A Basic Introduction to Capital Markets and Financial Disclosures
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Capital markets and financial disclosures are a key aspect of a functioning financial system and modern economy. They play a major role in the allocation of capital across the economy.
Capital markets are intermediaries where financial securities are bought and sold (such as the New York Stock Exchange). Capital markets can be divided into primary and secondary capital markets. Primary capital markets are where investors buy newly issued securities from an issuer (e.g., a corporation) to help it raise capital. Issuers can use capital from primary markets to fund a variety of activities, such as paying workers, building new factories and plants, and making acquisitions.
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Secondary capital markets are where investors trade previously issued securities. Secondary capital markets don’t directly raise money for issuers, but they make it easier for issuers to sell securities on primary markets. This is because investors have more incentive to buy newly issued securities if they can quickly sell them at a reasonable price in secondary markets when necessary.
The rest of this piece will focus on primary capital markets for corporate securities (which will just be referred to as “capital markets”), but much of this logic applies to capital markets in general.
For capital markets to work well, investors need information to determine whether a company is a good investment or not. A lack of information about a company can discourage investors from buying securities in the company because they cannot properly evaluate it. It can also make investors more susceptible to deception and fraud.
Financial disclosures can help provide investors with access to this information, so they can decide which companies to invest in and how to best allocate their capital. This can make the economy more efficient by directing capital towards productive and well-managed companies. Financial disclosures can include information such as a company’s cash on hand, net income, and liabilities for investors to evaluate. The federal government mandates financial disclosures from publicly traded companies to provide investors with useful information for making investment decisions and to help protect these investors from deception, fraud, and abuse. Public companies must provide certain information in these disclosures, but they have more discretion on whether to disclose other information.
Deciding what information a company should disclose to investors is a balancing act. Disclosing too little information can prevent investors from adequately evaluating a company, which can lead them to underinvest or make poor investment decisions.
However, disclosing too much information, can be overly burdensome to the company and overwhelm investors with excess information.
Getting financial disclosures correct is important in fostering a well-functioning capital market. These disclosures can help investors determine where to invest and provide productive companies with a vital source of capital.
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