EQUITY MARKETS IN ECONOMIES IN TRANSITION

The transition from a state controlled economy to a market economy necessitates the development of an appropriate financial infrastructure. Privatized firms will need funds for modernization and expansion and de novo firms will certainly need more funds than the entrepreneurs can supply by themselves. Because firms will need equity as well as debt funds, a market for equity is absolutely essential. In market economies the availability of true equity prices is important for the establishment of appropriate hurdle rates for capital expenditures and to provide investors with the confidence that they are not being cheated. In economies in transition, the sooner sound equity markets can be established, the sooner there will be sound benchmarks for evaluating enterprises to be privatized. If equity markets are not to become casinos, there must be an appropriate accounting, legal, and regulatory framework. Regulation, however, should be confined to prudential and behavioral matters. Price regulation should be avoided. Market centers should not be operated by self-regulatory organizations. Among the prerequisites of a viable equity market are: an efficient clearing and settlement system, a stable currency, and adequate custodial facilities, in other words, a sound banking system. The new markets should be organized as screen based order-driven systems rather than quote-driven systems. Most of the objections to order-driven systems are myths. Among other things, in a order-driven system the supply of capital available for providing immediacy is greatly enhanced and this is especially important in new markets where firms are not used to making markets.