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