Introduction

Some observers have expressed concern that New Zealand’s stock market appears to be underdeveloped relative to many other OECD countries. John McMillan (2004) has speculated that poor investor protection could be an underlying factor. The purpose of this paper is to evaluate evidence regarding the hypothesis put forward by McMillan about the potential link between weak investor protection and stock market development in New Zealand.

Poor investor protection could potentially be a factor constraining the development of the New Zealand stock market 

In a review of the flexibility of the New Zealand economy, McMillan (2004) gives provisionally good marks in several areas, including turnover of wealth, labour market flexibility, and barriers to firm birth and growth. However, McMillan expresses concern that existing large firms perform poorly and worries there may be barriers to medium-sized firms becoming large. He offers three possible reasons: scarce managerial talent, “smallness of the NZ market” and “financial-market frictions” (p. 164-5). McMillan places particular emphasis on the last of these. In short, after taking a wide lens to review the flexibility of the New Zealand economy, McMillan raises a particular issue: the possibility that poor investor protection may be constraining the development of the stock market. He speculates that protection of the rights of minority shareholders may not be as strong as it appears on the surface, with the result being a poorly capitalised stock market characterised by concentrated ownership.

Cross country studies have been undertaken by La Porta et al into the development of stock markets as a function of the protection of minority rights

McMillan’s discussion echoes four strands of research pursued by economists in various industrialised countries. One strand examines the decision of firms to “go public” as part of the firm lifecycle and transition from small to large (eg, Pagano et al 1998, Kim and Weisbach 2005). A second strand investigates the importance of large firms to the overall productivity of the economy (eg, Pagano and Schivardi 2003). The third strand looks at the links between financial system development and overall economic development (eg, Levine 2002, Claus et al 2004, de Serres et al 2006). The fourth is concerned with explaining the relative development of stock markets around the world as a function of the protection of minority investors (eg, La Porta et al 1998 and 2006, Leahy et al 2001).

The focus of the current paper is on the fourth strand, examining evidence regarding McMillan’s concerns about the adequacy of investor protection and stock market development in New Zealand and look closely at measures of stock market development.

In particular, this paper examines:

• Two possible measures of stock market development. Firstly, capitalisation of the New Zealand stock market which appears low by international standards. Secondly, updated data on the concentration of ownership of New Zealand firms – an issue that strikes McMillan as a possible symptom of poor investor protection.
• International measures of private and public investor protection (produced by La Porta and various co-authors) in order to compare New Zealand with other OECD countries in 2000.
• Some legislative changes affecting investor protection that have been occurring within New Zealand since 2000.

My overall conclusion is that the available evidence tends to allay McMillan’s concerns that poor investor protection could be contributing to underdevelopment of the New Zealand stock market. It is therefore more plausible that other factors have constrained the development of the stock market.