Do Stock Markets Really Fund Fresh Investment? Analysis of France over the Last 20 Years Suggests That the Bourse Is Playing a Bigger Role in the Economy-But the Link to Innovation and Productivity Is More Complex

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During the last two decades of the twentieth century, the stock market seemed to assume a position of much greater importance in many countries in the world. If that trend was particularly striking in the US and the UK, the growing prominence of the equity markets was also evident in countries like France, Italy, Germany and Sweden where the stock market had historically been less prominent. These developments are highlighted by data on the capitalisation of stock markets as a percentage of Gross Domestic Product (GDP)--see Table 1.

Ideally we would like to know what drove these trends and how they affected economic behaviour and performance in the countries in which they emerged. Such an analysis is particularly important in the light of the recent reversals that we have seen in stock markets throughout the world. Did the flurry of stock-market related activity merely reflect a temporary speculative bubble or was it evidence of a long-term structural change that will resume its trajectory in the coming years? To address these questions for a particular country, it is necessary to understand exactly what functions the stock market performed in the corporate economy.

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That is, the identification of the changing functions of the stock market is an important first step in the analysis of the effects of the stock market on the activities and performance of the industrial corporation, and by extension the activities and performance of the economy as a whole.

In principle, according to Lazonick and O'Sullivan (2002), the stock market can perform four distinct roles within the publicly-traded industrial corporation. The stock market mediates the relation between the ownership of corporate shares and control over the allocation of corporate resources. It can do so in quite distinct ways either to encourage fragmentation or consolidation of control over corporations. The stock market also makes it possible for corporations to issue stock for the purpose of raising cash. It also enables a company to use its stock rather than cash as a combination currency for the purpose of merging with or acquiring another company. Finally, the stock market also allows corporations to use their stock as a compensation currency for selected employees.

Conventional wisdom has it that the main function of the stock market is the supply of cash to the industrial corporation to fund its growth. Notwithstanding the theoretical stakes associated with the subject, empirical studies of the role of the stock market as a source of cash for corporate investment are remarkably few. Empirical studies that do speak to the issue such as those by Mayer (1988), moreover, appear to contradict the notion that the stock market is an important source of cash for corporate investment.

Most empirical studies of the economic importance of the stock market rely on proxies for capital raising such as market capitalisation as a percentage of GDP. However, growing market capitalisation does not necessarily imply that portfolio shareholders are funding a wave of new productive investment in the real economy. Rising market capitalisation could be driven primarily by increasing valuations assigned to existing shares rather than the issue of new shares. The possibility of a stark difference in market valuations and real activity is especially likely, of course, when speculative conditions prevail in the equity markets as they did in the late 1990s.

The stock market as a source of cash in France

Certainly commonly-used proxies for stock market activity suggest that significant change has occurred in France, especially in the second half of the 1990s. It is often asserted that the stock market has become much more important as a source of finance for French corporations. The greater availability of equity financing is seen as a particular boon for young, high-growth companies on which the future strength of the French economy will depend. …