The overall challenge was described as how to stimulate equity financing for a segment that is characterised by low survival rates and a large diversity of entities, the two main drivers that make it difficult to assess risk. The focus of the debate was more on analysing the current drivers of a challenging environment for SME equity financing and less on solutions.
Let’s focus on a more fundamental driver of an investor´s motivation to ensure a sustainable flow in SME equity investments: cultural change.
The lack of a risk equity culture across Europe is an important obstacle. In Germany only 13.8% of the population invests in listed equity securities, compared with around 50% in the US. Both the US and Germany have seen a slight deterioration in equity ownership since 2000, explained by the long-term effects of the dot.com bubble during the 2000s and the pro-cyclical behaviour of retail and institutional investors, leading to a reduction in their exposure caused by the Great Recession.
How can this trend of sinking equity ownership in Germany and neighbouring countries be reversed? Let’s analyse what drove the rise of equity owners in Germany from 3.9 million in 1992 to 6.2 million in 2000 and back down to 4.5 million by 2013. Two main factors can explain the rise: pro-equity friendly sentiment in politics; and accessible home bias lowering the entry barrier for investors.
The dot-com bubble deformed the first. Since it burst, politicians have been stigmatising equity markets as too dangerous to get exposed to. The Great Recession acted as reaffirmation of their convictions. Some even enacted policies to forcefully dry up market liquidity, as seen in Austria with its stock exchange tax.
The dot.com bubble also caused millions of Germans to divest their home bias. Home bias is well-researched in behavioural finance, driven by both rational and irrational factors. Local bias in SME investments is driven by: pride of local ownership; ambiguity aversion (investors are more likely to choose an option with known risks over unknown risks, and with fewer unknown elements rather than many); identification with product, service or entrepreneur; and reduced information asymmetry through local knowledge.
Sourcing information globally on listed companies works well thanks to its digital distribution, but identifying yourself with them doesn’t. The affinity to an equity home bias for both institutional and retail investors can be used as an entry point for changing the equity culture in Europe.
Extract: the full version of this post appeared on oecdinsights.org on 3 December 2014.
Mr Schuller participated in financial market roundtables at the OECD in 2014.
©OECD Observer No 301, Q4 2014