Chapter 9 • The secondary capital market and its efficiency
managers’ actions. In other words, if managers act in a way that promotes the inter-
ests of shareholders, this will in fact promote their interests through the share price.
l Managers may have an interest in withholding unfavourable information. The strong-
form inefficiency revealed by research shows that not all information that exists is
impounded in security prices. Thus management might have a vested interest in
withholding unfavourable information. Whether this would in fact be valid in the
long run is doubtful since most information emerges sooner or later. Probably,
a widespread feeling among investors that managers are prepared to suppress
unfavourable information would ultimately be detrimental to those managers.
l The secondary capital markets provide a guide to required returns from risky investments.
In the same way that if we wish to value a second-hand car we might look at the
price for similar cars in the second-hand car market, it is logical to try to assess the
value of assets with risky return expectations by looking at prices of similar assets
in the secondary capital markets.The general conclusion on efficiency is that management and security holders are
directly linked through security prices. Significant actions of management immedi-
ately reflect in security prices. The evidence is clear that security prices react rapidly
and rationally to new information. The implications of secondary capital market
efficiency for managers will be referred to at various points throughout the remainder
of this book.The London Stock Exchange (LSE)
l As with other stock exchanges, the LSE acts as a primary and a secondary
market.
l Members of the LSE are either market-making dealers, who act as ‘stall
holders’, or brokers, who act as agents for their investor clients.
l LSE dealing is either ‘quote-driven’, using SEAQ and involving dealers, or
‘order-driven’, when buyers and sellers deal directly with one another through
the SETS approach.
l Brokers act on behalf of their clients in all transactions and charge a commis-
sion for their work.
l The LSE is not the only secondary capital market, though it is by far the largest
and most important. It must compete with its rivals for business.Capital market efficiency (CME)
l CME means that the market rationally prices securities so that the current
price of each security at any given moment represents the best estimate of its
‘true’ value.
l CME would imply that all available information bearing on the value of a par-
ticular security is rapidly and rationally taken into account in its price.
l It is reasonable to believe that CME could exist in practice because many
skilled individuals with the financial weight to affect security prices con-
stantly assess the value of those securities and monitor their market prices.