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THE IMPACT
OF STOCK MARKET PERFORMANCE ON THE
GROWTH OF NIGERIAN ECONOMY
CHAPTER ONE
1.1 BACKGROUND TO THE STUDY
Primarily, a
stock market is the place where companies can raise money to make their
businesses bigger and better. Companies raise money by selling shares or stocks
to investors. At the same time, the stock market gives investors an opportunity
to invest in these companies and benefit from any profit they can make.
A stock
market can also be called a capital or securities market as it encompasses the
stock exchange, the branches, and the stockbrokers. An organized securities
market requires a securities exchange, a securities commission or other
regulatory agency, and intermediaries such as dealers, brokers, securities
analysts, etc. Virtually all costs are borne by those who benefit. The
intermediaries receive their fees from the issuers or investors to whom they
provide a service. The stock market is usually funded through fees paid by
investors and issuers; even the expenses of the securities commission may be
partially paid for by registration fees rather than being a major burden on the
government budget. Companies which go public are subject to continuous cost of
providing financial information, transferring shares, paying dividends, and
other aspects of shareholder relations. The stock market is the aspect of the
financial system which mobilizes and channels long term funds for economic
growth. The stock market embraces trading in both new issues (primary) and old
issues of stocks (secondary). Securities are primarily of 2 types: debt and
equity. Debt securities include federal government development stock (GDS),
industrial loans, preference stocks, bonds e.t.c, while equity securities
mainly concern ordinary stocks which impose higher liabilities on the holders.
Portfolio investment in the capital market is the acquisition of financial
assets (which includes stock, bonds, deposits, and currencies) from one country
in another country. It is a form of investment that attempts to achieve a
mixture of income and capital growth, it deals with an institutional
arrangement involving the Securities and Exchange Commission (SEC), the
Nigerian Stock Exchange (NSE), the operators, and the investors. Stock market
is viewed as a medium to encourage saving, help channel savings into productive
investment, and improve the efficiency and productivity of investment. The
emphasis on the growth of stock markets for domestic resource mobilization has
also been strengthened by the need to attract foreign capital in non- debt
creating forms. A viable equity market can serve to make the financial system
more competitive and efficient. Without equity markets, companies have to rely
on internal finance through retained earnings. Large and well established
enterprises are in a privileged position because they can make investment from
retained earnings and bank borrowings, while new companies do not have easy
access to finance. Without being subjected to the scrutiny of the stock market,
big firms get bigger, and for the emerging smaller companies, retained earnings
and fresh cash injections from the controlling shareholders may not be able to
keep pace with the needs for more equity financing which only an organized
market place could provide. The corporate sector would also be strengthened by
the requirements of equity markets for the development of widely acceptable
accounting standards, disclosure of regular, adequate, and reliable information.
While closely held companies can camouflage poor investment decisions and low
profitability, at least for a while, publicly held companies cannot afford this
luxury. The availability of reliable information would help investors make
comparism of the performance and long term prospects of companies; corporations
to make better investment and strategic decisions; and provide better
statistics for economic policy makers.
The capital
market in any country is one of the major pillars of long term economic growth
and development. The market serves a broad range of clientele including
different levels of government, corporate bodies, and individuals within and
outside the country. For quite some time now, the capital market has become one
of the means through which foreign funds are being injected into most
economies, and so the tendency towards a global economy is more feasible/
visible there than anywhere else. It is, therefore, quite valid to state that
the growth of the capital market has become one of the barometers for measuring
overall economic growth of a nation.
Historically,
the financial sector in the developing world has been primarily bank based.
But, in recent years, there has been a gradual shift to a more holistic
approach which, alongside the banks, seeks to develop the securities market.
Some of the strength of the securities market which makes them the focal point
of the shifting emphasis is their ability to:
1. mobilize long term savings for financing
long tenure investments;
2. provide risk capital (equity) to
entrepreneurs;
3. encourage broader ownership of firms; and
4. Improve the efficiency of resource
allocation through competitive pricing mechanisms.
5. Provision of alternative sources of
finance other than taxation and foreign loan to fund public projects.
Apart from
these primary benefits, a developed securities market in the sense of efficient
financial intermediation further brings additional gains to the economy. These
gains arise through:
1. lower cost of equity capital for firms;
2. imposition of discipline on corporate
managers as share prices react to right and wrong judgment in firm’s investment
decisions;
3. existence of mechanisms for appropriate
pricing and hedging against risk; and
4. Increased flow of funds to the domestic
economy as international capital responds to the thriving stock market.
The
development of securities market could help to strengthen corporate capital
structure (i.e. the composition of the capital of the firms) and efficient and
competitive financial system. The stock market encourages savings by providing
households with an additional instrument which may better meet their risk
preferences and liquidity needs.
In
well-developed capital markets, share holding provides individuals with a
relatively liquid means of sharing risks in investment projects. To the extent
that securities and bonds are a viable and relatively secure form of investment
with an attractive long term return, they serve two functions:
1. stocks provide an incentive to save and
invest; and
2. Financial savings are promoted and
domestic savings rate increase as a whole.
Stock market
development has an important role to play in economic development. Shahbaz and
his friends (2008) argue that stock market development is an important wheel
for economic growth as there is a long-run relationship between stock market
development and economic growth. Stock market development has the direct impact
in corporate finance and economic development. Gerald (2006) states that stock
market development is important because financial intermediation supports the
investment process by mobilizing household and foreign savings for investment
by firms. It ensures that these funds are allocated to the most productive use
and spreading risk and providing liquidity so that firms can operate the new
capacity efficiently. A growing body of literature has affirmed the importance
of financial system to economic growth. Financial markets, especially stock
markets, have grown considerably in developed and developing countries over the
last two decades. Claessens, et al (2004) states that several factors have
aided in their growth, importantly improved macroeconomic fundamentals, such as
more monetary stability and higher economic growth. General economic and
specific capital markets reforms, including privatization of state-owned
enterprises, financial liberalization, and an improved institutional framework
for investors, have further encouraged capital markets development. Similarly
Mishkin (2001) states that a well-developed financial system promotes
investment by identifying and financing lucrative business opportunities,
mobilizing savings, allocating resources efficiently, helping diversify risks
and facilitating the exchange of goods and services. From the view point of
Sharpe, et al (1999), stock market is a mechanism through which the transaction
of financial assets with life span of greater than one year takes place.
Financial assets may take different forms ranging from the long-term government
bonds to ordinary shares of various companies. Stock market is a very important
constituent of capital market where the shares of various firms are traded
Trading of the shares may take place in two different forms of stock market.
When the issuing firm sells its shares to the investors, the transaction is
said to have taken place in the primary market but when already issued shares
of firms are traded among investors the transaction is said to have taken place
in the secondary market. Stock markets are very important because they play a
significant role in the economy by channeling investment where it is needed and
can be put to best (Liberman and Fergusson, 1998). The stock market is working
as the channel through which the public savings are channelized to industrial
and business enterprises. Mobilization of such resources for investment is
certainly a necessary condition for economic take off, but quality of their
allocation to various investment projects is an important factor for growth.
This is precisely what an efficient stock market does to the economy
(Berthelemy and Vardoulakis, 1996). Earlier research emphasized on the role of
the banking sector in the economic growth of nation. In the past decade, the
world stock markets surged, and emerging markets accounted for a large amount
of this boom (Demirguc-Kunt and Levine (1996a).
Recent research has begun to focus on the linkages between the stock
markets and economic development. New theoretical work shows how stock market
development might boost long-run economic growth and new empirical evidence
supports this view. Demirguc-Kunt and Levine (1996a), Singh (1997), and Levine
and Zervos (1998) find that stock market development is playing an important
role in predicting future economic growth. In underdeveloped countries like
Nigeria, the development and growth of stock markets have been widespread in
recent times. Despite the size and illiquid nature of stock market, its
continued existence and development could have important implications for
economic activity. For instance, Pardy (1992) has noted that even in less
developed countries capital markets are able to mobilize domestic savings and
able to allocate funds more efficiently. Thus stock markets can play a role in
inducing economic growth in less developed country like Nigeria by channeling
investment where it needed from public.
Mobilization of such resources to various sectors certainly helps in
economic development and growth. Stock market development has assumed a
developmental role in global economics and finance because of their impact they
have exerted in corporate finance and economic activity. The role of financial
system is considered to be the key to economic growth (Neupane, et. al. 2006).
Paudel (2005) states that stock markets, due to their liquidity, enable firms
to acquire much needed capital quickly, hence facilitating capital allocation,
investment and growth. Stock market activity is thus rapidly playing an
important role in helping to determine the level of economic activities in most
economies Tuladhar (1996) states that financial markets are catalyst in the
development of economy. The study further added that developed economies have
highly sophisticated financial institutions. Over the past decade, many
developing economies have established capital markets as they moved towards
more liberal economic policies. These emerging markets have shown extraordinary
growth with very high volatility, which have attracted many investors into
these markets.
1.2 STATEMENT OF THE PROBLEM
Mobilization
of resources for national development has long been the central focus of
development. To this end, various papers, research works, seminars, e.t.c. have
been written and held to find the best way to mobilize resources for economic
growth. It is now increasingly being recognized that the growth process of the
Nigerian economy depends to a considerable extent on the effects of stock
market. Whether this effect is positive or negative is a research problem to be
solved. In the light of the research problems, the key question this study
attempts to answer is:
1. Does the Stock Market Performance have an
effect on the GDP?
2. What is the impact of change in investment
links on the growth of Nigeria stock market?
1.3
OBJECTIVES OF THE STUDY
The main
objective of this study is to examine the role which the stock market plays in
the growth process of the Nigerian economy.
However, the
specific objectives include:
1. To determine if the market capitalization
can lead an economy to growth
2. To
determine the impact of change in investment links on the growth of Nigeria’s
stock Market.
1.4 HYPOTHESIS OF THE STUDY
The
hypothesis tested in this study is:
H0: there is
no significant impact of Stock Market performance on economic growth.
HO: changes
in investment links have no significant impact on the growth of Nigeria’s stock
Market
1.5 SIGNIFICANCE OF THE STUDY
Due to the
fact that there are no viable equity markets, the capital structure of firms
are generally characterized by heavy reliance on international finance and bank
borrowings which tend to raise debt/ equity ratios.
Thus, the
development of an active market for stocks could provide an alternative to the
banking system for both savers and users of funds.
There are a
lot of studies about the connection between stock prices fluctuations and
economic growth as well as other economic variables which have detected that
changes in stock prices reflect real economic situation. Economic growth
through the changes in levels of real economic activities affects profitability
and activity of firms. As a result, with changes in profitability prospects,
expected earnings and dividends of shares, stock prices fluctuate (Fama, 1990;
Ferson and Harvey, 1993; Cheung and Ng, 1998; Mauro, 2003; Ritter, 2004; Liu
and Sinclair, 2008; Shahbaz et al., 2008).
On the other
hand, other studies have examined the impact of stock prices on macroeconomics
indicators. According to the results of these investigations share prices
fluctuations play a role in directing economic activities in the medium and
long term. Stock prices reflect the expectation of public towards the future
economic activity. In other words, the stock market is forward-looking and
stock prices reflect anticipations about future economic activity. If a
recession is expected, for example, then stock prices reflect this by
decreasing in value whereas large increase in stock prices may reflect the
expectation towards future economic growth (Jefferis and Okeahalam, 2000;
Nasseh and Strauss, 2000; Mauro, 2000; Shirai, 2004; Adajaski and Biekpe, 2005;
Mun et al., 2008). This work represents an attempt to close the gap between
these different literatures, by examining the impact of stock market
performance on the growth of Nigeria economy.
1.6
SCOPE AND LIMITATIONS OF THE STUDY
This study
appraises the performance of the stock exchange in consonance with its impact
on the success or failure of the Nigerian economy.
The scope of
the study is based on the Nigerian stock exchange from the key sectors of the
economy.
The study
examines the performance level over a 28 year period (1980-2007). The reason
being that, a study period this long will, probably, reduce any form of bias in
the results of estimate
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