Tuesday, February 21, 2012

The World's First Stock Exchange (and first bear raid, first dividend, first equity derivatives...)

‘This little game could bring in more money than contracting charter parties for ships bound for England’, wrote Rodrigo Dias Henriques to Manuel Levy Duarte on 1 November 1691.1 Dias Henriques was referring to the ‘game’ of trading shares of the Dutch East India Company (Verenigde Oost-Indische Compagnie, VOC, founded 1602) and its derivatives* on the Amsterdam securities market.
A marvelous piece of scholarship from the University of Amsterdam.
VOC=Vereenigde Oost-Indische Compagnie "United East India Company" was created two years after the British East India Company.

How the Amsterdam market for Dutch East India Company
shares became a modern securities market, 1602-1700

Berckheyde Gerrit Adriaensz - 'Dam Square, Amsterdam'

Dam Square, Amsterdam

Note: this view is not from the paper (231 page PDF)

The aim of this chapter is to give a general overview of the development of the secondary market for VOC shares. For that purpose, it discusses the main events that shaped the market in chronological order. Naturally, this overview starts with the subscription of 1602 and the basic rules for share transfers. Thereafter, the introduction of derivatives, the bear-trading* syndicate of Isaac le Maire, trading locations, the first dividend distributions, the relation between the company and its shareholders, the role of market
makers and brokers...
1607 – The emergence of a derivatives market
Soon after the founding of the VOC, traders also started to trade share derivatives – financial securities derived from shares, such as forwards, options and repos. These types of transactions had VOC shares as underlying assets; they allowed traders to participate in the share trade without necessarily having to pay the full value of the shares they traded....

1609-10 – Isaac le Maire
Apart from lowering transaction costs, the use of derivatives provided yet another advantage: they allowed traders to go short on shares. The VOC bookkeeper was of course not allowed to overdraft shareholders’ accounts, but derivatives bypassed the company’s capital books. On expiration of a forward short sale*, for example, there were two possibilities: either the contractors opted for money settlement, in which case the price difference between the forward price stipulated in the contract and the market price on the expiration date was paid, or they chose to actually transfer the share. In the latter case, of course, the seller had to make sure that he possessed a share to be able to transfer it to the buyer. Short selling is often associated with speculators who seek to gain from intentionally bringing the price of a security down. This is of course objectionable behavior...

...The VOC directors explained in their petition to the States of Holland that a group of share traders had conspired to sell a large number of forward contracts. They had sold many times the value of the shares actually registered on their accounts in the company’s capital books. When the agreed date of delivery approached, the sellers began to spread bad rumors about the company, thus bringing the share price down. Subsequently, this bear trading syndicate offered a small amount of stock for sale at a still lower price, thus reinforcing the downward motion of the share prices. Hence the short sellers could buy shares at far lower prices than agreed upon in the forward sales contracts and make a good profit....
The first dividends were not paid for seven years but once they started...
...Shareholders could collect their first dividend in April 1610: 75% of the nominalvalue of their share in mace.39 In November of that same year, another 50% in pepper was distributed, together with 7.5% in cash – the latter distribution was only for those shareholders who had also collected the pepper. In March 1612, a distribution of 30% in nutmeg followed.40 Shareholders who had collected all dividends in kind had received a total of 162.5% of the nominal value of their shares, but the market value of the spices proved to be significantly lower. Shareholders complained that the distributed dividends had a market value of only 125%41; the sudden abundance of spices on the market had brought the prices down....
These guys were not believers in the Modigliani-Miller Dividend Irrelevance Theorem,

If I remember correctly the company averaged 18% per year in dividends on the original subscription price over the first 110 years of its existence.
That number sticks in my head because the greatest U.S. bull market averaged 18%  per year for 18 years, 1982-2000.
I know it's an Apples and Mangosteens comparison but it gives an indication of what a wealth machine the VOC was.
Here's some financial reporting Dutch Masters style:
$64.98 (+$13.84) (+27.1%) Shares in the spice purveyor soared on word that the three sturdy galleons dispatched two years afore had been sighted off the coast of Cape Verde, returning from their dangerous voyage to the exotic Orient with their casks brimful of redolent cinnamon, cardamom, and mysteriously intoxicating curried powder.
Okay, that's actually America's Finest News Source.