Jump to ContentJump to Main Navigation
Private GovernanceCreating Order in Economic and Social Life$

Edward Peter Stringham

Print publication date: 2015

Print ISBN-13: 9780199365166

Published to Oxford Scholarship Online: August 2015

DOI: 10.1093/acprof:oso/9780199365166.001.0001

Show Summary Details
Page of

PRINTED FROM OXFORD SCHOLARSHIP ONLINE (www.oxfordscholarship.com). (c) Copyright Oxford University Press, 2018. All Rights Reserved. Under the terms of the licence agreement, an individual user may print out a PDF of a single chapter of a monograph in OSO for personal use (for details see www.oxfordscholarship.com/page/privacy-policy). Subscriber: null; date: 17 January 2019

Markets Creating Transparency

Markets Creating Transparency

Competing Listing and Disclosure Requirements from the Big Board in New York to the Alternative Investment Market in London

(p.79) chapter 6 Markets Creating Transparency
Private Governance

Edward Peter Stringham

Oxford University Press

Abstract and Keywords

In addition to adopting rules of conduct between members, stock exchanges started adopting requirements for companies that wanted to be listed. By the mid-nineteenth century, the New York Stock Exchange had various requirements if a firm wanted to be listed on the Big Board. Such disclosure requirements were not costless, but they were valuable to investors, so the exchange benefited companies and investors by adopting the rules. In modern times, stock exchanges compete and help put a stamp of approval on listed firms. From the strictest requirements of the New York Stock Exchange to the more flexible requirements of the Alternative Investment Market in London, stock exchanges compete to offer sets of rules that investors prefer.

Keywords:   private certification, exchange as regulator, asymmetric information, stock exchange, Alternative Investment Market

6.1. Introduction

I knew today was lucky day and that was confirmed by this investment opportunity emailed personally to me:

Dear Friend,

I am a director in the foreign affairs department of the Nigerian National Petroleum Corporation (NNPC). I wish to use this opportunity to notify you of the existence of a certain amount we wish to transfer overseas for the purpose of investments and importation of goods from your country. In May 2001, a contract of sixty-six million United States dollars ($66,000,000) was awarded to a foreign company by my ministry. The contract was supply, erection and system optimization of supper polyore 200,000-bpsd, system optimization of 280,000-monax axial plants and the computerization of conveyor belt for Kaduna refinery. With only the consent of the head of the contract evaluation department, I over invoiced the contract value by thirty four million United States dollars ($34,000,000).

The contract has been completed long ago and the foreign company fully paid off. But in the office files and paper work, the company is still owed USD34M representing the over invoiced amount. Because this amount is derived from the (p.80) award and execution of a foreign contract, there is no way the money can be paid locally. That is why I contacted you so that we can do the project together for our mutual benefit. We have concluded every necessary arrangement to transfer this amount to a foreign account as the final phase payment for the said contract. What we need is your bank account into which we can deposit the money and after we shall come over there to share the money with you.

Kind regards,

Mr. Joseph, Victoria Island, Lagos, Nigeria

Since receiving his first letter, Mr. Joseph and I have become close Internet friends and he assures me I can trust him. I also know that fraud is illegal in the United States and Nigeria, so if anything goes wrong I can simply call the Securities and Exchange Commission in the United States or Nigeria and get my money back. My success is guaranteed.

Almost all economists agree that investment markets are a good thing for firms and investors. The process of financial intermediation channels money from savers or investors to firms who need capital, and that enables savers or investors to share in a firm’s success. Fraudulent “enterprises,” however, are a different matter, and they can range from totally bogus schemes to quasi-legitimate enterprises that actually make money but whose managers swindle part or all of investors’ profits. In a world with imperfect information, recognizing the difference between a manager who tried and failed and one who intentionally took money can be difficult, so most people look to government to create transparency. The Securities and Exchange Commission (2012) states its goal is “to protect investors, maintain fair, orderly, and efficient markets, and facilitate capital formation,” and its tools include various listing and disclosure requirements for firms accepting money from investors. Lopez-de-Silanes (2004, p. 6) summarizes the most common view: “Regulation of securities is beneficial because it protects investors by mandating disclosure and . . . foments the growth of markets by increasing the supply of truthful information.”

As in other markets, the existence of fraud scares investors, and that fear reduces the amount of mutually beneficial investments (Prentice, 2002). Yet just because potential problems exist, it does not follow that transparency, listing, or disclosure requirements must come from (or were innovations of) the state. In fact, the first transparency, listing, and disclosure requirements all predated the Securities and Exchange Commission in America and the precursor to the Financial Conduct Authority in England. When the Securities Act and the Securities Exchange Act were implemented in 1933 and 1934, they simply mandated many of the requirements that the New York Stock Exchange had already adopted. Firms that wanted to be listed and traded at the New York Stock Exchange had to meet certain requirements that helped show they were legitimate firms.

(p.81) By providing extra assurances to investors, the New York Stock Exchange, the Big Board, increases the demand for its market. Here the exchange acts as a reputational intermediary, providing the equivalent of a Good Housekeeping Seal of Approval on listed firms (Macey, 2013). The New York Stock Exchange does not guarantee the lack of fraud, but its listing and disclosure requirements make fraud more difficult and preclude most fly-by-night firms. When competing to make its venue more attractive, each exchange must evaluate the marginal costs and benefits to firms and investors of additional rules and regulations. Other exchanges have their own requirements, and many are more flexible than the New York Stock Exchange. One of the most flexible markets today is London Stock Exchange’s Alternative Investment Market (AIM), which caters to smaller firms. When choosing where to list, firms can opt for the strict rules of the New York Stock Exchange or more flexible rules of AIM, but they must consider what will be most attractive to investors.

If rules such as listing or disclosure requirements are so beneficial, private parties can contract to have them. The goodness or badness of the rules becomes internalized into the price of stocks and the exchange where they are traded. Stock exchanges without good assurances (or, on the flip side, with onerous regulations) will lose potential investors, so this creates incentives for stock exchanges to make rules that enhance markets. Mahoney (1997) refers to this role of the exchange as the regulator, and Romano (1998) outlines how such competition encourages exchanges to create rules that that investors trust.

Let us begin by giving a sketch of the origins the strictest listing requirements at the New York Stock Exchange and then provide a more detailed view of the more flexible listing requirements at London’s AIM. I highlight both, not to show that one is categorically better or that these are the two best in the world, but to show that different exchanges can offer different listing and disclosure requirements depending on investors’ wants. A market for governance offers choices, whereas government regulations do not.

6.2. The Cadillac of Listing and Disclosure Requirements: The New York Stock Exchange, the Big Board

If the Exchange [the New York Stock Exchange] had been nothing more than a meeting-place for buyers and sellers of securities, and the borrowers and lenders of funds based on securities—a huge automatic dial to register vibrating values, and a legalized centre of speculation—it would even then have been worthy of an important place in the national annals. But though created only for these functions, it has come to discharge another and (p.82) more striking one. In doing so it has formed that connection with the country’s development which may be reckoned the most value feature in its history.

Stedman and Easton (1905, p. 18)

The New York Stock Exchange helped finance American industry by letting the public participate. The New York Stock Exchange created an attractive market by prescreening and having rules of conduct for brokers and later for listed firms.

Similar to other stock markets, the New York Stock Exchange (so named since 1863) evolved over time. The earliest available written agreements between brokers date to 1791, when signatories agreed to fourteen rules about trade, and 1792 when twenty-four brokers signed the Buttonwood Tree Agreement, in which they agreed to “solemnly promise and pledge ourselves to each other.”1 An association of merchants created the New York Tontine Coffee House Company in 1791–1792, and opened the Tontine Tavern and Coffee House (see figure 6.1) in 1793 “for the purpose of a Merchants Exchange with 203 subscribers at $200 each” (Werner and Smith, 1991, p. 216). In 1794 one commentator wrote:

The Tontine Tavern and Coffee House is a handsome, large brick building; you ascend six or eight steps under a portico, into a large public room, which is the Stock Exchange of New York, where all bargains are made. Here are two books kept, as at Lloyd’s, of every ship’s arrival and clearing out. This house was built for the accommodation of the merchants, by Tontine shares of two hundred pounds each. It is kept by Mr. Hyde, formerly a woolen draper in London. You can lodge and board there at a common table, and you pay ten shillings currency a day, whether you dine out or not. (Quoted in Bayles, 1915, pp. 360–61)

They adopted a “Constitution And Nominations of the Subscribers To The Tontine Coffee-House” as early as 1796, and by 1817 brokers created a more formal membership club and trading venue, the New York Stock and Exchange Board (Tontine Coffee House, 1796; Stedman and Easton, 1905, p. 62). The 1817 “Rules to be adopted and observed by the ‘New York Stock and Exchange Board’” were quite simple and included “fines for non-attendance at the calling of the Stocks” rules specified that “any member refusing to comply with the foregoing rules may have a hearing before the Board, and if he shall still persist in refusing, two-thirds of the Board may declare him no longer a member” (Stedman and Easton, 1905, p. 64). Members added different resolutions over the years, and by the 1860s, in addition to blacklisting those who did not follow through with their contracts, to make sure everyone was proper (p.83) (see figure 6.2) they had rules prohibiting “indecorous language” (suspension for a week), fines for “smoking in the Board-room, or in the ante-rooms” ($5), and fines for “standing on tables or chairs” ($1) (Hamon, 1865 pp. 26–29; New York Stock Exchange, 1869, pp. 31–33). By 1865 the initiation fee was $3,000 and by 1868 one’s membership seat became a valuable property right that could be sold to potential members (Hamon, 1865, p. 12; New York Stock Exchange, 2013). The Exchange moved to Wall Street and Broad Street in 1865 (see figure 6.3) and the current building in 1903 (see figure 6.4).

Markets Creating TransparencyCompeting Listing and Disclosure Requirements from the Big Board in New York to the Alternative Investment Market in London

Figure 6.1 Tontine Coffee House [on left], Merchant Coffee House [in center], and Wall Street [on right facing East], Francis Guy, 1797

Markets Creating TransparencyCompeting Listing and Disclosure Requirements from the Big Board in New York to the Alternative Investment Market in London

Figure 6.2 Downtown Lunchroom, Thure de Thulstrup, 1888

Markets Creating TransparencyCompeting Listing and Disclosure Requirements from the Big Board in New York to the Alternative Investment Market in London

Figure 6.3 The New York Stock Exchange 1882

Markets Creating TransparencyCompeting Listing and Disclosure Requirements from the Big Board in New York to the Alternative Investment Market in London

Figure 6.4 The Floor of the New York Stock Exchange, Secretly Shot with a Camera Hidden in the Photographer’s Sleeve. Pearson Publishing Company, 1907

In addition to rules of membership, the Exchange established rules about the securities that could be listed. Letting any “enterprise,” including likely fraudulent ones, approach investors had the potential to create a tragedy-of-the-commons situation where the fraudulent ventures crowded out the good. To deal with this problem, the Exchange adopted listing and disclosure requirements to make the market more transparent. By 1865 the New York Stock Exchange had two lists of securities, the regular list and the secondary list, and the first list would be called at the “First Board” in the morning session that members had to attend. To be on the first list, companies had to apply: “Applications for placing of Stocks on the regular list, shall be made directly to the Board, with a full statement of capital, number of shares, resources, &c.” (New York Stock Exchange, 1865, pp. 16–17).

(p.84) Over time the New York Stock Exchange adopted more explicit listing requirements and required companies to maintain a transfer agency and registrar that are approved by the Exchange (New York Stock Exchange, 1914, Article XXXIII, Sec. 1); to obtain permission from the Committee on Stock before issuing initial or subsequent shares (Article XXXIII, Sec. 2, Sec. 5); and to comply with various rules of the New York Stock Exchange Governing Committee, which had the authority to suspend dealings or remove a company’s shares from the Exchange (Article XXXIII, Sec. 4). By the 1920s, the New York Stock Exchange (1925) required various reports and disclosures from companies.

Although listing and disclosure requirements involve costs to listing firms, they can bestow certain benefits to investors, and in turn listing firms. One can think of the New York Stock Exchange as solving a sort of collective action problem between individual investors and firms. A listing firm nominally bears the costs of compliance, but it willingly does so because the rules increase the value of its stock. If investors value transparency through listing or disclosure requirements, the New York Stock Exchange can require them. That means individual investors need not visit a company’s offices if they know that a stock exchange and auditors have reviewed the company’s books (Macey, 2013). A stock exchange helps provide an off-the-shelf package of rules for corporate governance, and the costs and benefits of that package become internalized within the exchange. The rules do not address (p.85) all problems, but they can address as many as market participants deem appropriate.

We now know that those running the New York Stock Exchange made a lot of good choices, and that by World War I, it surpassed the London Stock Exchange as the most important exchange in the world. But at the time, the success of the New York Stock Exchange was not inevitable. Adopting stricter rules had the potential to attract more market participants or to push them away to less strict competitors. The New York Stock Exchange always had to compete for business and throughout the years faced competition from the Open Board of Brokers (merged with the New York Stock Exchange in 1869 (p.86) [Stedman and Easton, 1905, p. 214]), the Curb Market and its more formal outgrowth, the New York Curb Exchange (founded in 1921 and renamed the American Stock Exchange in 1953), the Consolidated Stock Exchange of New York (founded in the 1880s, it included many mining companies), and regional exchanges including the Boston Exchange and Philadelphia Stock Exchange (founded in 1834 and 1754, respectively, the latter in the London Coffee House). Investors also could have focused on “the Coal and Iron Exchange, the Coffee Exchange, the Cotton Exchange, the Maritime Exchange, the Metal Exchange, the New York Insurance Exchange, and the Leaf Tobacco Board of Trade” (Markham, 2002, p. 6) to name a few.

Today the New York Stock Exchange competes with NASDAQ and many other stock exchanges worldwide. Firms wishing to list in North America can select from the choices summarized by Cormick (2010) in table 6.1, and similar to the New York Stock Exchange, which had a First Board for the main stocks and Second Board for other stocks, many stock exchanges offer different tiers (represented under a, b, c, etc., in rows of table 6.1), and if firms are willing, they can opt for the Cadillac of listing standards at the New York Stock Exchange. An advantage of markets, however, is that not everyone is required to buy a Cadillac, and market participants will only pay to comply with New York Stock Exchange’s stricter rules if they consider them value added. If firms or investors find an exchange’s listing or disclosure requirements too onerous or not appropriate for a certain type of form, they can opt into venues with different rules. A market for private governance requires exchanges to continually search for rules that market participants value. (p.87) (p.88)

Table 6.1. Summary of the Listing Requirements at Major North American Venues


New York Stock Exchange

NASDAQ Global Market

Toronto Stock Exchange

TSX Venture Exchange

Canadian National Stock Exchange

U.S. Over-the-Counter Bulletin Board

Pretax income last year

$2,000,000 (minimum multitiered formula)

  1. a. $1,000,000

  2. b. N/A

  3. c. N/A

  4. d. N/A

  1. a. C$300,000

  2. b. C$200,000

  3. c. C$200,000

Tier 1: $5,000,000 in NTA; or $5,000,000 in revenue



Two-year average pretax income

$2,000,000 (minimum multitiered formula)

  1. a. $1,000,000 (2 out of 3 years)

  2. b. N/A

  3. c. N/A

  4. d. $75,000,000 (2 out of 3 years)

  1. a. C$500,000

Tier 2: $750,000 in NTA; or $500,000 in revenue or $2,000,000 in arm’s-length financing



Net tangible assets


  1. a. N/A

  2. b. N/A

  3. c. N/A

  4. d. $75,000,000 and $75,000,000 total revenue

  1. a. C$7,500,000

  2. b. C$2,000,000

  3. c. C$7,500,000

  4. d. N/A

  5. e. N/A

See above



Market value publicly held stock



$40,000,000 (if IPO)

  1. a. $8,000,000

  2. b. $18,000,000

  3. c. $20,000,000

  4. d. $20,000,000

C$4,000,000 (ind.)

C$10,000,000 (tech)

Tier 1: $150,000

Tier 2: $75,000



# of shares publicly held




Tier 1: 1,000,000 or 20% of Float

Tier 2: 500,000 or 20% of Float


10% of Float


# Public board lot holders

  1. a. 400 (U.S.)

  2. b. 2,200 (if monthly trading vol. of 100,000 shares recent 6 months)

  3. c. 500 (if monthly trading vol. 1,000,000 shares recent 12 months)



Tier 1: 200

Tier 2: 250



Trading price of listed securities



No minimum

No minimum

(IPO minimum of $0.15 per share)

No minimum

No minimum

Shareholder equity

No minimum

  1. a. $15,000,000

  2. b.$30,000,000

  3. c. N/A

  4. d. N/A

No minimum

No minimum

No minimum

No minimum

Source: Reproduced by permission from Cormick (2010).

(p.89) 6.3. More Flexible Listing and Disclosure Requirements: The Alternative Investment Market in London

At the other end of the spectrum from the New York Stock Exchange’s formal listing requirements are the flexible listing requirements of the Alternative Investment Market (AIM) in London.2 Founded by the London Stock Exchange in 1995, AIM sets the basic rules and regulations for the exchange, but then approves nominated advisors, or Nomads, to oversee individual firms and decide whether firms can list shares. AIM must comply with certain government rules (e.g., as required by the Financial Services and Markets Acts of 2000, the government reviews the prospectus for each company, and firms associated with the market can still be sued by government), but because AIM is classified as an exchange-regulated market, many European Union directives and the United Kingdom’s Combined Code on Corporate Governance do not apply (Mendoza, 2008). These Nomads are basically paid (directly by the firm but indirectly by the investors) to ensure that a firm is legitimate before giving it a stamp of approval to go public. If a firm is not legitimate, this damages the reputation of AIM and the Nomad that endorsed the firm.

Nomads are typically investment banks or other financial services firms with experience in helping other firms go public (Financial Times, 2006). The London Stock Exchange sets the rules and must approve companies as Nomads. Such companies must (1) “have practiced corporate finance for at least the last two years,” (2) “have acted on at least three relevant transactions during that two-year period,” and (3) “employ at least four ‘qualified executives’” (London Stock Exchange, 2012a). Nomads must be members of a “firm of experienced corporate finance professionals approved by the Exchange” (London Stock Exchange, 2010b) which prevents fly-by-night organizations or “anything goes” firms from becoming regulators. As a residual claimant on the success of the market, the Exchange does not want to approve private regulators who will undermine the reliability of AIM. At the same time, the Exchange has an incentive to approve any private regulator who is likely to enhance the value of the market.

6.3.1. The Listing Process at AIM

The exchange is open to small firms but does not let just any firm list. To prevent fraudulent firms from getting in, Nomads are hired basically as private gatekeepers to decide whether companies desiring to list are “appropriate for (p.90) the market.” The Nomad also monitors companies to ensure that exchange-regulated corporate governance standards are met (London Stock Exchange, 2010b). Beyond that, AIM has “no minimum market capitalization, no trading record requirement, no prescribed level of shares to be in public hands, no prior shareholder approval for most transactions, admission documents not pre-vetted by the Exchange nor by the UKLA [United Kingdom Listing Authority] in most circumstances” (London Stock Exchange, 2010, p. 6).

The initial public offering (IPO) process is quite streamlined, and a typical IPO takes from three to six months (London Stock Exchange, 2010, p. 23). Companies already traded on other approved exchanges are eligible for a fast-track option for joining AIM, which takes five to eight weeks (Withers, 2011). For a typical IPO, the Nomad submits an admission document (see table 6.2), which provides disclosure and other information potentially relevant to investors. The privately produced disclosure requirements include “Operating and Financial Review, Capital Resources, Research and Development, Patents and Licenses, Profit Forecasts or Estimates, and Remuneration and Benefits” (London Stock Exchange, 2010b). The Nomad also prepares a legal due diligence report, a working capital report, historical financial information, pro forma financial information, and a report on financial reporting procedures (Hanson Westhouse, 2012). Each of these documents must be available for potential investors for various periods of time, such as ten to fourteen days, before a firm can be admitted (London Stock Exchange, 2010, p. 25). If there are any changes in a firm’s “financial or trading position between the balance sheet date of its latest published financial information and the date of the admission document” that could affect the price of the security, the AIM Rules for Companies require the firm to disclose this information in the admission document (London Stock Exchange, 2010, p. 36). In addition to helping coordinate the initial due diligence process for an IPO, a firm’s Nomad also provides ongoing consultation, advice, and review (London Stock Exchange, 2012b). (p.91)

Table 6.2. Contents of an AIM Admission Document

The very front

  • • Cover page, including certain “health warnings” and important information for non-UK investors

  • • Summarized key information in relation to the company

  • • Index

  • • List of directors and advisers

  • • List of definitions and glossary of technical terms

  • • Timetable

  • • Placing statistics

The front end:

detailed description of the business and the investment proposition

  • • History of the business

  • • Information about the present-day business, current trading, and investments

  • • Key business and market trends and prospects; in the case of an investment company, details of its investment strategy

  • • Summarized information about directors and key personnel

  • • Intellectual property

  • • information about the placing or offer for subscription

  • • Use of funds

  • • Corporate governance policies

  • • Share option arrangements and dividend policy

  • • City Code information (if applicable)

Risk factors

  • • Risk factors relevant to the business

Historical financial information

  • • Historical financial information relating to the company and its subsidiaries—usually audited accounts for the last three years, or a shorter period of time if the company has been in existence for less than three years. If more than nine months have elapsed since the company’s financial year end, interim financial information also must be included, which may or may not be audited.

  • • An auditor’s or reporting accountant’s opinion as to whether the financial information shows a true and fair view for the purposes of the AIM admission document

  • • If appropriate, pro forma financial information

Other reports

  • • Experts’ reports; these are necessary for mining and oil and gas companies, and they may be desirable for a company with a specialist business (e.g., technology, life sciences, intellectual property).

Statutory and general information: the back end

  • • A responsibility statement confirming that each of the directors and proposed directors accepts general information: responsibility, individually and collectively, for the information contained in the document, and that to the best of their knowledge and belief (having taken all reasonable care to ensure that such is the case) the information contained in the admission document is in accordance with the facts and does not omit anything likely to affect the import of such information

Statutory and general information: the back end

  • • Details of the incorporation and legal status of the company, its registered office, and its objects

  • • Information about share capital, including rights attaching to the shares and authorities to issue

  • • Further shares

  • • Information about the company’s articles of association and constitution documents

  • • Directors’ interest in the company, directorships of other companies, and involvement in previous personal or company insolvencies

  • • The name of any person who, so far as the directors are aware, holds an interest of 3 percent or more in the company’s issued share capital and the level of that interest

  • • Share option plans

  • • Material contracts, including the placing or introduction agreement

  • • Related party transactions

  • • Terms of engagement of the directors and senior personnel summarized tax position

  • • Statement by the company’s directors that, in their opinion, having made due and careful enquiry, the working capital available to the company and its group will be sufficient for its present requirements, i.e., for at least 12 months from the date of admission of its securities to AIM

  • • Material litigation

  • • Any “lock-in” statement required by the AIM Rules or the Nomad

  • • Level of dilution resulting from any offer

  • • Expenses of the issue

  • • Terms and conditions of any offer for the sale of shares

  • • Sundry information

Source: London Stock Exchange, 2010, p. 40.

On the front of the admission document firms are required to print: “AIM securities are not admitted to the official list of the United Kingdom Listing Authority” and “The London Stock Exchange has not itself examined or approved the contents of this document” (London Stock Exchange, 2010b, p. 17). Following the guidelines recommended by a 1992 Cadbury Committee report from the London Stock Exchange and the UK Financial Reporting Council (Seidl, Sanderson, and Roberts, 2012), AIM gives firms a comply-or-explain option for rules. This rule allows companies to comply with any rule given by the market regulators or to explain why they should not follow this rule. If certain rules are inapplicable or inappropriate for a certain firm, this provides a way for the firm to skip them. AIM companies (London Stock Exchange, 2010, p. 67) are encouraged, but not required, to follow the UK Corporate Governance Code.

Table 6.3 summarizes the costs of going public as well as continuing listing costs for a firm selling $50 million in shares on AIM versus NASDAQ. Not only (p.92) are the initial costs of going public on AIM $1 million less, but firms will save upward of $2 million annually going forward because they avoid regulations such as those associated with the Sarbanes-Oxley Act (SOX). The majority of foreign companies listed on AIM (104 of 157) chose to list on AIM between 2004 and 2005 (Rousseau, 2007, p. 54), which coincides with the period when the onerousness of the Sarbanes-Oxley regulations, passed in 2002, became evident. In the words of one broker, “You guys should erect a statue to SOX outside the LSE” (quoted in Grunfeld, 2006).

Table 6.3. The Cost of Listing on AIM versus NASDAQ

Direct listing costs



Nomad/broker fee


Underwriting fee


Corporate finance fee


Legal fees


Company counsel


Miscellaneous expenses


Nomad counsel


Printing fees


Accounting fees


Accounting fees


AIM fee


NASDAQ listing fee


Registrar fee


SEC and NASD registration fees






Indirect ongoing costs



Nomad fee


SOX compliance


AIM annual fee


NASDAQ annual fee








Source: Reproduced by permission from Mendoza (2008).

(p.93) As the saying goes, the proof of the pudding is in the eating, and by this account the London Stock Exchange and its AIM have been quite successful. Figure 6.5 presents the total number of IPOs at AIM, NASDAQ, and the New York Stock Exchange. The dollar value of those in the NYSE and NASDAQ far surpasses that of AIM, but the AIM enabled IPOs for more firms.

Markets Creating TransparencyCompeting Listing and Disclosure Requirements from the Big Board in New York to the Alternative Investment Market in London

Figure 6.5 IPOs on the London Stock Exchange AIM Market, NASDAQ, and New York Stock Exchange

Source: Data are from AIM Market Statistics, 2012, and Ritter, 2011.

The market attracts firms not just from the UK but from many countries. As the vice president of one Canadian brokerage firm, Mark Maybank, stated:

Everywhere we go in the U.S. or Canada to meetings with potential clients, investors or venture capital companies, the only thing that people want to talk to us about is AIM. We’re coming into deals that five years ago would have been part of a drip-feed onto NASDAQ. Now that’s flipped completely. (Quoted in Dey, 2006)

And in the words of another financial commentator, “AIM is flourishing and companies from around the world are coming to London exactly because the dead weight of regulation is so much greater in their own markets” (Financial Times, 2006).

With the economic downturn starting in 2008, all markets, including AIM, saw a decrease in the number of IPOs and downward movement in the market capitalization of listed firms. But as of 2012, the London Stock Exchange (p.94) and AIM are experiencing recoveries similar to those of competing markets. Figure 6.6 shows the number of companies on AIM as increasing from 10 companies in 1995 to 1,122 companies in 2012. The number of total firms has decreased from its peak in 2007 (with some of the firms going bankrupt, some being acquired by other firms, some going private, and some moving to other exchanges, such as the London Stock Exchange’s main market); as a result, the total market capitalization on AIM is down 27 percent from its peak in 2008 (figure 6.6).

Markets Creating TransparencyCompeting Listing and Disclosure Requirements from the Big Board in New York to the Alternative Investment Market in London

Figure 6.6 Number of Companies and Market Value of Firms Listed on AIM

Source: Data are from AIM Market Statistics, February 2012.

6.3.2. The Process for Dealing with Fraud at AIM and Why Flexible Regulation Does Not Lead to a Race to the Bottom

How well do flexible private regulations work? AIM clearly has attracted many new firms, and as measured by the number of deals and amount of money raised, AIM appears to be a clear success. But what about the longevity of these firms and cases of fraud? There are two potential sources of failure, namely, honest but unintentional firm failure, and deliberate fraud. The result for both is shareholders losing money. Securities fraud occurs when investors are given false information that induces the buying and selling of securities. Oftentimes people debate about whether a firm going into bankruptcy (p.95) deliberately committed bad choices or just made poor but well-intended business decisions. Without knowing what managers were thinking, sometimes we cannot easily disentangle the two, but the two summed together can be measured by looking at firms’ survival rates.

In AIM’s case the firms going public get to select the firms that regulate them. Advocates of centralized government regulation argue that allowing competition among regulators can allow firms to shop for regulators that allow them to bend or ignore good rules (Coffee, 1995). London’s Sunday Business (2007) reports, “Critics claim that AIM, with 1,634 constituents with a combined market value of £90.66bn to the end of 2006 and including 306 non-British firms, is a dustbin for poorly-run businesses.” In 2007, former SEC commissioner Roel Campos accused AIM of creating a market like a casino (Treanor, 2007). The number of firms listed on AIM went from a peak of 1,694 in 2007 to 1,091 in 2015 (London Stock Exchange, 2015).

Espenlaub, Khurshed, and Mohamed (2012) conducted a study of the IPO survival rate of firms going public on AIM (the survival rate looks at the percentage of firms that fail various numbers of years after going public) and found it to be very much in line with the survival rate of firms going public on more regulated exchanges. From a comparative point of view, even though firms traded on AIM have had their successes and failures, they do not appear to be significantly different from firms traded elsewhere as a result of fewer government regulations. Khurshed, Paleari, and Vismara (2005) note that (p.96) AIM firms utilize IPOs mainly to finance growth and have a high level of equity retention. Critics of AIM companies may highlight the illiquidity of AIM shares relative to larger exchanges. However, average AIM firms have greater liquidity than they would otherwise have on other exchanges (Litvintsev, 2009, p. 26).

Is AIM a good place for firms to raise capital, but also a place where investors are more likely to be swindled? It must be recognized at the outset that no stock market, however regulated, can ever be 100 percent free of listed firms going broke (nor should it be—that is how markets work). The whole point of stock markets is that they allow investors to become partial owners in firms, creating the potential for both higher risks and higher returns. Putting the issue of fraud aside completely, markets for small-cap firms can be especially risky. Nevertheless, although many firms have indeed been delisted from AIM (Matthews, 2010), many were simply purchased (Dawber, 2010), which in no way is an indication of failure. Figure 6.7 plots the performance of the FTSE AIM All-Share Index (an index created by the Financial Times and the London Stock Exchange for all equities listed on AIM) versus the Dow Jones Industrial Average. One contains very small firms and the other contains established blue chips, but both have had their ups and downs over the past ten years; the AIM All-Share Index possesses higher variance but not substantially worse or (p.97) better performance overall. Even though many small-cap firms traded on the more privately regulated AIM have faced tough times in recent years, so have firms on more regulated markets. Yet AIM has enabled many smaller firms to raise money and has provided more investment outlets to investors.

Markets Creating TransparencyCompeting Listing and Disclosure Requirements from the Big Board in New York to the Alternative Investment Market in London

Figure 6.7 Performance of All Firms Listed on AIM Compared with the Dow Jones Industrial Average

Source: Data are from Google Finance Historical Prices, 2012.

Why have failure and fraud not run rampant, as the “race to the bottom” theorists would have predicted? Even though Nomads are hired by the firms that they regulate, both the London Stock Exchange and investors must approve these regulators. The London Stock Exchange is the first gatekeeper, as it can expel a Nomad for improperly fulfilling its role. The second gatekeepers are the investors, many of whom are institutional and have repeated experience with the Nomads. If a Nomad establishes a reputation among listing firms for laxity in its regulatory duties (the race to the bottom), that reputation can be easily transmitted to investors. Although investors may find it difficult to fully investigate each of the thousand-plus firms listing shares, they can more easily see if a Nomad is consistently peddling fraudulent firms. As Mendoza (2008, p. 318) states, “Nomads build their reputational capital by servicing clients over prolonged periods of time, and ultimately pledge this highly valuable asset to vouch for the suitability of AIM companies and the accuracy of their disclosures to the market.” Nomads include widely recognized firms such as Deloitte and Touche, PricewaterhouseCoopers, JP Morgan, Morgan Stanley, and HSBC Bank. Each of these firms has significant reputational capital that it does not want to risk.3 Furthermore, to continually improve its regulations, the Exchange has formed the AIM Advisory Group to provide input from Nomads, brokers, advisors, and market participants (London Stock Exchange, 2012a). In this way, AIM can continually receive feedback from its community to encourage and develop its operational efficiency and regulations.

The amount of fraud will never be zero, but AIM has effectively kept its level quite low. In order to completely eliminate fraud, there would have to be no transactions. Since the founding of the Exchange in 1995, AIM has experienced four major instances of alleged fraud. The first involved Langbar International, which in 2005 had its shares suspended from trading and was put under investigation by the Serious Fraud Office for allegedly defrauding investors of £570 million (Mason, 2011). Appropriately, this led to negative repercussions against Langbar International’s Nomad, Nabarro Wells. In October of 2007, AIM fined Nabarro Wells £250,000 because it “failed to undertake the necessary level of due diligence to assess the appropriateness of certain companies for admission to AIM” (Kennedy, 2007). Following the incident, Nabarro Wells recorded a loss of £300,000, as compared with the previous year’s profit of £183,000, and in April 2008 Ambrian Capital acquired Nabarro Wells for less than £1 million (Evening Standard, 2008).

(p.98) The second largest fine issued by AIM was in 2009 on a Nomad named Blue Oar Securities. In that case, an air conditioning company, Worthington Nicholls, had floated shares at 50p in 2006 and saw them rise to 194p in 2007. But by 2008 financial shortfalls emerged and Worthington Nicholls shares fell to 10p. AIM conducted an investigation and found that Worthington Nicholls had “made announcements to the market which were misleading and/or omitted material information” between 2006 and 2007. AIM publicly censured and fined the Nomad Blue Oar for £225,000. Disgraced, Blue Oar ended up changing its name to Astaire Group and divesting its main division, Astaire Securities, for £2.45 million in 2010 (Bates, 2010. One article in the Telegraph concluded, “After all, few things like a good public flogging serve to remind brokerage houses to show a little caution in who they bring to market in the first place—and the importance of never, ever misleading investors” (Taylor, 2009). Another commentator stated, “People will admire them [AIM] for taking a tough line” (quoted in Taylor, 2009), which makes sense because AIM does not want to see the value of its market tarnished.

Although critics could argue these examples of fraud show a failure of the system, it must be recognized that no system, including the extremely regulated markets, has prevented 100 percent of fraud. If anything, the fact that only four known major instances of fraud have occurred among the more than 3,200 firms that have traded in the history of AIM indicates that AIM has been extremely successful in keeping fraud to a minimum. John Pierce, CEO of the Quoted Companies Alliance, notes that for every fraudulent company “there are hundreds of AIM success stories with upstanding management teams working earnestly in the interests of shareholders” (quoted in Taylor, 2009). The ratio is 1 to 800, to be precise. The cases of fraud are quite contained and have not cascaded as the “Regulatory competition leads to a race to the bottom” theorists would have predicted.

6.4. Conclusion

When rules listing and disclosure requirement are valuable to investors, providers of private governance have incentives to provide them. Brokers from nineteenth-century New York and twentieth-century London realized they could make their market more attractive by screening firms, creating listing requirements, and requiring disclosure for investors. The requirements were not decided by government, but by the market participants themselves, win or lose, based on the attractiveness of their venue. Those that failed to adopt good rules or that adopted burdensome rules were at a competitive disadvantage, and those that adopted good ones succeeded. Rather than taking part in “a race to the bottom” in which anything goes, the New York Stock Exchange worked to make its market attractive and only put its stamp of approval on (p.99) firms that warranted trading. One of the main reasons for the success of the New York Stock Exchange and the more recent success of AIM is their effective systems of private regulation. Each offers a different set of private rules and regulations and caters to different market segments.

Where private regulators must always cater to investor wants, government regulators receive no market feedback about the desirability of their rules. I think Stigler (1975, p. 87) is right when he states, “Grave doubts exist whether if account is taken of cost of regulation, the SEC has saved the purchasers of new issues one dollar,” but let us assume, contrary to what I believe, that some rules and regulations from the Securities and Exchange Commission, the Sarbanes-Oxley Act, or other government mandates are indeed value enhancing. If they were indeed so value enhancing, then why not let market participants voluntarily adopt them? One exchange could say, “Our companies and member firms are in full compliance with the Securities and Exchange Commission and all other government rules,” while another could opt out, just as accredited investors are currently allowed to opt out. If the government rules were so great, then investors would flock to markets regulated by them, and no mandates would be necessary. The fact that mandates are required, however, is prima facie evidence that the rules are not value enhancing and would not pass a market test.

Providers of private governance have done an extraordinarily good job at putting a stamp of approval on legitimate firms and not putting a stamp of approval on bad ones. If investors, the customers of private governance, want to do business in the safest settings, they can do business with firms at New York Stock Exchange, or if investors want to opt out of those rules and trade elsewhere, they can. With private governance, the customer is king, and the servants are providers of private governance. Providers of private governance must remain faithful servants and have entirely different sets of knowledge and incentives than government bureaucrats. The more that providers of private governance make their markets transparent and prevent customers from being defrauded, the more that providers and customers of private governance gain.


(1) Banner (1998, pp. 250–51) argues against the somewhat popular belief that these two agreements cartelized markets.

(2.) Sections 6.3 and 6.4 of the chapter draw from Stringham and Chen (2012).

(3.) For a discussion on the role of reputation, see Shearmur and Klein (1997).