Finance & Accounting Policy Jun 1, 2011

Devel­op­ing Stock Exchanges In Devel­op­ing Countries

The impe­tus for a new stock exchange can deter­mine its fate

Based on the research of

Klaus Weber

Gerald F. Davis

Michael Lounsbury

Klaus Weber was perus­ing the day’s news when an arti­cle on Swazi­land caught his eye. The coun­try had recent­ly estab­lished a stock exchange, in 1990 — but the exchange trad­ed in only two com­pa­nies and had a trad­ing vol­ume of less than $1,000. A Swazi who had pre­vi­ous­ly worked for the World Bank had come home, the arti­cle said, decid­ed his coun­try need­ed a stock exchange, and used his con­sid­er­able exper­tise to set it up. 

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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.

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.

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.

Relat­ed read­ing on Kel­logg Insight

Trust­ing the Stock Mar­ket: Impres­sions influ­ence investors decisions

Sus­tain­abil­i­ty is a Team Effort: Cor­po­rate sus­tain­abil­i­ty works best when employ­ees are stakeholders

Grow­ing Social­ly Respon­si­ble Mar­kets: Grass-fed meat and dairy products

Featured Faculty

Klaus Weber

Professor of Management & Organizations

About the Writer

Valerie Ross is a science and technology writer based in New York, New York.

About the Research

Weber, Klaus, Gerald F. Davis and Michael Lounsbury. 2009. “Policy as Myth and Ceremony? The Global Spread of Stock Markets, 1980-2005.” Academy of Management Journal. 52(6): 1319-1347.

Read the original

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