THE IMPACT OF STOCK MARKET PERFORMANCE ON THE GROWTH OF NIGERIAN ECONOMY


THE IMPACT OF STOCK MARKET PERFORMANCE ON THE GROWTH OF NIGERIAN ECONOMY

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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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