Financial History

Adam Smith on the Profits of Stock

by hurricanecapital

“All money is a matter of belief.” —Adam Smith

The rate of return, or the level of profit, is one of many issues discussed by Adam Smith in his now famous and influential economics book The Wealth of Nations. Below is a brief excerpt of the first few paragraphs of chapter nine—Of the Profits of Stock. In this chapter Adam Smith lays out his view on profits, returns and interest rates, and also where to look to get some indications and guidance on what level of interest one could reasonably expect. To read the whole chapter, click on the link at the end of the text (emphasis added).

OF THE PROFITS OF STOCK

I.9.1

The rise and fall in the profits of stock depend upon the same causes with the rise and fall in the wages of labour, the increasing or declining state of the wealth of the society; but those causes affect the one and the other very differently.

I.9.2

The increase of stock, which raises wages, tends to lower profit. When the stocks of many rich merchants are turned into the same trade, their mutual competition naturally tends to lower its profit; and when there is a like increase of stock in all the different trades carried on in the same society, the same competition must produce the same effect in them all.*49

I.9.3

It is not easy, it has already been observed, to ascertain what are the average wages of labour even in a particular place, and at a particular time. We can, even in this case, seldom determine more than what are the most usual wages. But even this can seldom be done with regard to the profits of stock. Profit is so very fluctuating, that the person who carries on a particular trade cannot always tell you himself what is the average of his annual profit. It is affected, not only by every variation of price in the commodities which he deals in, but by the good or bad fortune both of his rivals and of his customers, and by a thousand other accidents to which goods when carried either by sea or by land, or even when stored in a warehouse, are liable. It varies, therefore, not only from year to year, but from day to day, and almost from hour to hour. To ascertain what is the average profit of all the different trades carried on in a great kingdom, must be much more difficult; and to judge of what it may have been formerly, or in remote periods of time, with any degree of precision, must be altogether impossible.

I.9.4

But though it may be impossible to determine with any degree of precision, what are or were the average profits of stock, either in the present, or in ancient times, some notion may be formed of them from the interest of money.*50 It may be laid down as a maxim, that wherever a great deal can be made by the use of money, a great deal will commonly be given for the use of it; and that wherever little can be made by it, less will commonly be given for it.*51 According, therefore, as the usual market rate of interest varies in any country, we may be assured that the ordinary profits of stock must vary with it, must sink as it sinks, and rise as it rises. The progress of interest, therefore, may lead us to form some notion of the progress of profit.

Source: Econlib

KKR and RJR Nabisco: Video + Case

by hurricanecapital

“I think Henry might tell you today that part of what was driving him subconsciously was the desire to win. The single most deadliest sin that you could have in the acquisitions business.” —Bryan Burrough, Author “Barbarians at the Gate”

Warren Buffett wrote about RJR Nabisco as a major arbitrage position in the Berkshire Hathaway’s letter to shareholders for fiscal year 1988, as follows:

At yearend, our only major arbitrage position was 3,342,000 
shares of RJR Nabisco with a cost of $281.8 million and a market 
value of $304.5 million. In January we increased our holdings to 
roughly four million shares and in February we eliminated our 
position. About three million shares were accepted when we 
tendered our holdings to KKR, which acquired RJR, and the 
returned shares were promptly sold in the market. Our pre-tax 
profit was a better-than-expected $64 million.

     Earlier, another familiar face turned up in the RJR bidding 
contest: Jay Pritzker, who was part of a First Boston group that 
made a tax-oriented offer. To quote Yogi Berra; “It was deja vu 
all over again.”

     During most of the time when we normally would have been 
purchasers of RJR, our activities in the stock were restricted 
because of Salomon’s participation in a bidding group. 
Customarily, Charlie and I, though we are directors of Salomon, 
are walled off from information about its merger and acquisition 
work.  We have asked that it be that way: The information would 
do us no good and could, in fact, occasionally inhibit 
Berkshire’s arbitrage operations.

     However, the unusually large commitment that Salomon 
proposed to make in the RJR deal required that all directors be 
fully informed and involved.  Therefore, Berkshire’s purchases of 
RJR were made at only two times: first, in the few days 
immediately following management’s announcement of buyout plans, 
before Salomon became involved; and considerably later, after the 
RJR board made its decision in favor of KKR. Because we could 
not buy at other times, our directorships cost Berkshire 
significant money.

RJR Nabisco – 1990, HBS Case

RJR Nabisco – 1990, HBS Case Solutions

A Case Study of a Complex Leveraged Buyout

Businessweek Archives: ‘Barbarians’ Revisited

Collection of RJR Nabisco newspaper articles

Disclosure: I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company or individual mentioned in this article. I have no positions in any stocks mentioned.

Book on historical property prices and other data (Volume II)

by hurricanecapital

New book on historical property prices and other data

(Source: the Swedisk Riksbank)

Boldings below are my own.

R2“Friday 23 April will see the publication of a new book of statistics concerning the emergence of the Swedish monetary and financial systems, Historical Monetary and Financial Statistics for Sweden, Volume II: House Prices, Stock Returns, National Accounts, and the Riksbank Balance Sheet, 1620–2012.
The book is the second in a series of two books on financial history and focuses on property prices, gross domestic product, equity prices, money supply, national debt and the Riksbank’s accounts.

Sweden is a small country, but provides an interesting historical example of an area on the periphery of Europe with statistical data of a high quality. The Riksbank is considered to be the world’s oldest central bank. Presenting its balance sheets and central monetary and financial variables thus offers a unique account of monetary history. Price and macroeconomic stability are constantly recurring issues. What we can learn from history is that the timing of crises and major changes in the economic system tend to be very difficult to predict.

The book also presents property prices going all the way back to the 1870s, which may bring a new perspective to the discussion of whether or not price increases on Swedish property can be interpreted as a housing-price bubble.

[…]

The book, which is published by the Riksbank together with publishers Ekelids Förlag AB, forms part of a more comprehensive project that has previously resulted in a database of historical monetary statistics which can be found on the Riksbank’s website. The first book was published in 2010 and presents data on exchange rates, prices and wages, with some series going all the way back to the 13th century.”

Links

Historical Monetary and Financial Statistics for Sweden: Exchange Rates, Prices, and Wages, 1277-2008 (Volume I)

by hurricanecapital

Historical Monetary and Financial Statistics for Sweden: Exchange Rates, Prices, and Wages, 1277-2008

(Source: the Swedisk Riksbank)

Boldings below are my own.

R1“Swedish monetary and financial history is fascinating yet perplexing. The authors of this book – economic historians from the universities of Göteborg, Lund, and Stockholm, in co-operation with Sveriges Riksbank – present new data concerning the long-term evolution of monetary units, exchange rates, consumer prices and wages in the second millennium. In this period the Swedish monetary system has changed significantly but there are also similarities that span centuries.

In the Middle Ages, different currencies were used in different parts of the country. Later, in the 17th and 18th centuries, five or six domestic currencies – copper, silver, gold and paper monies – were used side by side with floating exchange rates relative to each other. While the use of several currencies was common in the early modern period, the copper standard added to the complexity in Sweden.

Sweden introduced paper notes in 1661 – the first European country to do so – and this was followed by the formation of Sveriges Riksbank, the world’s oldest central bank, in 1668.

The high transaction costs involved in handling copper money contributed to the attraction of paper notes. In the 18th century it was experience of paper note inflation that produced the first clearly formulated quantity theory for fiat money.

The new data on real wages suggest that unskilled labourers were better off in the late Middle Ages than in the mid-19th century. The newly constructed Consumer Price Index shows that the average annual rate of inflation in Sweden 1290–2008 was 2.5 per cent, remarkably close to Sveriges Riksbank’s present two per cent inflation target. Historically, the Swedish currency has been weak compared with the currencies of its main trading partners. Commitments towards a stable currency have been made time and again, but great events, such as wars and deep economic crises, have often, though by no means always, shattered such assurances.”

Links

Swedish stock and bond returns, 1856–2012 (part 3)

by hurricanecapital

Stocks and Bonds for the Long Run

Data and text in this post taken from the chapter House Prices, Stock Returns, National Accounts, and the Riksbank Balance Sheet, 1620–2012 in the book Historical Monetary and Financial Statistics for Sweden, Volume II.

P1The chapter contains facts about:

  • The long-run evolution of Swedish financial market returns over the past one hundred and fifty years
  • The short-term risk-free rate of return is presented from 1856 and a representative long-term government bond yield from 1874
  • A preliminary version of a new annual stock price and returns index for the period 1870–2012, using previously unexplored evidence of historical stock prices, dividends and equity capital from the last decades of the 19th century

Part 3: Swedish Markets – Bond Returns

“Turning to fixed income returns, Figure 6.6 shows the evolution of the yield on two securities: a long-term government bond and a short-term Treasury bill (actually, the Riksbank’s official discount rate) going back to the middle of the 19th century. As can be seen from the figure, there has been a high degree of correlation in the yield levels of these two instruments. The short-term rate lies somewhat below the longterm government bond rate in the latter part of the 20th century, except during the turbulent era in the 1990s when the Riksbank raised its short-term rates to dramatic levels in an attempt to support the fixed exchange rate (which was abolished after a short time).”

P11“A comparative view of the long-run evolution of inflation-adjusted returns on stocks, bonds and bills is provided in Figure 6.7. The main message is that stock investments have performed dramatically better over the course of the past 112 years than any of the fixed-interest securities. Note, however, that this only holds when dividend yields are incorporated; by themselves, stock price gains do not outperform yields on government bonds or bills. The order of magnitude is of interest. A stock investment of 100 SEK in 1901 rendered a portfolio worth 44,200 SEK in 2012 when dividends were reinvested and only 900 SEK when they were not. For government bonds, the same investment would give a portfolio of 1,300 SEK and for shortterm Treasury bills 700 SEK. Note that these ex post comparisons do not take into account the additional risk associated with stock investments.

While stocks outperformed fixed-interest securities over the period as a whole,
this was not the case in the first half of the 20th century. Up to 1950 both government bonds and bills represented a better investment than a stock purchase regardless of how dividends are treated. This is explained by the dramatic collapse of stock prices during the financial crises in the 1920s and 1930s. The total value of the stocks on the Stockholm Stock Exchange dropped by two thirds between December 1917 and December 1920 and by half between December 1930 and December 1932.”

P13 P12P14“As already mentioned in the introduction and data sections above, this chapter also presents a new stock price index and a new stock returns index for Sweden beginning in 1870, which allows an analysis of the entire era up to modern times. Due to a scarcity of data, at present these indices are only available annually. Furthermore, one sub-period (1892–1901) is based on a relatively small set of traded stocks and is therefore potentially less representative than both earlier and latter periods. Figure 6.8 displays the evolution of nominal and inflation-adjusted stock prices and returns on the Stockholm Stock Exchange during the late 19th century. There were two boom years, 1871–1872, when prices rose by a total of 56 per cent and returns by almost 80 per cent. This was followed by an international financial panic and long depression, when prices fell and even total returns were negative for a few years. In the period as a whole, it can be seen that capital gains were modest and most of the total return came from the dividend yield. As reported in Table 6.1, total returns averaged eight per cent a year between 1870 and 1901 and capital gains were somewhat over three per cent.”

P15“Table 6.3 presents summary statistics for bond and bill returns, both for the entire period and for the same sub-periods as for stock returns in Table 6.1. The average annual real return on a Swedish government short-term security was 1.7 per cent over the entire 20th century and up to 2012. For long-term government bonds the average annual real return was only marginally higher, 2.1 per cent. There is, however, a considerable variation across decades. Nominal yields were highest in the early era up to 1930 and in the 1980s and 1990s, largely due to relatively high inflation. Overall, comparing long-term and short-term yields suggests that the term premium, i.e., the return to investors for holding securities with longer maturities, has been significantly positive in almost every period in the past.

The typical argument for the existence of an equity risk premium is that investors demand compensation for holding volatile and risky corporate stocks instead of fixed-interest securities with lower returns, volatility and default risk.19 Table 6.3 shows the equity risk premium calculated as the difference between the nominal stock market return and the nominal short-term bond, both over a holding period of one year. Looking at the entire period 1901–2012, the equity risk premium is 2.5 per cent per year using geometric average returns and 4.7 per year using arithmetic average returns. Extending the period back to 1870 increases the premia to 3.8 per cent and 5.6 per cent, respectively. Interestingly, these premia are closer to what Frennberg and Hansson (1992b) found for the period 1919–1990: 3.6 and 5.5 per cent, respectively. In other words, the historical time dimension matters for the estimation of equity premia, as has been found for other countries (see Goetzmann and Ibbotson, 2006) and now also for Sweden.

A closer look at the equity premia across time periods reveals a striking degree of variation. There are decades when the equity premium is virtually zero (e.g., the 1900s and 1970s) or even negative (the 1910s through the 1930s and the 2000s), and decades when it is substantial (the 1950s, 1980s, 1990s). Holding stocks for one year has thus not been a universally successful strategy, not even when averaged over a decade.”

P16P17Links

Swedish stock and bond returns, 1856–2012 (part 2)

by hurricanecapital

Stocks and Bonds for the Long Run

Data and text in this post taken from the chapter House Prices, Stock Returns, National Accounts, and the Riksbank Balance Sheet, 1620–2012 in the book Historical Monetary and Financial Statistics for Sweden, Volume II.

P1The chapter contains facts about:

  • The long-run evolution of Swedish financial market returns over the past one hundred and fifty years
  • The short-term risk-free rate of return is presented from 1856 and a representative long-term government bond yield from 1874
  • A preliminary version of a new annual stock price and returns index for the period 1870–2012, using previously unexplored evidence of historical stock prices, dividends and equity capital from the last decades of the 19th century

Part 2: Swedish Markets – Stock Returns

“The Swedish bond market emerged in the middle of the 19th century. At first, the most important borrowers on the domestic market were mortgage associations and industrial corporations (Gårdlund, 1942). The Swedish government did issue bonds, but these were floated almost exclusively in foreign markets up until the 1920s. From the interwar period onwards, the Swedish government has been the main borrower and almost all of its loans have been issued to the domestic market.

Secondary bond trading in Sweden has traditionally been conducted outside the organized stock exchange. Investors have traded bonds over the counter at banks or in bilateral block transactions. The Stockholm Stock Exchange has regularly listed bond prices since the late 19th century. Within the Exchange, however, bond trading takes place in several markets, depending on the type of loan. Convertible public sector loans are quoted alongside stocks on the A (main) and O (subsidiary) lists. Premium lottery bonds are traded separately. Finally, there is a retail market – the SOX market – in which bonds are transacted freely. The volume of secondary trading on the Exchange has generally been smaller for bonds than for stocks.

Although bonds were not always traded actively on the Stock Exchange, quoted bond market prices have been published in several listings by the Stock Exchange as well as by stockbrokers and banks. In the postwar period, the Swedish secondary bond market has been dominated by trading in government and mortgage loans. Corporate bonds have been relatively few and are normally held by investors until maturity.

Stock returns and bond prices and yields are reported in both nominal and real terms, using inflation data from various sources. Annual consumer price index data are collected from the Riksbank project on Historical Monetary and Financial Statistics for Sweden, described in Edvinsson and Söderberg (2010). A monthly price index does not exist for the entire period. Frennberg and Hansson (1992a) use the Swedish National Board of Health and Welfare’s cost-of-living index to construct a monthly price index back to 1918.”

P5Stock market data: Descriptive Analysis

“Figure 6.3 presents stock returns on the Swedish stock market since 1901. The series are indexed so that they all equal one in October 1901, the starting date for the stock price index at the reorganized Stockholm Stock Exchange. Several interesting patterns emerge. First, the long-run picture differs quite markedly between prices and returns. Real prices were virtually unchanged throughout the 20th century up to 1980, when they started to increase. In contrast, real returns steadily increased, which emphasizes the historical importance of dividends to Swedish investors.”

P6“The level of stock returns has not been constant over time. Business cycles and periods of financial and economic crisis have led to fluctuations in corporate profits as well as in investors’ income and wealth returns. This warrants an investigation into the extent to which stock returns in Sweden have varied over time. Table 6.1 provides a set of summary statistics of Swedish stock market returns for different sub-periods. Using the arithmetic average to calculate the mean return since 1901 gives an annual real return of 7.6 per cent. There were, however, some decades when the real market return was much higher than this; in the 1950s it was almost 13 per cent and in the 1980s and 1990s it was 20–25 per cent. In other decades it was lower and in the 1910s and the 1970s the average return was even negative.

Table 6.1 decomposes the stock returns into the price change, or capital gain, component and the dividend income component. The average nominal annual continuously compounded stock return over the entire study period, 1901–2012, is 7.8 per cent. Adjusting for consumer prices almost halves the return to 4.2 per cent. Decomposing the total nominal return of 7.8 per cent, about half comes from nominal capital gains (3.8 per cent) and half from the dividend yield (3.9 per cent). What the table also shows, however, is a considerable variation in stock returns across eras. Investing in the stock market portfolio in either 1930 or 2000, and then selling a decade later, resulted in losses. In contrast, an investment in the portfolio in 1980 yielded an average return of almost 30 per cent each year! It is also noteworthy that almost all of the variation across decades comes from differences in stock prices, whereas dividends have been fairly stable over time (see further on dividends below).

Another way of assessing the variation in stock market returns is to look at the individual months and years when returns were extremely high or low. Table 6.2 provides such evidence by listing the top and bottom ten months (Panel a) and years (Panel b) based on a ranking of all returns during the entire period studied. The list of dates in the table also provides a snapshot of the historically important events in the history of the Swedish stock market.

Looking at the highest returns, it is striking that most of them stem from the period after 1980. Nine out of ten top years and eight out of ten top months occurred during the 1980s, 1990s or the 2000s. This reflects the long boom on the Swedish stock market that occurred after 1980. However, some of the top months represent bounce-backs during recessions. The highest monthly return, on November 1992, occurred in the middle of the 1990s financial crisis but reflects the sudden drop in the Swedish exchange rate after the Riksbank decided to leave the ERM’s fixed exchange rate system. The high returns in single months during the banking crisis of 1921 and 1922 likewise reflect bounce-backs.

Looking at extremely bad months and years, the share of years from earlier historical eras is higher. The worst month on the Swedish stock market over the past 112 years was March 1932, when the industrialist Ivar Keuger committed suicide and his conglomerate collapsed. The other bottom return months also reflect important economic or political events, including collapses of financial firms that mark the beginning of financial crises (November 1907, September 1990, October 2008), global stock market crashes (October and November 1987) or political events such as Germany’s invasion of Denmark and Norway during the Second World War (April 1940). The picture of the lowest yearly returns is similar; they are typically associated with the major economic crises and political turbulence during the historical period under study.”

P7

P8“The volatility of stock prices is one of the most distinct features of this form of investment, distinguishing it from most other forms of financial investment such as bonds or bank deposits. Figure 6.4 shows the evolution of stock market volatility on the Stockholm Stock Exchange since 1901. Volatility is calculated as the 12-month standard deviation of the nominal capital gain, presented as a rolling window over the entire period. There are three peaks in volatility: the early 1920s (deflation and a banking crisis), the early 1930s (international financial crisis and the Kreuger crash) and the early 1980s (devaluations and stock market boom).

As can be seen from Figure 6.4, stock market volatility varies over time. Determining whether this variability is significant or merely a matter of nuances requires a more systematic take. I therefore applied the estimation methodology for detecting and measuring structural breaks in time series proposed by Bai and Perron (1998, 2003). The results of this estimation are indicated by the horizontal solid line. Stock price volatility on the Swedish stock market did indeed increase significantly from the early 1980s onwards. In this estimation the recent era been the most volatile in the modern history of Swedish stock markets, which may contradict some preconceptions about the role of technological development in stock market volatility. The second most volatile period was the interwar era, which is hardly surprising considering the extreme economic and political turbulence in this period. The quietest periods were the early 1900s and the postwar era up to 1980.”

P9“As apparent from the analysis above, dividends have been a significant part of total stock returns in Swedish stock markets. Figure 6.5 displays the evolution since 1901 of dividend yields on the Stockholm Stock Exchange, calculated as the annual average dividend level divided by monthly stock prices. Although the monthly variation in the series is considerable, dividend yields follow a fairly clear secular decreasing trend. An application of the Bai and Perron (1998, 2003) time series method for estimating structural breaks revealed two significant breaks in the mean dividend yield. Dividends hovered around five per cent up to the early 1940s; they were somewhat lower, around four per cent, in the postwar period up to around 1980 and then decreased again to a level of around three per cent. It is difficult to tell just what explains the level of dividends. One hypothesis, put forward by Baskin (1988), is that in early financial markets firms used dividends to overcome information asymmetries vis-à-vis stock investors. By making stocks more similar to fixed-interest securities, e.g., bonds, a smaller premium was sufficient when firms acquired external finance.”

P10Links

Swedish stock and bond returns, 1856–2012 (part 1)

by hurricanecapital

Stocks and Bonds for the Long Run

Data and text in this post taken from the chapter House Prices, Stock Returns, National Accounts, and the Riksbank Balance Sheet, 1620–2012 in the book Historical Monetary and Financial Statistics for Sweden, Volume II.

P1The chapter contains facts about:

  • The long-run evolution of Swedish financial market returns over the past one hundred and fifty years
  • The short-term risk-free rate of return is presented from 1856 and a representative long-term government bond yield from 1874
  • A preliminary version of a new annual stock price and returns index for the period 1870–2012, using previously unexplored evidence of historical stock prices, dividends and equity capital from the last decades of the 19th century

Post 1: History of the Swedish Stock Market

P2“The Swedish stock market emerged gradually during the second half of the 19th century. One of the largest brokers in Stockholm was mandated by the City in 1863 to hold the first auction of securities; this is generally considered to be the foundation year of Sweden’s largest stock exchange, the Stockholm Stock Exchange. At that time there was a growing demand for organized trading in financial securities, primarily stocks and corporate bonds. In the initial years, no governing authority closely directed the business activities on the Exchange. In 1866, however, the City of Stockholm set up the Trade and Shipping Commission (Stockholm stads handels- och sjöfartsnämnd), which exercised the supreme operative and regulatory control of the Exchange. Auctions were held only once a month until 1895, after which they  became weekly. Securities auctions were also held in some other cities but, as shown by Algott (1963), these market-places never accounted for an important share of Sweden’s total securities trading.

The trading framework on the securities auctions was such that buyers and sellers submitted their orders to the responsible broker in good time before the monthly auction. Then, at the auction, the broker declared the orders one at a time, followed by an opportunity for investors to either accept the trade or offer either higher or lower bid or sell orders. The broker then recorded the number and value of traded securities. Trading activity was relatively slight at first. Figure 6.1 shows the value of traded securities (stocks and bonds) as a share of market capitalization from the beginning of the Exchange’s practices to the present day. As can be seen, trading activity was relatively low in the 19th century and in the middle of the 20th century, and relatively high during the early and late 20th century.

P3As Sweden’s industrialization gradually took hold during the last decades of the 19th century, many new corporations issued stocks to a growing population of investors. This led to demands for a more organized market for securities trading. The monthly, and in the late 1890s weekly, auctions without a fixed list of shares or firm rules for pricing were clearly not sufficiently continuous for the market participants. Algott (1963) refers to the contemporary critical discussions. For this reason, the Stockholm Stock Exchange was thoroughly reorganized in 1901. The new trading structure was largely copied from the Copenhagen Stock Exchange, except that the existing auctioning system was retained, in contrast to Copenhagen’s dealership market. Trading in Stockholm was conducted by the head of the Exchange, who called out the registered stocks in a predetermined order. When a stock was called out, all market participants were able to state the levels at which they were willing to buy/sell (bid and ask quotes). When a bid and an ask level matched, a trade was registered and the transaction was completed.

Under the new framework, trading was confined to listed securities. Listing was contingent on approval of a written application submitted to the board of the Stock Exchange, containing detailed information about the security (e.g., articles of association and the latest audit report). Moreover, only brokers certified by one of the City’s councils were allowed to broker deals on the Exchange. The Exchange’s membership was small initially, only a handful or so during the first five years, but when membership was extended to banks in 1907, it rose to more than 20. Trading initially took place three times a week; daily auctions were introduced in the 1910s. Several stock price lists were published in this early era. Before 1912, the Exchange did not compile an official price list; instead, brokers and banks published their own lists in newspapers (Algott, 1963, pp. 121f).

When the First World War started in 1914, Sweden left the international gold standard and the Stockholm Exchange closed down for three months (August 3rd to November 3rd). Leaving the gold standard, combined with an initial boom in the export-oriented domestic industry, led to a higher rate of inflation in Sweden during the war. This inflation boom was one of the factors behind a remarkable increase in trading activity on the Exchange during these years; stocks are normally one of the few forms of inflation-proof investment. The increased economic activity spurred increased volumes of new equity issues, which were at century-high levels (2–4 per cent of total market capitalization) during this period (Waldenström, 2004). Figure 6.2 presents the evolution of market capitalization as a share of GDP from 1870 to 2012. The increased activity also attracted new market actors; the number of stock exchange member firms increased from 20 in 1908 to 28 in 1914 and 46 in 1921. After the war, however, the spectacular bull market turned into a devastating crash when Sweden joined the gold standard at the prewar parity, which set off a deflationary spiral and plummeting stock prices.

P4The spectacular wartime bull market also inspired politicians in Parliament and the liberal-socialist government to finally incorporate the Swedish stock market in the national legislation. Acts passed in 1919 and 1920 formally regulated both the financial intermediaries dealing and trading in stocks and the Stockholm Stock Exchange. One important change was that the government took charge of appointing the Exchange’s board. Moreover, the right to establish new stock exchanges was restricted. In practice, though not formally, the Stockholm Stock Exchange acquired a monopoly of organized securities trading in Sweden. This legislation remained intact until the end of the 1970s and the Exchange’s monopoly status was not abolished until 1992. Thus, the legislative changes in 1920 were of immense importance in the long run.

Another consequence of the First World War and the postwar global depression, which greatly affected the Stockholm Stock Exchange, was the economic crisis in Sweden in the early 1920s, when industrial production almost halved. The  government launched a devastating deflationary monetary policy in order to bring the exchange rate back to the same level in relation to gold as during the classic gold standard. On top of this, Swedish commercial banks faced a period of systemic financial distress caused by the economic depression.

The early 1930s was another turbulent period that affected the Stock Exchange. Great Britain’s departure from the gold standard in September 1931 caused both economic and political problems in Sweden. The discount rated was doubled in a few days and the Stockholm Stock Exchange actually closed for three weeks. In 1932, by far the largest industrial conglomerate in Sweden failed in an enormous debt scandal with both governmental and international connections. This was the infamous “Kreuger Crash”, named after the conglomerate’s owner Ivar Kreuger, whose suicide in Paris on April 12th initiated the crisis. His holding company, Kreuger & Toll, owned large blocks of shares in all the main Swedish industrials.

After the Kreuger crash, the Swedish stock market was stagnant. Trading activity decreased and new listings were few. The Second World War put an end to Sweden’s relatively unregulated financial markets. Wartime mobilization and the effect of disrupted patterns of trade gave rise to an increased need for public funds, which necessitated a series of new laws to regulate the credit and financial markets. Banks and other financial market actors were required to offer funds to the central government. Furthermore, strict controls were imposed on cross-border capital flows.

In the history of the Swedish stock market, the postwar period up to roughly 1980 was on the whole relatively quiet. The wartime credit and capital market regulations were intact. Credit markets were entirely controlled by state authorities, especially the Riksbank, Sweden’s central bank. Stock-exchange trading activity was relatively low. For these reasons, the period is sometimes described as a “financial ice age”. At the same time, the Swedish economy performed well, with annual real per capita GDP growth at 2–3 per cent. Swedish companies were highly profitable and could meet most of their financial needs from retained earnings. Consequently the stock market became relatively unimportant as a source of funds. About 40 new companies floated their stock on the exchange in the 1950s and early 1960s, which brought the total number of listed companies up to 115. In the following decade, however, the number decreased by 20 (Boman, 1988). In these decades the valuation of the Swedish stock market was very low. Some of the main factors behind this weak development were no doubt the strict rules for issuing and floating new shares, listing and participation in trading at the Stockholm Stock Exchange.

In the 1970s, financial innovations aimed at increasing stock market turnovers were introduced in the Western world, including Sweden (see Werin, 1993). One of the major moves was the introduction of computers in trading systems. More trades were executed at a faster pace and more customers were able to acquire exchange information and submit trades thanks to the wider outreach of brokerage firms and banks.

In 1980 Sweden was still a highly regulated economy with virtually no stock market activity, regulated capital and credit markets, and a debate about “wage-earner funds”, a scheme designed to shift corporate ownership to trade unions by way of higher corporate taxes. All this changed dramatically largely through a series of reforms, starting with the deregulation of capital markets and international capital movements in the 1980s, tax reforms in the mid-1980s and early 1990s and an end to the idea of wage-earner funds in the early 1990s. As a result of technological developments and the reforms of Swedish financial markets, of which the deregulation of credit and currency in the latter half of the 1980s was the most important, the Swedish stock market boomed. In the 1980s the stock market index rose twelvefold, or four times as much as the Dow stock index in the US. The boom attracted both new capital and new actors. By 1997, 352 IPOs were registered on the Stockholm Stock Exchange, a dramatic increase from the low levels in earlier decades (Holmén and Högfeldt, 2005). A derivatives market, OM (“Optionsmäklarna”), also emerged in Sweden in the second half of the 1980s. This market enabled investors to trade a number of new financial instruments, such as options and warrants, which offered insurance mechanisms as well as new investment opportunities that did not exist on the Stockholm Stock Exchange.

Further important changes occurred on the Swedish stock market in the 1990s. In 1993, trading was opened up for non-residents, which led to an increase in foreign ownership of the exchange-listed stocks from a few per cent to forty per cent in the course of a decade (Henrekson and Jakobsson, 2012). Another change was the formal end to the Exchange’s trading monopoly, allowing securities trading to take place elsewhere. Other market actors organizing trading started to grow and in 1998 the Stockholm Stock Exchange was acquired by the largest of the private actors, OM, forming the OM Stockholm Stock Exchange (“OM Stockholmsbörsen”). As a consequence, the exchange ceased to be a semi-public market place and became a privately owned for-profit company selling products associated with securities trading.

In the early 21st century, the OM Stockholm Stock Exchange expanded by purchasing the Helsinki Stock Exchange in 2003 and changed its name to OMX. In 2005 OMX acquired the Copenhagen Stock Exchange and in 2006 the Iceland Stock Exchange. In 2008, OMX was itself purchased by Nasdaq, which gave the market-place its current name, NASDAQ OMX Nordic. These organizational changes have not involved any dramatic changes in securities trading on the Stockholm stock market. The new owners have, however, introduced several new features, including new lists containing various selections of Nordic securities as well as separate listings for small-, middle- and large-sized companies in terms of equity capital.

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