Stock exchanges - Part 2


3. Critics and challenges in Stock Exchange Mergers

There are several challenges facing stock exchange mergers, among which, are regulatory and competition law issues. Stock exchange mergers are most likely to have severe impacts on the competition among the stock exchanges. This directly leads to lower quality services or higher fees. These mergers can also induce competitive harm that results into a lower degree of competition in the post-merger market. This lowers the degree of innovation and hinders improvements in exchange services. The burden falls on competition authorities, which must ensure that there is effective and sufficient competition after the consolidation in the stock exchange industry. The development and integration of stock exchanges in the global market purely lies in the soundness and the effectiveness of the regulation. With effective regulation, there is great confidence and the investors are highly attracted, allowing the stock exchanges to grow and interact. However, none of the regulation structure has been suitable to all the countries. The regulatory issues can be either external (compliance with the regulatory requirements of the competent regulatory body or bodies) or internal (compliance with rules of the stock exchange). Regulatory issues have adverse effects on the stock exchange itself and the parties involved in the stock exchange. The issues can also be exteriorized at either national or international level.

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Because of the intensity of home bias, it should be noted that cross-border merger between stock exchanges is not likely to create any competition concerns. Concerning the issue of potential competition between cross-border stock exchanges, liquidity issue makes the establishment of a new stock exchange in the home country of another not likely. Hence, in the absence of any potential or actual competition between cross-border stock exchanges, such mergers are unlikely to raise competition issues, as far as primary listings of companies are concerned.

Despite the benefits associated with stock exchange mergers, it should be known, beyond any reasonable doubt, that such mergers are extremely difficult. Stock exchange mergers and alliances in many cases face a lot of skepticism and resistance, and many of them have failed in the past (Thorwartl 2005). In a stock exchange merger, the expected synergy values may not be realized and the merger may be considered a failure. The reasons behind failed stock exchange mergers are numerous, as the process is riddled with all kinds of problems, ranging from the organizational resistance to loss of customers and key personnel. Some of these reasons are highlighted in the following paragraphs.

Poor strategic fit is most likely to affect stock exchange mergers, especially when the merging markets have strategies and objectives that are very different and conflict against each other. Cultural and social differences may make the synergy values to be very elusive in stock exchange mergers. In the merging process, serious problems are posed by incomplete and inadequate due diligence. Management problems are most likely to derail stock exchange mergers. Integration of two markets requires a very high level of quality management. With little planning and design, the management is most likely to be poor, resulting in implementation failures. Future expectations and over optimism are most likely to induce bad and biased decisions, which hinder the realization of the expected synergies. An overly optimistic forecast or conclusion about a critical issue can lead to a failed merger.

In the merger consider herein (NYSE Euronext and Deutsche Borse), various views have been expressed, from both the US point and the German point. The opinions are different and contrary. The Germans view the merger from a positive side and consider it as “a win-win situation” according to the German press. From the Americans point of view, the merger is a great blow. According to the Global Atlanta, the merger has been greatly criticized by the US, and the U.S. press expresses panic, skepticism, and anger. Stated hereunder are examples of some of these Criticisms.

Peter Morici, in America’s Economic Report-Daily states, “The acquisition by merger of the New York Stock Exchange by Deutsche Borse is bad news for the U.S. economy”.  The merger  favors Deutsche Borse in a 60-40 ratio, which means that it is the dominant party, thus profound negative consequences to the NYSE.  These consequences, according to Morici, include the prestige impact, where the symbol of American capitalism (NYSE) shall be foreign owned, rendering the super power vulnerable. Secondly, the merger shall erode the U.S. primal position in the global equities trading, as pressure shall dictate the move to Europe or cheaper locations in Asia. In addition, the distinction between the NYSE and other exchanges shall blur. Whoever owns the underlying infrastructure shall be the “location” of equities trading. In other word, more and more U.S. equities shall be traded in Europe and other locations, and fewer foreign equities shall be traded in the United States.

David Weidner, on the Wall Street Journal, writes, “Loss of the Big Board to Germans Is a Crime, but Who's Guilty?” Also contained in the news headlines were titles such as “Just Admit It. The Germans Are Taking Over the NYSE”, “What’s in a Name?”, “New York Stock Exchange Could Lose Out in Merger”, “Issue of American Economic Pride”, among others. These articles expressed concerns that NYSE would ultimately fall into the hands of the foreigners, resulting into the loss of the primary symbol of American capitalism.

Despite the surety by both the head of the Deutsche Börse and the New York Stock Exchange that the deal represents a merger of equals, the Americans are not convinced and believe that the superior position of the United States in global trading shall be at risk. This skepticism was also propelled by the fact that there were some previous failed deals between Germany and United States. An example is the merger between the Daimler-Benz AG and the Chrysler Corporation in 1998 with the name DaimlerChrysler Motors Co. LLC. Based on its scale, there were high expectations, however, after only nine years; Daimler sold Chrysler to Cerberus Capital Management. This merger was one of the least successful and the most expensive in the history of auto industry.

Before the merger benefits are realized, regulatory hurdles must first be overcome. The individual stock exchanges must abide by the local government rules when trading in the shares of particular companies, depending on the listing of the companies. Most companies are not eager to list on multiple exchanges that may subject them to securities regulations and bookkeeping nightmares of many countries. European companies list their shares on the exchanges owned by the combined companies. The exchanges are overseen by individual national regulators in Europe, while in US, the SEC oversees the NYSE but have no direct say over Europe. It is therefore not clear whether this shall work in practice as the European Union member states continue to set their own rules for the clearance and settlement of trade. The merger herein could possibly spark a regulatory war over the rules to prevail. Consequently, it may take several years before much of the anticipated synergies are actually realized.

4. History of NYSE Euronext Merger

On May 22, 2006, NYSE Group bid €8 billion in both cash and shares for the Euronext, outbidding the rival offer from the German stock market’s Deutsche Börse (BBC News 2006). Despite the opinion that Deutsche Börse would not raise its bid, on May 23, 2006, it unveiled the bid for a merger for Euronext valuing the exchange at €8.6bn, €600 million higher than the NYSE Group's initial bid (BBC News May 23, 2006). Nevertheless, the NYSE Group and Euronext reached a merger agreement, which was subject to the shareholder vote and subsequently the regulatory approval. The initial response from the United States Securities and Exchange Commission was positive according to the Commission’s chief, with an approval expected by the end of 2007 (Lucchetti, Alistair, and Kara 2006). The resulting firm was tentatively dubbed the NYSE Euronext and would have its headquarter in the New York City. Its European operations and the trading platform would run out of Paris. The NYSE CEO would head the NYSE Euronext and make the merger the world's first global stock market. The market would be continuous in trading of stock over a time span of 21 hours. The two merged exchanges also hoped to add the Milan stock exchange, Borsa Italiana into the grouping. However, on June 23, 2007, the Milan stock exchange was bought by the London Stock Exchange.

On November 15, 2006, Deutsche Börse dropped its bid for Euronext, clearing the major obstacle for the NYSE Euronext transaction. The NYSE Group's stock price run-up in late 2006 boosted the attractiveness of the offering to the Euronext's shareholders. The shareholders of Euronext approved the transaction on December 19, 2006, by 98.2% margin while the 1.8% vote was in favor of the Deutsche Börse offer.  The Euronext’s Chief Executive Officer stated that the transaction was expected to close within three or four months (Lucchetti and Alistair 2006). The regulatory agencies binding the merger gave their approval and on December 20, 2006, the NYSE Group shareholders also gave their approval.

NYSE Group and Euronext merged on 4th April, 2007 and together they formed the first global equities exchange.

5. Liquidity and Volume

For every financial market, liquidity is one of the most important considerations. An economy operates smoothly when the liquidity is adequately provided. To understand what Liquidity is and its effects in the stock market, it is of utmost importance to know its definition.

5.1 Definition of liquidity

Generally, no common definition of liquidity exists; only simple definitions are used in explaining the concept of liquidity. Shen and Starr (2002) define liquidity in a financial market as the ability to absorb smoothly the flow of buying and selling orders. This definition, however, presents liquidity as a one-dimensional variable, which is not the case. Von Wyss (2004), in explaining the properties of liquidity, stresses the fact that liquidity includes the quantity dimension of depth and the price dimension of the spread, which in essence results into the four dimensions of liquidity. According to For Bodie, Kane and Marcus (2004), liquidity is the speed and ease with which an asset can be sold and converted to cash; cash and money market instruments such as Treasury bills are highly liquid assets. Sarr and Lybeck (2002) agree with this definition; however, they perceive a financial asset as liquid when large amounts of the same asset can be easily sold without affecting its price. Wuyts (2007) support the idea of no changes in price, and he describes a market to be liquid when traders can quickly buy and sell large numbers of shares without large changes in price effects. Liquidity can therefore be defined as a key feature of any particular asset that allows it to be easily sold and converted to cash. The four dimensions or the abilities for liquidity that are identified by Sarr and Lybeck (2002), Von Wyss (2004), and Wuyts (2007) are summarized as: Trading Time i.e. the ability to execute transactions immediately without change in price; Tightness i.e. the ability to buy and sell an asset at the same price in the same moment; Depth i.e. the ability to sell or buy a given amount of an asset without change in the quoted price; and  Resiliency i.e. the ability to buy or sell a given amount of an asset with slight influence in the price.

Market depth considers only the volume at the best bid and the prices. On the other hand, resiliency takes into account the elasticity of supply and demand, which is best described by the liquidity ratio or the variance ratio (Chordia, Roll & Subrahmanyam 2001).

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5.2 How liquidity is measured

Liquidity, in itself, is not observable. It is therefore important to understand how it can be measured. Von Wyss (2004) postulates that when assessing the liquidity of a financial market, different measures of liquidity brings forth conflicting results. A good measure must therefore take into account all the dimensions as it captures on different variables in one measure.

Bodie, Kane and Marcus (2004) mention that measuring Liquidity is part of market structure and trading mechanism on stock exchanges affect the liquidity of assets traded on the stock exchange markets, consequently affecting their market value.

The effects of liquidity are vast; one of which is its ultimate effect on the cost of capital. Nielsson (2009), in an attempt to explain the effects of liquidity on the cost of capital, states that the stock is usually harder to sell and the bid-ask spread is typically high when the trading volume is low. The stock is thus less desirable and the price reflects the same. The value of the stock highly depends on its liquidity and, a value gain of 50% can be realized if the most illiquid stocks are raised to the level of the most liquid ones (Chordia and Swaminathan 2000). Stock returns greatly depend on various measures of liquidity, one of which is the turnover. To the firms and the stock exchanges that serve the firms, liquidity is of great concern.

Examined in this project is the future merger between NYSE Euronext and Deutsche Borse. The main aim is to analyze the liquidity and the earnings of both the markets and to give a short-term forecast. Also considered herein is why liquidity and earnings are perfect reasons behind most of the mergers. Most of the previous studies have majorly been focused on theoretical analysis; however, some empirical analysis-based studies also exist. Such studies include Arnold et al. (1999), which analyzes the effects of regional stock exchange mergers on the liquidity and market share of exchanges. The study finds out that merged stock exchanges attract market share from other exchanges and provide narrower bid-ask spreads. The study, however, fails to provide firm heterogeneity analysis. The study by Padilla and Pagano (2005) looks into the effects of harmonization of clearing systems in the Euronext exchanges. The study finds that liquidity among the largest 100 stocks substantially rose. Padilla and Pagano’s study also indicates that the Euronext stock exchange merger gains have been unevenly allocated and the increase in liquidity concentrated among big firms and those with foreign exposure.

Primarily, liquidity is measured by turnover. Turnover is defined as the number of shares traded in a given firm relative to the number of the outstanding shares.

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