Developing Stock Exchanges In Developing Countries

“The whole contractual and legal background was all very good, but the exchange wasn’t, really,” remembers Weber, an assistant professor of management and organizations at the Kellogg School of Management.

Weber, already interested in how financial flows spread across the globe, started looking at the state of stock exchanges in other nations, along with Gerald Davis, a professor at the University of Michigan, and Michael Lounsbury, a professor at the University of Alberta. A number of relatively small, still developing countries had created stock exchanges, starting in the mid-1980s. Between 1980 and 2005, fifty-eight countries created exchanges. The researchers began to wonder what factors—domestic systems, international pressures—differentiated countries that created a stock exchange during those years from those that did not.

Remembering Swaziland’s somewhat lackluster example, however, Weber realized that whether or not a country started a stock exchange was not the whole story. “We thought: Well, it’s nice that these countries all have an exchange, but are they terribly successful?” Exchanges are considered a major player in a country’s economic growth and financial globalization, but little research had examined how stock exchanges in the developing world fared once they were established.

Founding Factors

Weber and his colleagues set out to investigate two questions: What factors predict whether a country started a stock exchange between 1980 and 2005? And, are those same factors related to how successful the exchange is—the number of companies it trades in, the trading volume—later on? The researchers found that a variety of factors predicted that a country would start a stock exchange, including proximity to countries creating an exchange and pressure from global financial institutions like the World Bank and International Monetary Fund (IMF). Exchanges tended to be successful when countries were inspired by their neighbors to create a stock exchange or were working to keep up with competitors, Weber and his colleagues found. But when nations started exchanges due to international pressure, the new systems tended to be adopted only superficially and did not fare as well.

To distinguish the various social factors that might influence a country, Weber and his colleagues turned to organizational research. Companies are constantly influencing each other, both directly, such as when companies do benchmarking to compare themselves to competitors, and indirectly—such as when individual employees switch companies—bringing ideas from one to the other. The same things happen in countries, Weber says. Officials who want to emulate the successful economic policies of a neighboring country, or financial professionals who have global connections, can influence whether or not their country creates an exchange.

Weber and his colleagues categorized social influences into four types often used by researchers studying organizations: coercion, competition, learning, and emulation. By analogy, coercion occurs when a country changes its policies in respond to international pressure. For financial policies, this often happens when the World Bank, IMF, or other global organization provides a country with concessional aid (discounted loans tied to the implementation of particular policies and economic institutions, such as an exchange). Most of the time, however, countries are not forced to change their economic policies; they make changes for themselves based on what they have seen other countries do. Countries keep a close eye on other nations competing for the same expert market, learn from the successes—and mistakes—of other nations’ stock exchanges, and work to emulate the policies of nations with strong economies.

Earlier work “assumed that whether you’re coerced to do it or whether you voluntarily copy or learn from your neighbor would be totally unrelated to how successful the exchange is later,” Weber said. “But we thought that couldn’t be plausible.”

The researchers started with every country that did not have a stock exchange as of 1980, and they looked at whether the country created a stock exchange during the following 25 years and how large the country’s exchange became in subsequent years. They gathered data on the social influence factors at work in each country—whether a country was dependent on international aid, which countries it competed with, how often it adopted policies from nearby nations, what its overall position on the world financial system was—as well as other relevant factors, like a country’s GDP growth and GNP per capita. Then, they compared the 75 countries for which all that data could be found, analyzing what factors predicted whether a stock exchange was founded and how successful it would be.

Weber and his colleagues found, as they expected, that World Bank or IMF involvement in a country greatly increased the chances that the country started a stock exchange. When aid was tied to economic reforms, as it is in many World Bank and IMF programs, the motivation for creating an exchange was strong. But while concessional aid made a country more likely to create a stock exchange, it also meant the exchange was likely to be less successful in the future, with fewer companies traded and smaller market capitalization. “I think it’s an important finding that yes, those processes do happen, but they often lead to more symbolic behaviors in the developing countries, to stock exchanges that are not quite as functional as exchanges created for other reasons,” Weber says. “External pressure doesn’t really give you the best results.”

Looking to the Neighbors

What surprised Weber was how positively interactions with “peers”—in this case, other countries—affected a country’s economic development. The benefits of learning from neighboring countries, emulating successful economies through ties to the international finance community, and even keeping an eye on competitors were two-fold: These influences not only significantly increased the chances that a country would create a stock exchange but also made it more likely the country’s exchange would thrive. “This suggests that what’s important for the vibrancy of the exchange is that the social influence doesn’t stop at the point when the exchange is formally created,” Weber says. Instead, countries are still embedded in the same trade networks, working with the same financial experts.

Many of the economic development programs run by organizations like the World Bank, Weber says, tend to be based on well-defined projects. “There might be a program that creates these financial markets and sets up an exchange, but then after that the program’s done. There’s an evaluation, they check off the boxes—yes, yes, yes—and the people leave. There’s no kind of ongoing exchange of resources after that.” When countries learn from their peers, however, “it enables an ongoing learning process,” he says. “It allows countries to fix some of the mistakes that they’ve made, and it creates a larger community that is committed” to making the exchange a success.

The difference between coercion and peer influence could have important implications for development agencies, Weber says. Instead of focusing on meeting particular goals, organizations like the IMF might better help a country develop its economy by doing what is called capacity building, laying the groundwork that economic reforms need to truly take hold. “The implication from our study is that the way to facilitate those efforts is to create regional infrastructures,” he says, that encourage communication and idea-swapping “amongst countries or regions that have something in common, where there are already close ties, and enable those international networks, rather than have it be a one-on-one relationship between whatever the developing country is and the developed Western countries that created the organization.”

While Weber acknowledges this can be a difficult proposition for development agencies to follow—“Creating a community of learners isn’t a very tangible result, and you don’t get much money for it”—he points out that some agencies are already beginning to lean in that direction, and he hopes his research may bolster the trend. “There’s a growing awareness that this is what makes a difference,” he says.

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