Evolution in Nature and Society: The Evolution of Stock Markets

Prof. Edward Peter Stringham

Hackley Endowed Chair

School of Business and Economics
Fayetteville State University, North Carolina, 28301

Can the theory of evolution be applied to topics other than the evolution of species?

French economist Alain Marcaino argues that both Charles Darwin and Nobel prize

winning economist Friedrich Hayek “refer to the same theory of human nature, which is

borrowed from the founding fathers of political economy, Hume and Smith.” 1 This essay

provides support for the idea that theory of evolution can be used to describe many

important market institutions. Markets involve people who are often consciously choosing

various business practices so the analogy between evolution in markets and evolution in

nature has some importance differences. But just as different species vary or adapt so do

different economic practices. Those that are more suited for their time and place will

become more successful and will be copied and replicate. The history of stock markets

illustrates this point well.2

Stock markets were not suddenly invented. Harold Wincott begins The Stock

Exchange with the following, “It would be nice to start this book with a satisfyingly round

1
Alain Marciano “Why Hayek is a Darwinian (after all)? Hayek and Darwin on social evolution” Journal of
Economic Behavior & Organization, 2009, vol. 71, issue 1, pages 52-61
2
This essay draws from Edward Peter Stringham, “The Extralegal Development of Securities Trading in
Seventeenth Century Amsterdam.” Quarterly Review of Economics and Finance, 43(2) Summer 2003: 321-344
and Edward Peter Stringham. “The Emergence of the London Stock Exchange as a Self-Policing Club.” Journal
of Private Enterprise, 17(2) Spring 2002: 1-19.

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sentence: ‘one the –th day of –––– in the year of our Lord ––––, the Stock Exchange,

London, came into being.’ Alas for those with tidy minds, the Stock Exchange is a typically

British institution. No-one can say with any certainty exactly when it started. Like Topsy, it

almost seems it never was born, but just ‘grow’d’.” 3 No governor declared the

establishment of the London Stock Exchange; rather it evolved over time.

The first major joint stock companies had come into being in the sixteenth century 4

and it was not for some time before there were enough tradable stocks to warrant the

specialized occupation of stockbrokers. At the end of the seventeenth century

improvements in banking led to an increase in the quantity of joint stock companies from

fifteen to a hundred and fifty in a matter of six years. 5 At first sales were conducted on a

small scale directly between the buyers and the sellers. After there were enough stocks,

“obviously the time was ripe for the emergence of some kind of middleman who would

bring the promoters and subscribers together.”6

The earliest evidence of stockbrokers in England appears in the late seventeenth

century and in 1692 the trade was important enough for the weekly periodical Collection

for Improvement of Husbandry and Trade to begin publishing stock prices for eight

companies.7 Although trading of stocks took place, as Jenkins points out, “they were by no

means necessarily stock-brokers. They could deal in anything they liked—stockes, gold,

3
Harold Wincott, The Stock Exchange, (London: Sampson Low, Marston & Co, 1946.) p.1.
4
Charles P. Kindleberger A Financial History of Western Europe (George Allen & Unwin: London 1984) p.196.
5
Jenkins, p.18.
6
Jenkins p.18.
7
Larry Neal, “The Integration and Efficiency of the London and Amsterdam Stock Markets in the Eighteenth
Century,” Journal of Economic History, Vol.XLVII, No.1(Mar.1987):p.99.

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haberdashy, fish, bread, carpentry, spectacles, even bows and arrows.” 8 Anyone who was a

broker could become a stockbroker if he wished.

Eventually people began specializing in stockbrokerage but they still traded amidst

other merchants. Over time those specializing in stocks would meet at Jonathan’s

Coffeehouse. But the coffeehouse attracted many people including some brokers who were

unreliable and would unintentionally or intentionally default. At first they started posting

the names of defaulters on a blackboard but that was only partially effective. Certain

brokers then decided to turn Jonathan’s into a private club that could create and enforce

rules. Some of the excluded brokers argued against this exclusivity, so when Jonathan’s

eventually reopened to the public the more established brokers created a Stock

Subscription Room elsewhere that was a private club. The Stock Subscription Room was

originally referred to New Jonathan’s and eventually the Exchange. The members of the

Exchange were then able to create and enforce rules. They experimented with rules and

those who broke the rules would be fined or eventually expelled. This system of rule

enforcement enabled brokers to congregate in a venue where they were much less likely to

be defrauded than if they traded on the curb. The London Stock Exchange competed with

other trading venues in London (some people traded at a Rotunda) and around the world.

Those that came up with superior business practices became more successful and were

likely to be copied.

Other stock markets such as the New York Stock Exchange evolved in a similar

matter creating a system of competing self-regulating stock exchanges. In the United States,

8
Jenkins pp19-20

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the New York Stock Exchange competed with other exchanges such as the American Stock

Exchange and the Boston Stock Exchange. Under a system of competition exchanges are

always coming up with new ideas to make their exchanges more attractive otherwise they

will be lose to superior alternatives. The New York Stock Exchange pioneered many of the

financial reporting and disclosure requirements that publicly traded companies report

today.

Although historically stock exchanges were self-regulating and competing in a free-

market much of that changed in the early 20 th century, with the creation of the Securities

Exchange Commission much of the regulation became centralized. The S.E.C. ended up

requiring all exchanges to follow many of the stricter self-regulations of the New York

Stock Exchange. This ended up harming many of the smaller exchanges that offered more

flexible rules for smaller companies that could not bear the brunt of the expensive listing

requirements of the New York Stock Exchange. A one size fits all set of regulations

eliminates the ability of exchanges to experiment and evolve according to market demands.

The S.E.C. and other governmental bodies are notorious for imposing sets of regulations

that are harmful to companies and harmful to investors. 9 Rather than letting stock markets

evolve naturally the way they did for hundreds of years the government has decided to

become the central planner for rules and regulations in markets. There is still a degree of

competition between the stock exchanges (NASDAQ of the 1990s was attractive to many

high tech startups compared to the New York Stock Exchange which listed many blue

9
Nobel laureate George Stigler documented that after the creation of the S.E.C. the number of new listings
decreased.

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chips), but with increasing regulation the amount of competition and differences permitted

between the exchanges has been diminished.

With little knowledge of the history of stock markets, governments in many less

developed economies have thought that they need to centrally plan their stock markets as

well. Certain governments in Eastern Europe have not only created stock markets by edict,

but have also copied the American Securities Exchange Commission as well. It was common

for countries to think that they needed to have their own national stock exchange even

though it was not clear whether the market demanded it. In countries such as the Czech

Republic the results of these centrally planned “markets” have been lackluster. 10

Although government control and stifling of stock markets has increased in many

countries, an important amount of competition and its associated potential for variation

and selection still exists. When the United States government imposed onerous regulations

through the Sarbanes Oxley Act, many companies chose not to go public or go public in

countries outside of the United States. The London Stock Exchange’s Alternative

Investment Market is much more of self-regulating exchange (with listing requirements

decided by Nominated Advisors rather than government) and it has been attracting a lot of

companies in recent years. For the first time in decades the number of initial public

offerings in England now exceeds the number in the United States leading many groups

including the government of New York to start calling for a loosening of the prohibitive

regulations imposed by the federal government. Virginia and Yale law professors Paul

10
Stringham, Edward Peter, Peter J. Boettke, and J.R. Clark. 2008. “Are Regulations the
Answer for Emerging Stock Markets? Evidence from the Czech Republic and Poland.” Quarterly Review of
Economics & Finance, 48(3) August: 541-566 ; Stringham, Edward Peter, and Peter J. Boettke. 2006. “The Failings
of Legal Centralism for Helping Stock Markets in Transition.” Politická Ekonomie, 10(1) January: 22-34.

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Mahoney and Roberta Romano have proposed moving back to a system of having the

exchange as regulator rather than the federal government.11

Competition among stock exchanges historically led to variation and selection of

beneficial rules. In the past century much of that competition has been stifled by

governments that think that the rules in markets must be centrally planned. The

emergence and evolution of stock markets can be described in a way that is very similar to

the way a species evolves. What is best often depends on the specific situation. Rules that

make sense today would have been ill suited in earlier times and may likely be ill suited in

the future. When exchanges have the ability to select their own rules they can pick ones

that are most suited to them and their customers.

Stock exchange were not invented by one person nor designed according to a pre-

thought out plan. Rather people started coming up with new ideas and testing them in the

market place. The theory of evolution is well suited to explain the evolution of these market

institutions and they should be freed up to compete and evolve according to market

conditions as they successfully did for centuries.

11
Paul G. Mahoney, The Exchange as Regulator, 83 Virginia Law Review 1453, 1464-65 (1997); Roberta Romano,
Empowering Investors: A Market Approach to Securities Regulation, 107 Yale L. J. 2359, 2373 (1998).