BUSINESS WORLD Capital Market Operations in Sierra Leone....How Can Government Benifit Posted by Dr Mohamed Jalloh on Jan 6, 2009, 22:06

A Stock Exchange is actually a component of the Capital Market. The Capital Market is divided into two areas; the Primary Market and the Secondary Market. The Primary Market deals with the trading of new securities. When a company issues securities for the first time (i.e. IPO) , they are traded in the Primary Market through the help of issuing houses , Dealing /Brokerage Firms ,  Investment Bankers and or Underwriters. The acronym IPO stands for Initial Public Offering, which means the first time a company is offering securities to the general public for subscription.  The amount of money raised in the Primary market goes directly to the Issuing Company/Firm to finance its operations.  Once the securities (shares) of a company are in the hands the general public, they can be traded in the Secondary Market to enhance liquidity amongst holders of such financial securities.

Thus, the Secondary Market facilitates the buying and selling of securities that are already in the hands of the general public (investors). The Stock Exchange therefore is an organized financial platform that deals in transactions involving the buying and selling of financial securities in the Secondary Market. In short, the Stock Exchange does the work of a Secondary Market by facilitating a formal trading arrangement for financial securities. In this article, the author will first examine the benefits that a government will derive from having a viable Stock Exchange as well as the implications of non-optimal government tax policies.

How Can the Government Benefit From the Stock Exchange?

The government derives a lot of benefits from the operations of a viable Sock Exchange. First and foremost, the operations of a Stock Exchange help to promote government revenue generation by increasing the tax base. This is because; the Stock Exchange provides an avenue for the financing of companies through the sale of stocks and other class of financial securities which helps to boost private sector growth. Generally, as the private sector grows, there is a huge potential for tax revenue mobilization due to the general increase in income levels. The resultant increase in employment that normally accompanies private sector growth will inevitably increase the tax base of Revenue Authorities as taxable income increases with higher incomes from employments. Thus, the revenue generation ability of a Revenue Authority largely depends on the tax base which in turns depends on the level of employment which determines the income level of the people. The higher the income level of people, the higher the existing tax base and hence the higher the potentials for tax revenue mobilization.

Apart from income tax revenue, government Revenue Authorities also depend on corporation profit taxes as well as various forms of licences levied on corporations. As corporations grow larger and larger owing to the financial mobilization role of a Stock Exchange, the potency for government revenue generation will also be enhanced. Thus, a Stock Exchange can indirectly boost government revenue generation via way of accelerating private sector growth which increases the tax base of the Revenue Authority.

What Are the Revenue Implications of High Taxes?

Government should first endeavour to implement policy measures that will encourage the development of the private sector. By encouraging the development of the privates sector, government increases the chances for high revenue mobilization. For a government to win the mandate of its voters, it must be able to deliver it promises by having the capacity to generate enough revenue so as to meet the needs of the people.  By creating adequate incentives for private sector development through providing adequate tax incentives, the government will create an environment conducive enough to generate adequate revenue that will support its expenditure without having to look for external sources.

As government is desirous of raising more revenue to finance its expenditure through taxation, there is the need to always think of an optimal level of taxation that may not undermine the revenue generation process. When the taxes that government imposed on its citizens are very high, people will naturally attempt to reduce the burden by playing the game of tax avoidance by applying various forms of tax evasion.  Thus, high taxes have the tendency of reducing the tax base through several factors including low level of investment, high tax invasion, trade diversion and the surge in informal activities. By reducing the profit margin of corporations, high taxes reduce investment in the private sector which in turn undermines economic growth.

The increasing unemployment rate that accompanies reductions in private sector investment will not only reduce the tax base of the government but may also increase the crime rate as well as acting as a potential source for political instability. When taxes are very high, the large erosion in profit margins may force many businesses to eventually close down.  This will destroy the tax base of the government Revenue Authority and hence undermines revenue collection efforts. Taxes are like fishing nets, the bigger the holes the fewer the catch and the smaller the holes the bigger the catch.  Thus, for government to increase its tax base and hence its revenue collection, there is need to impose those tax rates that will not undermine the revenue collection efforts of the Revenue Authority. Low revenue collection may arise if taxes are set beyond their optimal levels. Just like the fishing net example, the larger the tax rate the lower the revenue generated from taxes and the smaller the tax rate the bigger the revenue generated. This is because; it takes full compliance to make a tax collection drive successful. 

Thus, when tax rates are very high, never blame a Revenue Authority for non performance because they can only collect from what the people are ready to pay, and people are ready to pay when it is easy to do so.  So the more you make payment difficult for the people the more difficult it takes to collect from them.

How Can Private Individuals Benefit From the Stock Exchange?

People can benefit from the stock Exchange by investing in the securities traded on the floor of the Stock Exchange. Once you buy the shares of companies or other financial securities, then you become an investor. Here, the term investor is used to refer to an individual or an institution that buys the securities (Shares) of a Company with the intent of making some financial returns as an investor; you cannot buy and sell financial securities directly from the Stock Exchange.  If you have some money that you don’t need to spend now, it will be wise to invest it in the Stock Exchange by buying shares from reputable companies so as to get some returns from your idle balances.

In order to buy securities from the Stock Exchange you first need to approach a licensed Stockbroker who is mandated by law to buy and sell securities on the floor of the Exchange. Once you get a licensed Stockbroker, you will instruct him/her to buy for you the shares of any company that you wish to invest in. If for example you want to buy the Shares of Union Trust Bank, or Sierra Rutile, or Africell, you can do so by instructing your Stockbroker(s) to buy for you a given quantity of these shares. If for example you buy the 2,000 Shares of say Union Trust Bank at Le300 .00 (three hundred Leones) per share, then you will spend the sum of Le 600,000 .00 (six hundred thousand Leones) to get the 2,000 Shares.

Now suppose that the price of the Shares that you originally bought for Le 300.00 went up to Le 700.00 per share after holding them for three months.  In that case, the investor makes a profit of Le 400.00 for each share that is now sold at the new price of Le 700.00.  Since the person bought 2,000 shares, his/her total profit will be Le 800,000 ( Eight Hundred Thousand Leones).  However, if he/she had decided to keep his/her money under his/her pillow for three months, he/she would not have been able to make the Le800, 000.00 profit that was realized by buying the Shares at Le 300.00 and selling them later at Le 700.00.  Now, suppose he/she had plenty of money and was able to buy 2,000, 000  (two million ) Shares,  his/her profit would have been  Le 400 .00  X   2,000,000  =  Le800, 000,000 ( Eight  Hundred Million Leones )  after selling the Shares at Le700 .00 each. The amount of profit generated from the buying and selling of Shares depends on both the shares price appreciation over time and the volume of shares traded.  The more one invests on shares that rapidly appreciate with time, the more the profit that accrues to the investor.  Thus, buying the Shares of companies whose share prices appreciate with time will result in investors making huge capital gains. 

Again, if one decided not to sell his/her shares for the time being; he/she can also receive annual dividend payments and bonuses distributed to shareholders of the company. In any case, one stands to benefit from the decision to invest money in the Stock Exchange through the purchase of companies’ securities. However, it should be noted that when share prices fall, investors are likely to make a loss if they decided to sell their shares.  To avoid making a loss when share prices are falling, it is advisable for shareholders to continue holding their shares until prices start to rise again.

How Can Corporations Benefit From the Stock Exchange?

Sometimes, it may be very difficult to raise additional finances to support expansions in the company’s operations. With the Stock Exchange, a company can raise a huge amount of long-term capital by issuing financial securities tradable at the floor of the Exchange. For instance, if a company issues 1,000,000 (one million) shares at the price of Le 1,000.00 (one thousand Leones) per share, the company will be able to mobilize Le 1,000,000,000.00 (One Billion Leones) upon selling all its shares.  If the issue price is increased to  say Le 5,000.00 per share, then the company will mobilize Le 5,000,000,000.00 ( Five Billion Leones ) upon selling the 1,000,000  (one million ) shares to the public. 

This amount can be easily raised by the company to finance its projects through the Stock Exchange without much stress. Alternatively, if a company chooses to raise this amount from a Commercial Bank, it would be required to provide some form of collateral security that may not be easy to get. It may also required a long process of bureaucratic measures that may be time consuming and costly. But with the Stock Exchange, raising capital is less costly and less time consuming. A company will not be required to provide any form of collateral security to raise capital from the Stock Exchange.   

However, any company that wants its securities to be traded on the floor of the SLSE must be listed on the Exchange.  A lot of benefits can be derived from being a listed company on the Sierra Leone Stock Exchange. Once a company is being listed on the Sierra Leone Stock Exchange, additional financing is easier to raise through subsequent issuing of securities. The credibility of both investors and potential creditors can be enhanced because of the high standards that must be met and maintained by listed companies. There is increased visibility of the company through the comprehensive disclosure of information on the public and publishing of trading statistics by the Sierra Leone Stock Exchange.

The Exchange creates a market place where the securities of all listed companies can be bought and sold.  This in turn increases the demand for securities and adds to the value and acceptance of the securities because the purchaser knows that there is a ready market for shares.