CHAPTER TWO
LITERATURE REVIEW
2.1:
INTRODUCTION
The stock exchange is a specialized market for the buying and
selling of securities are stocks and share which represent ownership interest
in business, dabtedness and government bonds. The need for the stock exchange
arises from two main factors. Firstly, after meeting their basic financial
needs some people do have extra funds left with them. Instead of spending this
extra funds left with them. Instead of spending this money extravagantly, they
may decide to invest the money in company share or government bonds where the
money will yield them more income.
Olufemi (2001) viewed the Nigeria stock exchange as a place were
listed securities of varying types are bought and sold, he saw the stock
exchange as the central poling of the Nigeria capital market which provide the
mechanism for mobilizing private and saving
and making such funds available for production purposes.
Furthermore, odife (1985) viewed the Nigeria stock exchange as an
organized market where large and small investors buy and sell securities the
rough stock brokers.
The bottom line is that the stock exchange has been the engine
room where share of companies exchange hand between buyers and sellers of
securities to make available move capital for business ownership and capitalization.
1.2
THEORETICAL
FRAMEWORK
Stock market and economic growth nexus
in this section an attempt is made to revive both theoretical and
empirical literature on stock market development and economic growth. Earlier,
scholars such as schumpter (1912) Goldsmith (1969), shaw (1973) and
Mc-kinnon(1973), emphasizes the importance of the financial system in economic
growth. Hicks (1969) argued that the industrialization process in England was
promoted by the development of the financial sector which increased the access
of the government and people to funds that were used to finance capital projects
which led to the development of the economy. Levine (1991) argued that
developed stock market reduces both liquidity stock and productivity stock of
business. This in turn increases the access of businessmen to investment funds
as well as enhancing the production capacity of the economy.
Thereby leading to higher economic growth.
This view was supported buying and Levine (1993) that financial development
fosters economy growth. Moreover, Bensivenga et al (1995) concluded that well
developed financial market (stock market) induces long rn economic growth.
Pedro S. Amaral and Ewran Quintin (2007) asserted that financial market
development raised output by increasing the capital used in production and by ensuring
that capital is put into best uses. Ogwumike and Omole (1996), Ojo (1998),
Abdullahi (2005) and Adam and sanni
(2005) aslo stressed the importance of capital market in economic
development in Nigeria. Agarwal (2001) argued that financial sector development
facilitate capital market development and in turn raise real growth of the
economy. Thronton (1995), Rousseru and Sylla (2001), and claderon and Liu
(2002) supported the claim that fianacial system, development promotes economic
growth. In the same vein, Beckart et al (2005) demonstrated that capital market
development increase economic growth. Similarly, Bolbo et al (2005) indicated
that capital market development was contributed to the economic growth of Egypt.
Aysan (2001) argued that lack of well developed financial markets and thigh
degree of capital market imperfections increase growth volatilyt. Tharavanji
(2007) observed that countries with deeper capital market face less severe
business cycle output contraction and lower chances of an economic downturn
compared to those with less developed capital market. On their part, Ben Naceur
and Ghasouani (2007) reported that financial system development could have
adverse effect on economic growth in a sample of 11 countries they studied and
therefore advocated for a vibrant financial sector.
The World Bank (1995) opined that stock market development does
not merely follow economic development, but provides the means to predict
future rates of growth in capital, productivity and per capital GDP. The
conclusion of the Bank is that increase in banking and stock market development
lead to increase in real per capita growth. Levine and Zervous (1998) observed
a significant positive effect of stock market development on economic growth.
Hamid Mohtadi and sumit Agarwal (1995) examined the relationship between stock
market development and economic growth for 21 emerging market over 21 years,
using a dynamic panel method. Their results indicates a positive relationship
between several indicators of the stock market performance and economic growth
both directly and indirectly by boosting private investment behavior. In
Belgium, Niewwerburgh et al (2006) investigated the long term relationship between
financial market development and economic development. The authors used a new
data set or stock market development indicators to argue that financial market
development substantially affects economic growth. They fund strong evidence
that stock market development lead to economic growth in Belfium, especially in
between 1873 and 1935. In Nepal, Surya Bhadar and suman Neupane (2006)
confirmed that the Nepalses stock market plays a significant role in
determining economic growth in Malaysia. The authors also reported that stock
market development Granger – cause economic growth. The study by Muhammed
Shahbaz et al (2008) suggests that there is a long run relationship between
stock market development and economic growth for positive. Stock market
development was found to be an important factor that enhances economic growth.
Moreover, the authors discovered a feedback relationship between
stock market development and economic growth in the long run. However, in the
short run, the causality runs only from stock market development to economic
growth. Minier (2003) showed that stock market has a positive influence on
economic growth. While underdeveloped stock market has a negative effect on
economic growth. Liu and Hsu (2006) reported a positive impact on growth of
stock market development in Taiwan, Korea and Japan. The work of Francis Xavier
et al (2007) showed that shareholder protection cause market development and
eventually economic growth.
In Nigeria, some have also attempted to examine the relationship
between stock market development and economic growth. For instance, Adam and
sanni (2005) examined the role of stock market in Nigeria economic using
Granger causality test and regression analysis. The authors discovered one way
causality between GDP growth and market capitalization and a two way causality
between GDP growth and market turnover ration. The authors advised that government
should encourage the development of the capital market since it has a positive
relationship that a significant positive effect of stock market on economic
growth. He suggested that government should create more enabling environment so
as to increase the efficiency of the stock market and to attain higher economic
growth.
Obamiro (2005) reported that a significant
positive effect of stock market on economic growth. He suggested that
government should create more enabling environment so as to increase the
efficiently of the stove market, and to attain higher economic growth. Osinubi
and Amaghonye doicwe (2003) also examined the relationship between the Nigeria
stove market and economic growth during the period 1980 – 200. Unfortunately, their
results did not support the claim that stock market development promotes
economic growth. Eaelier, Nyong (1997).
Analysis
the relationship between capital market development and economic growth. The
author use various indicators of stock market development (like market
capitalization- GDP Ratio, total value of transaction –GDP Ratio, value of
transaction –GDP and Listings). To capture capital market development. He also
included the degree of financial market debt in the growth model. The result
revealed in negative effect on economic growth of capital market. Ezeoha et al
(2009), investigated the nature of relationship that exits between stock market
development and the level of investment (domestic private inve stment and
foreign private investment) flows in Nigeria. The authors discovered that
stock market development promotes
domestic private investment flows, thus suggesting the enhancement of the economy’s production
capacity as well as promotion of the growth of national output. However, the result
shows that stock development has not been able to encourage the flow of foreign
private investment in Nigeria. For other studies that comform the positive effect of stock market development
on growth see, Atje and Jovanovic (1993), Demijue-Kurt (1994), Khan and Senhji
(2000), Arestic et al (2000), Mauro (2000). Rousseu and Wachtel (2000), Adjasi
and Biekpe (2005), and Siliverstors and Doung (2006).
Some authors focus on the
causal relationship between stock market development and economic growth. For
example cursoy and Muslumor (1998) confirmed the existence of a bidirectional
causal relationship between stock market development and economic growth in
developing countries. Following Gursoy and Muslumor, author like Luited and
Khan (1999) and Hondroyiannis et al (2005) reported a bi – directional between
stock market development and economic growth.
Other researcher
investigates the correction between stock market development and economic
growth. For instance, Ted Arqarmi et al (2005) examined the empirical
association between stock market development and economic growth in the entire period
they studies. Whereas the author found support for the relevance of stock market
development in economic development during pre-liberalization, they discovered
a negative relationship between stock market development and economic development
for the post liberalization period. Laura Obreja Brasoream et al (2008) examined
the correlation between capital market development and economic growth in
Romania using a regression function and VAR. It was shown that capital market
is positively correlated with economic growth with feedback effect. Moreover,
they revealed that the strongest link is from economic growth to capital
market. Scholar such as calin and Mayer (2003), Garrestsen et al (2004), Bose
(2005), and Back et al (2006) also indicated the existence of correlation
between capital development and economic growth.
This study is very
important because the Nigerian stock market which capitalization has declined
from over #13 trillion in 2007 to #5trillion in 2009. The all – share index has
also fallen from 57,990.22 point to approximately 25,000 points in the same
period moreover, the confidence of share holders and investor seems to be.
Thus, it is a specter that this study will complement the effort and policy
maker in reviving the Nigeria stock market and restoring the confident of share
holders and other participant in the marker. In addition, it’s the belief that
the vibrant and weel development market will attract foreign investor and
enhance the attainment of higher economic growth, beside, recent empirical work
in Nigeria, By Adam and Sani (2005), and Obamiro (2005) employed the ordinary
least square to analyze the relationship between the economic development and stock
market development. This paper imply a more robust and superior approach to
examine economic growth – stock market developing relationship, and include the
all share index as an important indicator and explanatory variable in the
growth model. Furthermore, unlike Adam and Sani *(2005), and Obamiro (2005),
The control variable use in this study
are openness and discount rate.
2.3 REVIEW
2.3.1 MEASUREMENT OF STOCK MARKET AND OTHER
VARIABLES
Two features characterize
an approach to measurement question.
First, as mention by able
to draw data from a single data source, the overcome the consistency and
measurement program data associated with Nevine and Zevros (1998) was of two
different data source.
Second, to maximized the
used of information extracted from data we used several different method of
stock market development as oppose to be single composite measures i.e is used
in Nevine and Zebrose. Although theory does not provide us with a foundation
for any unique indicator of stock market development, it does not suggest that
stock market size, and liquidity integration with the world capital market may
affect economic growth). (Demegue – kunt and Lenvine , 1996).
Using a variety of measure
provide a richer picture of the potential lain between stock market and growth
than if a single measure is used.
In this section, we
described the various measures of stock market development and other control
variable.
2.3.2 STOCK MARKET VARIABLE
Market capitalization ratio
(MCR):- these measures equal the value of listed shares divided by GDP. The
assumption behind this measure is that over run market size is positively
correlated with ability to mobilize capital and diversity risk on an economic –
wide basis
TOTAL VALUE OF SHARES TRADED RATIO (STR): This
measure equal total value of shares traded on the stock market exchange divided
by GDP. The total value traded ratio measures the organized trading of firm
equity as a share of national output and therefore should positively reflect
liquidity on an economic-wide basis. The total value traded ratio complements
the market capitalization ratio; although a market may be large, there may be
little trading
Turnover Ratio (TR): This
equal the value of total shares traded divided by market capitalization. Though
it is not a direct measure of theoretical definitions of liquidity, high
turnover is often used as an indicator of low transaction cost. The turnover
ratio complements the total value traded ratio. While the total value traded
ratio captures trading relative to the size of the economy, turnover measure trading relative to the size of the
stock market. A small liquid market will have high turnover ratio but a small
value trading ratio.
2.3.3 OTHER VARIABLES
Growth: this measure is
from the world development indicators (2000) data set.
Foreign director investment (FDI: Foreign direct investment is
used as control variables since it is presumed that FDI is a determinant of
economic growth.
Instrument (I.N.V): This
measure is defined as real investment divided by GDP.
Secondary School Enrollment (SE): Secondary school enrollment as a
percent of total population is also from the world development indicators data
base.
WHAT DETERMINES STOCK MARKET DEVELOPMENT IN AFRICA?
The previous section has
provided enough evidence to make a convincing case that the stock market
development at least create the enabling environment for a successful economic
growth. The policy question, therefore, is what determines stock market
development? The literature, suggest that sound macrocosmic environment, well
developed banking sector, transparent
and accountable institutions and
shareholder protection are necessary preconditions for the efficient
functioning of stock market in Africa.
A. Macroeconomic Stability
A stable macroeconomic environment is crucial for the development of
the stock market. Macroeconomic
volatility worsens the problem of information symmetries and becomes a source
of vulnerability to the financial system low and predictable rates of inflation
are more likely to contribute rates of
inflation are more likely to contribute to stock market development and
economic growth both domestic and foreign investors will be unwilling to invest
in the stock market where there are expectation of high inflation. Garcia and
Riu (1999) finds that that sound macroeconomic environments and sufficiently
high income level –GDP per capita, domestic saving,
B. Banking sector Development
The development of the
banking sector is important for stock market development in Africa. At the
early stage of its establishment the stock market is a complement rather than
substitute for the banking sector. Development the financial intermediary
sector can promote stock market development. Many East Asian countries are
successful examples. Support services from the banking system contribute
significant to the development of the stock market. Consequently, liquid
interbank market, largely supported by an efficient banking system, is
important for the development of the stock market. Conversely a weak-banking
system can constraint he development of the stock market. On the empirical
front, demirgul Kurt and Lerne
(1996) found that most stock market indicators are highly corrected with
banking sector development. Countries with well developed financial
intermediaries Yirtery (2007) finds that a percentage point increase banking sector development increase
stock market development in Africa by 0.59 Percentage point controlling for
microeconomic stability, economic development and the quality of legal and
political institutions.
c. INSTITUTIONAL
QUALITY
Institutional quality is
important for stock market development because efficient and accountable
institutions tend broaden appeal and confidence in equity investment. Equity
investment thus becomes gradually more attractive as political risk is resolved
over time.
Therefore, the development
of good quality institution can affect the attractiveness of equity investment
and lead to stock market development.
Varty (20070 find good quality institutions such aslow and order,
democratic accountability, bureaucratic quality as important determinant of
stock market development in Africa because
they reduce political risk and enhance the viability of external
finance. Bekert {1995} provides evidence that higher level of political risk is
related to higher degrees of market segmentation and consequently low level of
stock market development. Evbro et al (1996) slow that expected returns are
related to the magnitude of political risk. They find that in both developing
and developed countries, the lower the level of political risk, the lower is required
returns. The evidence in the literature suggest
that political risk is a priced
factor for which investors are rewarded and that it strongly affect the local cost of equity, which may have important
implications for stcok market
development.
d. SHAREHOLDER
PROTECTION
Another key determinant of stock market development
is the level of shareholder protection
in publicity traded companies, as
stipulated in securities or company laws (Shleiter and Vishny, 1997) stock
market development it more likely in countries with strong shareholder protection
because investors do not fear
expropriation as much. In addition, ownership
in such market can be relatively
dispersed, which provides liquidity to
the market . la forta et al (1999) provide eviudence for the
importance of minority right protection
by using indicators of the
quality of shareholder protection
as written in law.
They demonstrate that the
quality of shareholder protection is correlated with the capitalization and
liquidity of stock market in 49 countries around the world. Kporta et al (1997
find that countries with lower quality of legal rules and low enforcement have
smaller and narrower capital markets and that the listed firms on their stock
markets are characterized by more concentrated ownership, Demirgue – kunt and
maksmovic (1998) show that firms in
countries with high ratings for the effectiveness of their legal system are
able to grow faster by relying more on external finance
PROMOTING STOCK MARKET DEVELOPMENT IN
AFRICA
The results from the previous sections show that
Africa stock markets are small, illiquid, with infrastructural bottleneck and
weak regulatory institutions. Despite
these problems, still markets in Africa have helped in the financing of the
growth of large corporation but there
is little evidence of Brower economic benefits. How do you make the stock
market more beneficial to African countries?
Number of propositions here been suggested to help develop stock markets
in Africa.
A. AUTOMATION
Automation is also expected
to help reduce the costs nd inefficiencies in Africa stock market and increase
trading activity and liquidity. Automation helps to speed up operations and
activities of exchanges and reduces cost
associated with manual system. In addition, automation makes it easier
to extent trading days and hours due to less cumbersome procedures. Automated
trading also eliminates the need for trade intermediation since investors can log
onto systems to monitor market and also trade on market, thus by passing the
use of brokers
Automation of the trading
system usually either proceeds or is preceded by the adoption of a central depository
system (CDS). Under the CDS system, there is total elimination of risk such as
the loss, mutilation and theft of certificates associated with holding and
trading of paper based security of investor. CDS system also reduce errors and
delays associated with paper-base
Automation is an experience
venture and has huge budgetary implications for African governments. This might
explain why most Africa stock market have found it difficult to fully automate their systems, 10 however, with the
proliferation of electronic communication network’s (ECN) and alternative
trading system (ATS), the cost of automation is gradually reducing. Other African
stock exchanges can adopt the Namiblan model were by the NSX of Namibia uses
the trading system of the JSE of South Africa. The markets could also adopt the
CDS systems in similar manners. Admittedly the operational procedures of such
an approach are likely to be difficult in the absence of currency convertility
issues and harmonized financial system
Automation is particularly important if African stock exchanges
aim at integration. Without automation the much touted benefits of regional
stock market integrations is likely to be lost.
B. DEMUTUALIZATION
Demutualization can be
defined as a change in the legal status,
structure and governance of an exechange from a non-profit, protected interest
one to a profit oriented . the process of demutualization involves a change in ownership structure and a change in legal and organization from. With regard to the ownership structure,
members seat are monetized and values assigned per seat. Members then either
keep or sell shares. Ownership restrictions are placed (for example, 5- 10
percent non- controlling sticks) on
individual and group to prevent potential takeovers by other exchanges. The legal and organizational
change normally entail the exchange becoming a typical profit making company
with limited liabilities and abiding by composing laws.
Demutualization started giving popularity in the 1990s, due to a number of factors . these include
competition among exchanges, need for increased capital, need for good corporate governance in exchange and the
2003, the number of demutualized and
public exchanges in the world
increase from 10 to 25 (10SCO, 2005)
Demutualization is expected
to solve mutual structure problems by opinion uo triding right, admitting new
trading partner, and broadening ownership such
that the public can invest in exchanges. The absence of these in mutual
exchanges tends to bread poor governance structures. In a metalizes exchange,
traders and brokers enjoy monopoly power though exclusive right and access to trading
system, resulting in a protection of visited interest for traders. In a
demutualized exchange there is a vote persuade and once incentives for equity
stock to non members exists these is separation of powers. Decision making is
on ownership structure not trades intermediation. Thus, demutualization
includes better corporate governance systems. In addition, undue governmental
influence mutual exchanges in Africa is likely to be absent in demutualized
exchanges since appointment of
government officials become unnecessary
due to the fact that a demutualized exchange is a private company.
Demutualization also
increases access to services of the exchange and removes excessive investment
costs for fund holders. For instance, brokers usually package non-trade related
fees (research, computer system and TPO access) into institutional traditional commotional
often known as “soft commissions” or bundled commissions and pass on to client.
With demutualization, fund holders can directly access such information without
the use of brokers.
Finally it is also argued
that demutualization instill efficiency and better structures in exchanges and
results in commercial gains for
exchanges (Ryden, 1995).
A major problem with demutualization is that
of conflict of interest and regulatory oversight, exchanges against there
is a potential commercialization of
services; data and trade information that traditionally and oversight can be
compromise by the exchange concerned. To
solve these problem self listing arrangements can be implemented.
For mutual African stock
exchanges, potential conflict of interest could pose huge problems, since
current regulatory are still undergoing restricting to meet international
standards. In many African Countries, the establishment of formal stock
exchange precedes the creation of formal independent securities regulators.
However, it could also be argues that perhaps being a private venture ,
demutualization exchange could speed
up the formation of strong
regulatory system in African
2.4 SUMMARY
An attempt has been made to
examine the relationship between stock market development and economic growth
in Nigeria, by employing the error-correction method. It was shown that stock
market development (market capitalization)
contributes positively to economic growth. The recommendations therein
include among others removal of
implements to stock market development in the form of tax, legal and regulatory barrier; improvement of the trading system in order to increase
the case with which system investors can purchases and sell shares, development of the nation’s
infrastructure so as to encourage firms
to grow and increase the ease with which they raise capital or funds on the
stock market; and strengthening the capacity to check the activities of stock
market speculator.
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