HOW A DUTCH TRADING COMPANY CREATED THE WORLD’S FIRST STOCK EXCHANGE
Roy Davidson, 14 December 2020
Sharemarkets play a crucial role in today’s economy. However, they are a relatively recent phenomenon. The first true sharemarket arose in Amsterdam in the 17th century. This exchange almost entirely facilitated the trading of shares in one company, the Vereenigde Oostindische Compagnie, or the Dutch East India Company.
This company, formed in 1602 with the merger of six existing Dutch trading companies, was granted a monopoly lasting 21 years by the Dutch Government over trade with Asia. With its base in present day Jakarta (then known as Batavia), it traded in spices such as pepper, cinnamon, nutmeg and cloves, along with a myriad of other goods like tea, sugar, textiles, silk, exotic timber and porcelain.
The Dutch East India Company was the world’s first listed company
Trading in this part of the world was risky with several countries, namely the Dutch Republic, England, Portugal and France, vying to extend their empires. There were frequent battles as each attempted to exert their control over particular geographies and commodities. Furthermore, storms were a real risk, disease prevalent, and then there was the actual business of successfully trading for a profit.
To help share the risk, private companies developed, including the prominent English East India Company which was founded only two years prior to the Dutch East India Company. These early companies typically saw many investors contribute a certain amount of capital for a set length of time, say ten years. At the end of the ten years, the trading company would be liquidated, with investors receiving their money back plus any profits. Often, the company would be reconstituted in close to its previous form with a new round of funding, only to be liquidated again and again.
However, the Dutch East India Company was unique in a few ways that resulted in it becoming the world’s first listed company.
Firstly, its charter enabled shares to be transferred between investors and these began to be traded on a secondary market in Amsterdam (and in other Dutch cities) which to that point had dealt only with commodities trading.
Secondly, and with what was the real shot in the arm for the Amsterdam Stock Exchange, in 1623 the directors of the company opted against liquidating the company at the end of its charter. This was highly controversial but had the effect of turning shares in the company from a fixed-term investment into a perpetual investment. This is how shares work today – you buy a share in a company into perpetuity.
What this meant is that, in order to get their money back, investors in the Dutch East India Company had to trade on the market – there was no liquidation event to hold out for. The incentive to hold shares came in the form of dividends paid from profits (interestingly sometimes in the form of goods like cloves, pepper or nutmeg instead of cash), along with the hope that shares would become more valuable over time, incentivised shareholders to hold shares. This proved to be a hugely successful model and was eventually copied by the English East India Company in 1657.
The Amsterdam Stock Exchange piggy-backed on the success of the Dutch East India Company
Over time, secondary trading became even more important and, with the Dutch East India Company becoming the world’s most powerful company, the stock exchange in Amsterdam went from strength to strength.
Similar to today (without the electronic trading of course, or the 24/7 news coverage), buyers and sellers would gather on a trading floor at the exchange in Amsterdam to trade shares for themselves or for their clients – primarily wealthy merchants. Some made a living speculating on the day to day price of shares in the Dutch East India Company, with trading clubs popping up across the city where traders would look for the inside word. Derivatives also emerged, including forward contracts and options – both still mainstays of modern financial markets.
The Dutch East India Company established the Dutch colonial presence in places such as Indonesia and South Africa. It existed for almost 200 years and largely defined the Dutch Golden Age. Abel Tasman was in the service of the Dutch East India Company when he became the first European to discover New Zealand in 1642.
With its fixed and reliable capital base, the Dutch East India Company dominated trade between Europe and East Asia, eclipsing the hold the Portuguese had on trade in the region in the preceding centuries. Through its trade in rare spices and control over vast territories, it grew into a behemoth in every sense of the word.
More than a company, it was a centralised, quasi-governmental, multi-national conglomerate with its own military force. At its height it owned 40 war ships with 10,000 soldiers, along with 150 trading ships and had 50,000 employees, monopolising the trade of several commodities in the process.
From 1780 onwards, the company came under financial pressure due to its debt burden, the Fourth Anglo-Dutch War, poor management, and an unsustainable dividend, before ultimately being nationalised by the new Batavian Republic in 1796 – a ‘victim’ of the French revolution. Many of its overseas assets fell into British hands before being returned to the Netherlands decades later.
The Dutch East India Company’s legacy remains to this day
Despite its ultimate demise, the model of the Dutch East India Company was an overwhelming success. Publicly listed companies rose in prominence which necessitated the creation of more stock exchanges in the following centuries.
It wasn’t all smooth sailing though. In the 1710s, the loose monetary policy of the French Government, advised by Scottish economist named John Law, along with out of control speculation, and misleading claims from exploration companies, led to the formation of bubbles in the stock of the French Mississippi Company and British South Seas Company. This was one of the first bubbles in the world and made many cautious of the merits of limited liability companies. Anti-company laws popped up as a result. For instance, the 1720 Bubble Act in Great Britain forbade any companies without a royal charter from issuing stock.
Nonetheless, over time, the advantages stock exchanges bring companies in terms of being able to access capital and share risk shone through. This was helped in no end by the opening of the New York Stock Exchange in 1792 and the rapid growth of the United States.
Today, most developed countries have a stock exchange. There are now more than 60 major stock exchanges globally with a combined total value of over US$90 trillion and sporting more than 50,000 listed companies. A functioning stock exchange is seen by many as a sign of a healthy, sound economy.
The largest and most influential stock markets are found in the US, namely the New York Stock Exchange (where you’ll find the likes of Walmart, Visa and Johnson & Johnson) the NASDAQ (home of Apple, Microsoft and Amazon). These two exchanges comprise almost half of the global market capitalisation.
Other influential exchanges include the Shanghai and Hong Kong stock exchanges, the London Stock Exchange, and the Tokyo Stock Exchange. Meanwhile, Euronext, Europe’s largest stock exchange, can trace its history right back to that first exchange in Amsterdam 400 years ago.