What is a Stock Exchange and Why Do We Need it?

For a company with humble roots to be listed on the New York Stock Exchange (NYSE) or the Nasdaq exchange feels like a dream come true. It’s a mark of prestige that sets the company apart from most competitors and lends them a VIP status. For one thing, this is because there are certain minimum criteria the company has to meet in order to qualify for a listing. In the case of the NYSE, the company’s shares have to be worth at least $40 million, and they have to show a solid record of profitability in recent years. But beyond this, “A listed company may be perceived as more reliable to counterparties, lenders, and investors”, in the words of Joe Daniels of Nelson Mullins Riley & Scarborough. This, on its own, may make for a significant tailwind as far as the company’s future is concerned.

This doesn’t mean that, once a company celebrates its IPO (initial public offering) and joins the other listed companies on a stock exchange, it can just sit back and enjoy the good life. Along with the heightened prestige comes increased responsibility. The company will now have to prove its positive trajectory to its shareholders on a constant basis, and also gain shareholder consent to implement any changes in its operations. Key decisions can no longer be sought from the mouth of a single, all-powerful CEO because the company has become a democratic entity.

And then there are the costs of going public. The NYSE will charge you at least $150, 000 for the privilege of arranging an IPO for your company. In addition, you’ll have to maintain a robust accounting department from then on, in order to correctly submit you quarterly financial reports to the SEC (Securities and Exchange Commission). Plus, you’ll have to open up your books for the authorities to inspect and might end up receiving a harsh word or two, or even a penalty, if things are not up to scratch. In this way, getting listed on the NYSE is like renting store space in Manhattan’s famous Fifth Avenue, where the sheer prestige of the location may take a retail business far but, in the meantime, they have to pay $2,000 per square foot of shop space every month.

At the end of the day, is it worth it for a company to list its shares on a stock exchange? And while we’re at it, let’s clear up the basics of a stock exchange’s definition. Why do stock exchanges exist in the first place? What does it actually mean to list a company’s shares on a stock exchange?

What is a Stock Exchange?

When you have, on the one hand, lots of people who want to give their savings a chance to grow and, on the other, a company that needs cash to develop itself into something larger, there is a potential marriage to be made. A stock exchange is the venue for this union, (although the technical meaning of “stock exchange” derives from the exchange of money for financial securities, not marriage vows). This is the place where retail traders go to purchase a slice of a company with signs of growth potential. From the company’s perspective, they get the money injection they need to potentially take their business to the next level – from an idea conceived by two friends in a basement somewhere, to a multinational corporation making life-changing products for millions of people.

From the trader’s perspective, the arrangement is a chance to reap returns on their savings that could potentially dwarf anything they would receive through putting them in a savings account. This might come in the form of the appreciation of the stock’s value over a period of years, or in the form of dividends regularly paid out to the shareholder’s bank account.

The stock exchange is, firstly, the venue for the “wedding” between company and shareholder – the IPO – which effectively connects the two parties together for the first time. But, more than that, the stock exchange hosts the ongoing trading in that company’s shares from that point on – offering a home for the new couple to settle down in. Whenever established or prospective shareholders want to increase their holdings in the company, the place to do it is on the stock exchange. And the same goes for those who want to liquidate their shareholdings in order to access hard currency. A stock exchange does the job of matching buyers and sellers for a security and executing the necessary transactions. But how do they do that?

How Do Stock Exchanges Work?

For most of its history, the NYSE has operated in the way that’s familiar to us from the movies: through stockbrokers representing buyers bidding for shares from stockbrokers representing sellers, while frantically darting around on a trading floor. Due to the health concerns associated with the Covid-19 pandemic, the format changed to an entirely electronic one in 2020, which had been the Nasdaq’s modus operandi from the start. As of September 2023, however, there were up to 1,000 people working on the NYSE floor once again.

Another difference between the two biggest exchanges in America is that, while the NYSE pairs buyers with sellers through matching their orders one with the other, the Nasdaq does it by pre-establishing prices through dealers. The most commonly known distinction between the Nasdaq and the NYSE, perhaps, is that the former tends to list companies with an innovative edge, often those in the tech industry, while the latter deals in well-established companies that have been around, in some cases, for decades.

Alibaba: A Case in Point

The Chinese e-commerce company, Alibaba, was started in 1999 and chose to be listed, not in China, but in the USA on the NYSE. Their record-breaking IPO in 2014 raised a whopping $21.8 billion, having priced their shares at $68 apiece. The following day, things got even better for Alibaba when share prices leaped by 36%, helped along by highly bullish trading sentiment. As the months rolled by and 2020 got underway, Alibaba’s positive momentum continued strongly, bringing their share price up to a handsome $300 in October of that year. Looking ahead a year-and-a-half from that time, their market cap was holding at a hefty $292 billion, but their share price had settled down to $108.80.

One thing Alibaba gained from their listing on a US stock exchange was the status of viable competitor to e-commerce giant Amazon in American minds. Traders interested in sinking their money into such a company would now think twice before deciding on Amazon. After looking into the different operations of Alibaba or their management, traders might decide the latter was a better option. In the months following the IPO, this rationale seemed to hold water because many American traders bought shares in Alibaba, and, as a result, the company went from strength to strength. 

For a Chinese company like Alibaba, a US share listing sets them up to more easily acquire another American business. If they were listed on the Honk Kong Stock Exchange, for instance, and made overtures to buy a US company, they would be subject to a thorough examination by US authorities before anything could go through. Overall, it seems that Alibaba’s decision to go for a listing on the NYSE made their brand a lot more prominent in people’s minds, and also opened up new channels for capital and liquidity that weren’t available beforehand.

 Wrapping Things Up

Much like in the case of the retail stores lined up on Fifth Avenue, New York, not every listing on the NYSE or the Nasdaq ends happily for the company concerned. In a survey conducted in 2023, 44 of 72 listed companies were found to be selling their shares for a lower sum than their IPO price. Sometimes it happens that traders give the cold shoulder to a company despite all the name recognition that comes with being listed on a famous stock exchange.

There are also well-known cases of companies that elected to delist their shares from stock exchanges. Twitter, Dell Inc., and Hilton Hotels and Resorts have all decided to make this move in the past. Motivating factors for management can include dissatisfaction with the valuation given their company by the market, or, alternatively, a business plan that seeks to minimize public scrutiny and official oversight. In addition, since the market tends to be quite volatile at times, reacting sharply to news events of various kinds, some companies prefer to avoid public listing and keep things on a stable footing. A company that shies away from listing its shares on a stock exchange would not be barred from raising fresh capital. They could, for instance, raise funds by selling equity through private firms.