer from a lack of diversity.
Open capital markets across all sectors are important for an economy that is inherently democratic. If there is one thing we relitigate in 2019, let it be the wealth creation potential of open capital markets for all firms, not just publically traded ones.