Equity has different meanings, depending on the business context. In general, equity is the ownership interest of shareholders; in accounting it is the portion of a company’s assets owned by shareholders, as opposed to the amount the company has borrowed. In this context, equity equals assets minus liabilities, or net worth. This is also referred to as stockholders’ equity. Similarly, in banking equity is the market value of a property minus the loans against the property. Equity loans are based on this type of equity.
Equity, equity interest, and equity markets are all a critical part of any capitalistic economic system. By definition, capitalism is a social and economic system based on private property rights, private allocation of capital, and selfinterest motivation. Capitalism is often referred to as a free-enterprise or market system. Capitalism contrasts with socialism, in which most resources and industrial production systems are state-owned or controlled; and with communism, in which most resources are stateowned and most decisions regarding output are made through central planning. Equity and the ability to transfer equity interests are essential to the flow of capital. In the circular flow model of an economic system, households provide savings, either directly or indirectly, through financial intermediaries to businesses. Businesses use savings to purchase capital to produce goods and services, which in turn are purchased by consumers. In exchange for their savings, households receive either interest income for loans or an ownership interest in the business—equity.
Equity interests are often exchanged among investors in stock exchanges. While these venues create new equity interests through initial public offerings (IPOs), most stock trading is a transfer of ownership interests. In the United States the oldest and most prominent stock exchange is the New York Stock Exchange (NYSE). Established in 1792, along a wall that had been used to keep wild pigs out of settlers’ gardens in lower Manhattan, the NYSE is the largest stock exchange in the world based on dollar value of shares traded. In 2000 the exchange traded 262.5 billion shares, valued at $11.1 trillion dollars.
While NYSE dominates the stock exchanges in dollar volume traded, the over-the-counter (OTC) market is the largest stock exchange in terms of the number of different corporations whose stocks are traded there. The backbone of the OTC market is NASDAQ, the National Association of Securities Dealers Automated Quotation. Geographically dispersed securities dealers connected by computers are the intermediaries for the OTC stock traders. The enormous size of the OTC market is illustrated by the fact that NASDAQ surpasses NYSE in annual share volume.
As important as equity markets are to the U.S. economy, they are sometimes even more important to countries that are transitioning from socialism to capitalism. In the 1990s Mongolia, with the advice of former Secretary of State James Baker, privatized its few industries, issuing each adult shares of stock in what had been governmentcontrolled industries, including the electrical company, railroad, and a few factories. The old opera house in Ulan Batur, Mongolia’s capital, was converted into the national stock exchange. Government representatives held numerous education forums, explaining what shares of stock were and what value they might have.
Romania was one of the last post-communist countries to move toward capitalism. After the assassination of dictator Nicolae Ceaus¸escu, Romania was pressured by the International Monetary Fund (IMF) and World Bank to “establish the infrastructure for a market economy.” In response, Romania created two small stock exchanges modeled after the U.S. system. One, the Bucharest Stock Exchange (BSE), trades “listed securities.” Starting with six listings and 24 brokerage companies, by 2002 the BSE had 60 companies listed and 100 brokerage firms. The other, the Rasdaq, like the NASDAQ, acts as an over-thecounter electronic exchange. Romanian managers were initially shocked that the exchanges required financial transparency; disclosure of the balance sheets, and other financial information. They quickly learned that attracting equity investment in emerging markets like Romania required transparency. The Romanian stock exchange remains tiny, with a market capitalization of only the equivalent of $1.3 million, but it represents a starting point for creating equity ownership.
The Securities and Exchange Act of 1934 defines an equity security as “any stock or similar security, certificate of interest or participation in any profit sharing agreement, pre-organization certificate or subscription, transferable share, voting trust certificate or certificate of deposit for an equity security, limited partnership interest, interest in a joint venture, or certificate of interest in a business trust or any security convertible, with or without consideration into such a security, any such warrant or right; or any put, call, straddle, or other option or privilege of buying such a security from or selling such a security to another without being bound to do so.”
See also owner’s equity.