The East India Companies and the Development of Stock Exchanges - Coursework Example

THE EAST INDIA COMPANIES AND THE DEVELOPMENT OF STOCK EXCHANGES Contents 1 Introduction 2 2 Background of East India Company 2 3 The East India Company Capital Needs 3 1.4 Quality of Ships 4 1.5 Acquisition of Credit 5 1.6 Institutional innovation 8 1.7 Conclusion 13 1.8 References 14 1.1 Introduction The East India Company has the reputation of being the first most important joint stock corporation held publicly in England, Europe and the whole world.1 Its dealings laid down the foundation for the development of stock exchange markets we see in the modern world of business operations. Its large size enabled the corporation to operate in many countries raising the need of acquiring additional capital leading to the evolution of ideas regarding the development of stock exchange market. According to the theory of institutional economics, institutional innovations occur when an economic player seeks for means of lowering the costs of performing business transactions.2 In other words, an economic player will always look for means of benefiting financially by interacting with others to achieve the lowest costs of conducting business transactions. These entail the costs that enhance capital mobility, lowering the cost of information and those that assist in spreading the risks. This article will explain the activities and the steps undertaken by the East India Company that greatly contributed to the development of stock exchanges to address the problems faced by business corporations. 1.2 Background of East India Company The company obtained its charter on 31st of December 1600.3 The company predated about one hundred years the establishment of an efficient market in stock exchanges in the United Kingdom that started to gain control in the market for bonds owned by the government after the celebrated revolution of 1688. In the 18th century, it became the only live market trading in corporate shares. The establishment of the East India Company influenced a significant moment in the development of the economy in the entire Western region and more specifically, the United Kingdom. In the early times of the 17th century, British and Dutch oversea traders emerged as the major connectors between the European and Asian markets.4 European ships took control of the trade in the ocean in many parts of the Asian region. This increased European control, increased the significance of the role of the East India Company that led to institutional transformations in Britain and other European nations to control trade activities. 1.3 The East India Company Capital Needs At the end of the 16th century, there were a number of problems that English traders faced in their effort to establish sea trade with the Asian region. The East India Company promoters had the responsibility for determining the means of financing their projects using the various options available, whether to provide finance using their own wealth, acquiring loans or by raising equity capital from people outside the company in the form of shares in return for profits.5 However, before arriving at any of the decisions from the various available options, they had to assess the level of capital they needed. This clearly brought a hint towards the idea of developing the concept of stock exchange as the aim was to address capital requirements to finance business operations. It finally became clear to the company that a voyage that went farther than the Cape of Good Hope took more time than all other voyages involving trade with other regions. The earliest voyage of the East India Company started in February 1601 but only managed to return in June 1603 taking more than two years.6 The return voyage from the Asian region thus took around two to three years as opposed to that from other regions such as the Baltic and Spain that took only a few weeks. The financial outcomes that formed the difference in the time taken were the quality and the size of the ship that could be capable of supporting the journey as well as the time capital turnover. This raised the issues that necessitated the development of a system that would make the dealings profitable and efficient, which is the goal of any corporation in the modern world of business operations.7 1.4 Quality of Ships The East India Company had to look for better ships capable of supporting the voyages in terms of both the length of the voyage as well as the rougher conditions than those encountered in the other voyages within the European region. The ships had to be very strong in terms of both trading as well as fighting since they were faced by the risk of attack from rival merchants as well as pirates because of travelling far from the areas where they could receive protection from the British navy.8 The size of the ships was also supposed to be large enough to balance the costs from long voyages and hence more expensive voyages. The question was whether the company was going to be capable of economising from its investment in ships. Therefore, chartering the ships it required was going to be less expensive for the Company than buying or constructing the ships. The other question was whether the company could find owners of ships to enter into contract. The idea of chartering the ships for the company for every voyage to the Asian region was thus going to share the risks with the ship owners without sharing the profits. Therefore, the idea of part ownership, which is the idea of subdividing the ship ownership into parts that could be transferred or shared between parties, became the most important means of hiding the rights of property in the United Kingdom.9 This form of ownership spread the risks involved in the dealing between several parties. However, the part owners carried fewer risks than the full owners of the ships did. They were still individuals outside the trading organisation lacking any control over the ship and having no share on the profits generated. This was an idea that clearly reflected to the basic principles of stock exchanges of enabling a corporate entity to acquire enough capital to finance its activities and spread the risks over many individuals. 10 1.5 Acquisition of Credit The East India Company made efforts to solve the problems that inhibited the idea of raising equity capital from the unsuitable institutions controlling the long distance voyages. The company succeeded in acquiring credit from its own employees by deferring their payments. In some cases, the company bought goods on credit given on short-term bases for the Asian markets. The promoters of the East India Company could not, to some good extent acquire a portion of the capital it needed through acquisition of loans as opposed to equity.11 This is because; the high risks involved in the long voyages, posed numerous risks that contributed to this difficulty. The creditors of the East India Company could also not obtain good collateral because at its early stages, the company did not have a significant amount of assets or stock in Britain.12 Lenders were hesitating because of the possibility of losing all their money in the event of a completely lost journey. As a means of protecting themselves from the high risks involved, the lenders who accepted to give their money were charging very high interest rates. It was very difficult to assess the probability of occurrence of the risks involved.13 On the other hand, the idea of charging very high rates of interests was in contrary to the law regarding usury. Therefore, the idea of sharing profits was the only option left for dealing with this complex situation full of uncertainties. This idea was the only way of ensuring that there was going to be a fair distribution of the risks involved as well as sharing of profits in the case of a successful voyage. The situation was driving the traders and all the other parties to the idea utilised in the operation of stock exchange. To add on this, the idea of charging high interest rates was also a threat to the East India Company promoters because of the risk of incurring huge losses by the promoters themselves as well as their creditors.14 This was a time of failure of the entire voyage or if some ships arrived safely but the demand for the imported Asian goods was not high enough to enable the sale of the goods at reasonably high prices to cover the losses. The obligation of paying the creditors’ high and permanent interests, who were the individuals given the first priority during the settlement of the debts, could again put the promoters of the East Indian company at a greater risk of incurring high losses.15 This again necessitated the development of a system that could deal with the problems, for the company to be able to acquire capital without putting the personal assets held by the individuals serving the company at a greater risk. Even if we can assume that it was possible to solve the problem involving the idea of restructuring the transactions of loans, we still have the responsibility of identifying the individuals that are willing to provide such huge loans for a multinational company like the East India Company. A busy market for the debts of the government did not exist until later after the big revolution that occurred in the year 1688. The act of incorporating the bank of England also took place about six years after the big revolution. The establishment of the market for the corporate bonds also occurred even later after the incorporation of the bank of England.16 The idea of the government to seek for loans in both the Stuart as well as the reign of the commonwealth exerted a lot of pressure on the London city as well as the corporations involved in oversea trading including the East India Company. The idea of forcing the East India Company to lend money was not the best means of providing finance to the East India Company during its early times. Since the acquisition of loans from banks was also not a good option, it necessitated the development of the ideas leading to the modern system of acquiring capital for such corporations in the name of stock exchanges. By the year 1610, the VOC, when encountered a shortage in capital, it started using loans acquired on short-term basis to meet the seasonal requirement.17 This means that the VOC was capable of equipping an outgoing journey before they can sell the goods from the coming ships. This enabled the organisation to maintain three fleets at the same time. Two fleets will be in Asia as one prepares to leave. The VOC acquired its loans to finance its activities from the Bank of Amsterdam, which was a community bank formed in 1609 and enjoying monopoly in the region regarding exchange bills. The bank was only offering its loans to the community of Amsterdam and the VOC only. However, in the United Kingdom, things were very different as there was lack of any institution that could offer loans to the East India Company at that scale like that in Amsterdam. The United Kingdom had not yet imported that Italian idea to their country to help deal with these complex situations that East India Company was facing in the country. The goldsmiths, who were providing some banking services in England, could not provide the huge loans requested by the company.18 The need for acquiring loans from the public was therefore inevitable for the trade corporations like the East India Company. However, large scale acquisition of loans from the general public required a serious innovation in the institution in the name of middle parties or facilitators such as banks, credit network well developed or a market for the corporate bonds, which obviously directing towards the formation of stock exchanges. It is thus very evident that the East India Company provoked all such developments. 1.6 Institutional innovation This refers to the attempts made to acquire stock from several traders and using the acquired stock in a single account of trading and under a single corporation chartered to carry out business. The attempts to implement the idea came from promoters of various companies such as the Mascovy Company that was a Russian Company also faced with serious financial problems like the East India Company. However, their attempts did not bear significant outcomes for the system. Because of the fact that the East India Company selected in the year 1599 the corporation of joint stock establishes despite the numerous failures in the earlier attempts. The East India Company becomes the most influential and most preferred in the study of the early history of the formation of the system of joint stock corporations.19 Apart from a legal framework that is identical to that of the regulated conglomerate, East India Company established a component of the joint stock, which found light connection with the charter as well as the original corporate enterprise created through the charter. A collection of English traders held several meetings in September 1599 that became the naissance assemblies of the British East India Company. The aims of the meetings were to look for means of obtaining enough capital to finance the activities of the company and to obtain a charter from the government to enable the company to earn various benefits and privileges. In the first meeting that occurred on September 22, 1599, one hundred and one people agreed to collectively, contribute a total of thirty thousand pounds. The amount contributed by each individual varied from one hundred to three thousand pounds with the largest percentage of the individuals contributing two hundred pounds. By the time the company obtained the charter in 31 December 1600, the number of subscribers had grown to around two hundred and eighteen. The company continued to receive more subscriptions and by the time the company sent the first voyage in 13 February 1601, the amount of capital had reached sixty eight thousand pounds. This was a very substantial step to the formation of stock exchange as the best means of acquiring enough capital from the public. The people started experiencing the effectiveness of the system during this time. The promoters of the East India Company established a special committee to negotiate with the Privy Council to obtain an incorporation charter, trade privileges, tax privileges and a license for the export of specie as well as military and political support.20 The appointment of the few individuals to negotiate for the company is a reflection of the modern idea of letting a few individuals work for the company despite the presence of many people who own shares in the organisation.21 The charter obtained enabled the company to gain the power of possessing and conveying land as well as suing individuals for damages and possess a universal seal. Other individuals could also sue the company for damages as the company could also commit tort. Despite the fact that it did not include the modern concept of limited liability, the characteristics demonstrate those of the modern corporations that a particular corporation must meet to win a place in the stock exchange market.22 The idea of connecting the financial weapon of joint stock with that of separate legal entity represented a very important innovation to the development of the system of stock exchanges. However, for the East India Company, the step created several problems that needed solutions. From the beginning, the promoters of the company had the idea of financing the company through the utilisation of the system of joint stock but they did not ask for official permission from the authority.23 Despite the fact that the charter created the foundation for the adoption of the system of joint stock for the company, it failed to establish a complete overlap involving the structure of the organisation and the management of the organisation. However, the charter provided a very substantial transition towards dealing with the issue of acquisition of enough capital from the masses to finance business activities. The continued rise in capital after the acquisition of the charter as well as after the first voyage occurred in a very separate account from the initial account. There was a separate account for each of the voyages to the Asian region. The members had the freedom of choosing the account and the amount of money to invest. All the expenses incurred by the company in the country and out of the country regarding a voyage had a separate account. At the end of every voyage, the profits earned by the company went to the contributors according to the amount they contributed. This laid the foundation in the manner of functioning of modern systems of stock exchange.24 The profits generated at the end of trading period go to the shareholders in the name of dividends. The separate accounts created were an attempt of maintaining accurate records for each member to ensure fair distribution of the earnings.25 The risk and the profit sharing ensured that the public could invest their money in the company confidently with the hope of getting returns from their investments. The major challenge for the promoters of the East India Company was not the act of influencing members of the public to invest in the company but to win their loyalty and ensure that they turned up in the later voyages.26 This is similar to the contemporary functioning of modern corporations since in the operation of stock exchange; the management has the duty of convincing investors to invest in the organisation. 27 It is good to remember that the fundamental financial system of the East India Company existed before the acquisition of the charter; the charter did not match the system of the company. However, the content of the charter was almost identical to the charters issued to the current regulated organisations.28 This therefore, means that the East India Company is responsible for the development of the modern stock exchanges. In fact, the charter contained a list of one hundred and nineteen members only that it did not refer to them as shareholders to the company. The charter did not guarantee various rights to the members of varied contributions and did not include issues like additional shares and the payment of dividends to the members. However, it was the belief of every participant in the dealing that the sharing of profit from the voyage was according to the contribution of each member in the joint stock that financed the voyage. To continue, based on the belief held by the members, each particular member, irrespective of the amount he contributed to the company, owned only one vote in the General Court. This idea emanated from the model of the regulated organisation, where every member owned a single vote only. The charter did not reflect the financial position of the company in the future. It also did not provide for the creation of a separate account for each separate voyage that the company sent to the Asian region. In addition, the charter did not provide for the difference between the original membership and the future membership as well as between the management and the finance of the management. However, the East India Company promoters did not see the charter as an obstruction to the development of the company into a joint stock organisation. As a means of attracting more investors, the East India Company prioritised the interests of the investors, provided information to the investors and allowed them to withdraw their membership at will.29 These actions reflected to the modern functioning of the stock exchange since shareholders acquire information concerning the performance of the company in which they invested and they can withdraw their membership through the sale of their shares.30 In addition, the managements of the modern corporations accord the views of their shareholders very high regard and struggle to convince investors to continue investing in their companies.31 The argument is that the company was performing its activities based on the requirements in the environment and in the manner; it could satisfy every participant in the business. The company acted in a manner that provided the way for the development of the overall modern system of stock exchanges in the world. The minor differences that existed paved the way for the later developments. 1.7 Conclusion It is very clear that the activities of the East India Company were responsible for the development of stock exchanges in the modern world. The financial problems faced by the company and the weak financial institutions of Britain that could not provide the necessary lending led to the creative thoughts of the promoters of the company that in turn led to the useful advancements. The desire of the promoters was to solve the financial problems faced by the company and build confidence in the members that ensured growth and sustainability. 1.8 References Augustus Adolf Berle, and Gardiner Gardiner Coit, The modern corporation and private property, Transaction Publishers, (1991). Baskin Jonathan, ‘The development of corporate financial markets in Britain and the United States, 1600–1914: overcoming asymmetric information’, (1988), 62, Business History Review, 199. Bettis Richard, ‘Modern financial theory, corporate strategy and public policy: Three conundrums’, (1983), 8, Academy of Management Review, 8, 406. Blussé Leonard, ‘No Boats to China. The Dutch East India Company and the Changing Pattern of the China Sea Trade, 1635–1690’, (1996), 30, Modern Asian Studies, 30, 51. Boshoff Willem and Fourie Johan, Explaining ship traffic fluctuations in the early cape settlement: 1652–1793, University of Stellenbosch, (2008). Chaudhuri Kirti, The English East India Company: The study of an early joint-stock company 1600-1640, Taylor & Francis, (1999). Eisenberg Aaron Melvin, ‘Legal Roles of Shareholders and Management in Modern Corporate Decisionmaking’, (1969), 57, The Cal. L. Rev. 57, 1. Farrington Anthony, Trading Places: The East India Company and Asia 1600-1834, British Library Board, (2002). Femme, The Dutch East India Company: Expansion and Decline, Walburg Pers, (2003). Gaastra John Kaye, The administration of the East India Company: a history of Indian progress, Bentley, (1853). Gardner Brian, The East India Company, Hart-Davies, (1971). Grant Robert, ‘Toward a Knowledge‐Based Theory of the firm’ (1996), 17, Strategic management journal, 109. Haugen Robert, Modern investment theory, Prentice Hall, (1990). Hejeebu Santhi, ‘Contract enforcement in the English East India company’, (2005), 65, The Journal of Economic History, 496. Irwin Douglas, ‘Mercantilism as strategic trade policy: the Anglo-Dutch rivalry for the east India’, (1991), 99, The University of Chicago Press, 1296. Keay John, The honourable company: a history of the English East India Company, HarperCollins, (1991). Klein April, ‘Audit committee, board of director characteristics, and earnings management’, (2002), 33, Journal of accounting and economics, 375. Lawson Philip, The East India Company: A History, Routledge, (2014). Lubatkin Michael and Chatterjee Sayan, ‘Extending modern portfolio theory into the domain of corporate diversification: does it apply?’, (1994), 37, Academy of Management Journal, 109. Michie Ranald, The London and New York Stock Exchanges 1850-1914, Routledge, (2011). Misra Bihari, The central administration of the East India Company, 1773-1834, Manchester University Press, (1959). Morck Randall, Shleifer Andrei, and Vishny Robert, ‘Management ownership and market valuation: An empirical analysis’, (1988), 20, Journal of financial Economics, 293. Morgan Edward and William Arthur, The stock exchange: Its history and functions, Elek, (1969). Morse Hosea, The chronicles of the East India company, trading to China 1635-1834, Harvard University Press, (1929). Mukherjee Ramkrishna, The rise and fall of the East India Company: A sociological appraisal, Popular Prakashan, (1973). Ogborn Miles, Indian ink: script and print in the making of the English East India Company, University of Chicago Press, (2008). Roe Mark, ‘Legal origins, politics, and modern stock markets’, (2006), 120, Harv. L. Rev, 460. Ron Harris, Institutional innovations, theories of the firmand the formation of East India Company, Berkeley Program in Law and Economics, Working Paper Series, (2004). Scott William, The constitution and finance of English, Scottish and Irish joint-stock companies to 1720, The University Press, (1912). Stuart Lucy Sutherland, The East India Company in eighteenth-century politics,Clarendon Press, (1952). Sturgess Gary, ‘The East India Company’, (2011), 6, Journal of International Peace Operations, 5. Read More