CAPITAL MARKET AND ECONOMIC GROWTH IN NIGERIA

7/30/2019 CAPITAL MARKET AND ECONOMIC GROWTH IN NIGERIA

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CHAPTER ONE

INTRODUCTION

1.1 Background to the Study

Stock markets are markets for trading long term financial securities, including ordinary

shares, long term debt securities such as debentures, unsecured loan stock and convertible

bonds. Government bonds and other public sector securities are also traded on stock markets.A good functioning stock market is vital in the contemporary economy, in order to achieve an

efficient transfer of monetary resources from those who save money toward those who need

capital and who will succeed in offering it a superior utilisation; the stock market can influence

significantly the quality of investment decisions.

Murinde (2006) argues that the structure of any stock market has three components and plays

three vital roles. First, the primary market, for new issues by firms and other institutions,

long-term funds can be raised by companies from those with funds to invest, such as financial

institutions and private investors. Secondary market is the one in which shareholders can

resell their existing securities to other interested buyers on the stock exchange or to buy

additional ones to increase their portfolios. The third is the derivative market, which serves

the exchange of securities created by the exchange and whose value is derived from the

underlying securities.

An important part of the structure of the stock market is its complementarily role to the

financial institutions. The argument by Demirguc-Kurt and Levine (1996) is that the

existence of an active stock market increases the debt capacity of firms; in this context, equity

markets and financial intermediaries complement one another so that an active stock market

results in increased volumes of business for financial intermediaries. In addition, it has been

argued that well developed stock markets facilitate reforms in the financial sector of any

economy (Murinde, 2006). Similar conclusions are reached by Demirguc-Kurt and

Maksimovic (1996), who opined that stock market development tends to increase the volume

of other business. Some emerging stock markets have recorded a dramatic increase in foreign

investment due to an expansion in privatisation listings, the use of bond instruments in

international debt settlements and some successful implementation of economic stabilisation

programmes. However, some very small, less developed stock markets, which are defined as

frontier markets by the International Finance Corporation (2000), have not received much of

the foreign inflows. These markets have become consequently segmented from globalmarkets.

The Nigerian Stock Exchange is the only stock market institution in Nigeria, where securities

(shares, stocks and bonds) can be bought or sold (NSE 2009). The Nigerian stock market is

viewed as a complex institution imbued with inherent mechanism through which long-term

funds of the major sectors of the Nigerian economy comprising households, firms, and

government are mobilized, harnessed and made available to various sectors of the economy

(Nyong, 1997). The development of the Nigerian stock market provides opportunities for

greater funds mobilization, improved efficiency in resource allocation and provision of

relevant information for appraisal (Inanga and Emenuga, 1997).

For the twenty years covered by the study (1989 - 2008) the market capitalization increased

from N12.8 billion in 1989 to N13, 294.6 billion in 2007. The value traded increased form N

610.3 million in 1989 to N1, 679,138.7 million in 2008. Number of deals on the Nigerian

stock market floor increased from 33444 deals 1989 to 3535631 deals in 2008. The number


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of listed company on the Nigerian stock market increased from 111 to 213. According to

Osinubi (2004) there is need for rapid development of the Nigerian stock market, so that the

optimum benefits of linkages between stock market and economic growth can be realized in

Nigeria. Given that the stock market provides some services that have an impact on economy,

this study, therefore, tends to assess Nigerian stock market development and investigates

whether there is any relationship between the stock market development and GDP in Nigeria.Multiple regressions using Least Square method has been adopted to make analysis on

secondary data covering the period 1989 to 2008.

1.2 Statement of the Problem

The financial system of any economy is seen to be divided between the financial

intermediaries (banks, insurance companies and pension funds) and the markets (bond and

stock markets). In promoting economic growth, a key factor is seen to be a healthy

development of a nations financial sector, which in turn improves the private sectors access

to services such as bank credit, equity capital, payments and risk management services. Stockmarket development has assumed a developmental role in global economics and finance

following the impact they have exerted in corporate finance and economic activity. For

instance stock markets, due to their liquidity, enable firms to acquire much needed capital

quickly, hence facilitating capital allocation, investment and growth. Stock markets also help

to reduce investment risk due to the ease with which equities are traded. Stock market activity

is thus rapidly playing an important role in helping to determine the level of economic

activities in most economies.

Moreover, the work of Demirguc-Kurt and Levine (1996), Singh (1997) and Levine and

Zervos (1998) found that stock market development plays an important role in predicating

future economic growth in situations where the stock markets are active. The arguments of

Demirguc-Kurt and Levine (1996) indicate that economies without well-functioning stock

markets may suffer from so many financial imperfections. An empirical study by Levine

and Zervos (1998), King and Levine (1993), Sarkar, (2005) and Demirguc-Kurt and

Maksimovic (1996) showed there is relationship between various indicators of stock market

development and GDP. Other scholars who analyze the stock market development traditional

indicators and their relationship with Gross Domestic Product (GDP) include Chakraborty,

(2008), Claessens, Klingebiel, and Schmukler (2006) and Brasoveanu, Dragota, Catarama,

Semenescu (2007).

Adjasi and Biekpe (2005) have found a significant positive impact of stock market

development on GDP in countries they classified as upper middle-income economies. Also

Chen and Wong (2004) elaborates that the connection between stock returns and output

growth and the rate of stock returns is a leading indicator of output growth. Arestis,

Demetriades and Liuntel (2001) used time-series of five industrialized countries and conclude

that stock markets play a role in growth. Various studies such as Atje and Jovanovic (1993);

Filler, Hanousek and Campos (1999) and Aruwa (2009) supports the view that stock markets

development has significant relationship with economic growth. With well-functional

financial sector or banking sector, stock markets can give a big boost to economic

development (Roussean and Wachtel, 2000; Beck and Levine, 2003). Bahadur and Neupane

(2006) conclude that stock markets fluctuations predicted the future growth.

The empirical evidence, however, strongly showed that greater stock market liquidity boost

or at least precedes economic growth. Apart from the view that stock markets may be having

real impact on growth, there are theoretical constructs that show that stock market

development has negative relationship with GDP. For instance, Stiglitz (1985 and Bhide

(1993) opined that stock markets can harm economic growth. Their argument is based on the


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fact that liquidity in the stock may reduce savings rates. They also argue that stock market

can negatively affect GDP due to dispersed ownership which will lead to poor corporate

governance that will affect the performance of the listed firms.

Ironically, in many countries where there are investment opportunities, there is inadequate

access to finance, particularly risk capital and this underlines the need to accelerate thedevelopment of local stock markets (International Finance Corporations 2000). In addition to

this, Pardy, (1992) also recognized the need for the development of the stock market for the

less developed economies. He argued that stock markets could significantly raise the level of

domestic savings and contribute to a more efficient allocation of such savings among the

competing use of the savings. Despite the size and illiquid nature of the some stock markets,

their continued existence and development could have important implications for economic

activity. This is because even in less developed countries stock markets are able to mobilize

domestic savings and able to allocate funds more efficiently. Thus, stock markets can play a

role in inducing growth in less developed countries.

Considering the contributions of the developed stock markets to their economies, this has ledresearchers to focus on how the stock markets develop and affect the developing economies,

so that these economies also enjoy the benefits of the stock markets. There was a remarkable

performance in the Nigerian stock market activity in recent years, despite the fact that the

market is still small and illiquid when compared with those in some developed countries.

Consequently, analyzing the relationship between stock market development and GDP is

important in designing economic development programmes.

However, due to the fewness of empirical research in the area of stock market development

and its impact on GDP in developing countries such as Nigeria, this study attempts to fill in

this gap by following the work of the above mentioned studies. The study uses three measure

of domestic stock market development: size (market capitalization ratio), market liquidity(turnover ratio and value traded ratio), all as a percentage of GDP, with focus on how the

Nigerian stock market developed in recent time and its relationship with GDP.

Based on the above mentioned issues, the following research questions will guide this study:

(I). What is the relationship between the Nigerian stock market capitalization ratio and the

Growth Domestic Product (GDP)?

(II). What is the relationship between the Nigerian stock market turnover ratio and the


(III). What is the relationship between the Nigerian stock market value traded ratio and the


1.3 Objectives of the Study

The main objective of the study is to examine the Nigeria stock market development and

relationship between market development and GDP from 1989 2008. The specific

objectives of this study are:

(I). To determine the relationship between the Nigerian stock market capitalization ratio andthe Growth Domestic Product (GDP).

(II). To determine the relationship between the Nigerian stock market turnover ratio and the

Growth Domestic Product (GDP).


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(III). To determine the relationship between the Nigerian stock market value traded ratio and

the Growth Domestic Product (GDP).

1.4 Research Hypotheses

Some of the following hypotheses were formulated based on the research problem statement:

(I). There is no significant relationship between the Nigerian stock market capitalization ratio

and the Growth Domestic Product (GDP).

(II). There is no significant relationship between the Nigerian stock market turnover ratio and

the Growth Domestic Product (GDP).

(III). There is no significant relationship between the Nigerian stock market value traded ratio

and the Growth Domestic Product (GDP).

1.5 Significance of the Study

The growing importance of stock markets in developing countries around the world over the

last few decades has shifted the focus of researchers to explore the stock market development

indicators. The motivation is derived primarily from the obvious policy implications of the

findings of such studies for the developing economies such as Nigeria. An empirical study by

Levine and Zervos (1998), King and Levine (1993), Demirguc-Kurt and Maksimovic

(1996) showed policy implications of such study by examining the relationship between stock

market development and GDP.

The significance of this research work to the relevant literature lies first of all, in focusing the

Nigerian stock market developments in recent times. Secondly, this study focuses only on

stock market development and its relationships with GDP as evident in the study Levine

and Zervos (1996) and Brasoveanu, Dragota, Catarama, Semenescu (2007).

It is also expected that the findings would be an added knowledge to the area of this research

work. In particular, academic researchers, operators of the Nigerian stock market (both the

regulators and investors) are expected to benefit from the findings. These include Central

Bank of Nigeria, Nigerian Stock Exchange, Stock broking firms; Registrars, Security and

Exchange Commission and other players of the Nigerian capital market.

1.6 Scope of the Study

This study will cover transactions on the floor of Nigerian Stock Exchange from 1989 to

2008; market capitalization ratio, and value traded ratio and turnover ratios are the specific

variable to measure. All the data used in this study are expected to cover only 1989 to 2008.

This period is deemed reasonable enough to analyse the development in the stock market and

how it has contributed to the economy. Thus, the study is restricted to examining relationship

of the Nigerian stock market development or performance indicators and the GDP.


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CHAPTER TWO

LITERATURE REVIEW AND THEORETICAL FRAMEWORK

2.1 Introduction

In this chapter some related work are reviewed, the major findings, methodologies and

conclusions of existing research works related to this study are carefully synthesized.

Literature related to financial market, capital market, particularly stock market development

and relationship to economy, with emphasis on developing nations such as Nigeria are

reviewed. This is to give an idea of specific areas of the study that require new or additional

research work.

2.2 Overview of the Nigerian Financial Market

Many studies were conducted on the financial market development, most of them crosscountry regression. In general financial market deal with financial assets and liabilities of

various maturities and consist of institutions, instruments, rules and regulations which guide

the mobilization of fund from surplus units of the economy to the deficit units. In other

words, it is a forum for the exchange of any kind of financial products, which may be

represented by a physical location or by sharing data on prices and volume transacted where

professionals are among the participants of the market process (Masha, Essien, Musa, Akpan

and Abeng, 2004). Olowe (2008) viewed financial market as a market that enables efficient

allocation of funds from surplus units of the economy to the deficit units. The role of

financial market is institutional intermediation in capital flows (Subramanyam, 2007).

It was argued by King and Levine (1993) that the level of financial intermediation is a goodpredictor of long-run rates of economic growth, capital accumulation, and productivity

improvements. According to Classens (1995) financial development of any country provides

a way for growth and development of the country. A study by Demirguc-Kurt and Levine

(1996) showed that, an overall growth and development in any country or region are related

to, and to a large extent caused by, the development of financial market (capital and money

markets). They argued that lack of these markets will make it impossible for investor to

invest. Indeed, some scholars have opined notably Stiglitz (1991) and Bhide (1993) that they

contribute little to economic efficiency and may even be welfare-decreasing.

Financial Markets are defined as a network of individuals, institutions and instruments

working together in the process of mobilizing and transferring funds from the surplus to thedeficit units of the economy. Financial markets are made up of the money and capital and

markets. The length of time money is invested or raised determines the segment of the

financial market to which it belongs (SEC, 2007). Money market and capital market are the

major divisions of the Nigerian financial market; they determine the volume of credits

available as well as attract savings and set interest rates and securities prices. Nigerian

financial markets in terms of structure are unique and different from most of the financial

markets of other advanced countries.

According to Abudu, Bamidele, Okafor and Adamgbe (2004), Nigerian financial market is

unique and different due to the nature of the economy, the agrarian nature of production, and

communal restriction and laws that guide saving mobilization. In addition, the low level oftechnological transformation as well as the economy is cash kind, which has hindered the

growth of the market to global challenges. Some researchers agued as shown in some works

on low developing nations like Nigeria, financial sectors in developing countries do not

intermediate efficiently between savers and investors (Ojo, 1986, Kitchen 1988, Fry 1988 and


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Bhatt 1986 as cited in Ojo 2007). Some of the reasons include financial repression, poor

adaptation and orientation of financial system, market structure and management

performance of both the financial intermediaries and financial regulators (Ojo 2007).

2.2.1 Structure of Nigerian Financial Market

According to Abudu, Bamidele, Okafor and Adamgbe (2004) Nigerian financial market

structure is unique and different from those of most other countries. The structure of Nigerian

financial market is broadly divided into money market and capital market, of which money

market deals with short term securities while capital market deals with long term securities

(Ebajemito, Kama, Salam and Anyakoha, 2004). Capital markets made it possible to develop

projects that required large capital injections for long periods before the projects ultimately

yielded profits (Muhtadi and Agarwal, 1997).

According to Odoko, Adamu, Dina, Golit and Omanukwe (2004), the Nigerian capital

market is structured into the stock market and commodities market. Nigerian stock market is

one of the divisions of the Nigerian capital market that provides facilities for mobilising and

dealings in medium and long term funds. Commodities market is a segment of the Nigerian

capital market where commodities are traded such as agricultural product, oil products, and

precious metals. The Central Bank of Nigeria (CBN), which is the apex regulatory authority

in the financial system, has through its monetary policies the responsibility of creating stable

economic conditions in the country. The CBN has direct control and supervision over

government regulatory agencies, as well as banking and non-banking financial institutions.

Banking institutions are those who obtain their funds from deposits while non-bankinginstitutions obtain theirs from other than deposits. Regulatory agencies include the Security

Exchange Commission (SEC), and the Nigerian Deposit Insurance Corporation (NDIC).

SEC is at the apex of the capital market and its objectives are mainly the protection of

investors and capital market development. In order to achieve these objectives, the

commission has several powers. It regulates the market against malpractice of security

trading and assures that information flows smoothly. It encourages economic development by

providing incentives for domestic savers and by attracting foreign capital for domestic

investments. It determines the time, amount and prices of new issue shares so that excess

demand does not arise at any particular time. It registers the institutions and individuals

involved with the market-making so that investors have the necessary assurance that themarket is governed by proper standards of conduct. SEC has the function of de-listing a

firms securities for rule violations. It also has control over mergers/acquisitions and all other

forms of business combinations. By organizing workshops, symposiums and international

conferences, and also through co-operation with other regional and international

organizations and markets, it actively searches for stimulating ideas on the basis of which it

initiates policy changes that could enhance the growth of the Nigerian security market. The

NDIC is the insurer of all deposit-taking institutions in the financial system. It is empowered

to examine the books and affairs of insured banks and all deposit-taking financial institutions.

Yohannes (1999) observed that the availability of financial capital is a prerequisite for the

development and transformation of any nations economy. Finding and efficiently managingthis scarce resource is best facilitated by the existence and appropriate functioning of

financial institutions, also known as institutional investors. These institutional investors are of

three kinds: banking institutions, specialized banking, and non-bank financial institutions.

Banks mobilize financial resources from the surplus sectors of the economy and channel such


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funds to the deficit units of the economy through the extension of loans and credits.

Specialized banks provide loans for projects with medium to long maturity periods. The

specialized non-bank financial institutions are those institutions that fall into the category of

non-deposit-taking financial institutions or their agents. They include insurance companies,

national provident funds, stock broking firms, pension fund administrators, issuing houses,

registrars, building societies, venture capital companies and the Nigerian Stock Exchange(Yohannes, 1999).

2.2.2 Functions of Nigerian Financial Market

The importance of well functioning financial market cannot be over emphasized, for an

economy to grow and develop a sound financial market is needed. Many studies showed the

development of financial market is positively related to economic growth and development

(Abudu, Bamidele, Okafor and Adamgbe 2004). According to Nkwanko (1991) financial

market provides services that are essential to any economy by facilitating trade and offeraccess to a variety of financial institutions. Ojo (2007) outline the functions of the Nigerian

financial market, Economic and financial development, Financing systems and economic

development, and Expected role of financial sector in economic development.

The roles of financial market are financial intermediation, monetization and capital formation

for economic improvement (Ebajemito, Kama, Salam and Anyakoha, 2004). Grill (1975)

argues that financial institution performed three functions; monetary intermediations which

made up of central banks and commercial bank, non monetary intermediation which made up

of various specialized institutions such as saving and loan institutions, pension funds, mutual

funds, development banks, the last is securities market where stocks and bond are traded.

Financial market should facilitate the achievement of the entire financial system of anycountry, which includes provision of efficient banking services, high mobilization of savings

and channelling surplus fund to deficit unit as capital (Okigbo, 1981).

2.3 Nigerian Stock Market

Finance is the life-blood for any business enterprise. Funding for economic activities must be

adequate and appropriate. The issue of adequacy is easily comprehended as the evidence of

under-funded and consequently abandoned projects abound everywhere. What is however not

clear to many is that some otherwise viable projects have also collapsed due to the use of

short-term funds (money market), usually in the form of bank loans to finance projects withlong gestation periods.

The need to repay such loans before the projects can generate sufficient funds to sustain them

had often led to the collapse of such businesses. That is why stock market is more appropriate

since it facilitates the mobilization and allocation of medium and long-term funds through the

issuance and trading of financial instruments. Such instruments, otherwise known as

securities, include equities and bonds. While equities represent ownership stake in a company

which issued them, bonds are debt instruments with the principal and interest usually payable

to the bondholder at specific periods.

The stock market is made up of two inter-related segments primary and secondary market.The primary market is the mechanism for raising funds through the issuance of new

securities. The secondary market essentially provides facilities for trading in (transferring)

already issued securities, thereby creating liquidity in the market (Olowe, 2008). Thus,

quoted securities are usually more attractive as investors can more easily turn them to cash


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whenever they so desire. As the major source of appropriate long-term funds, the stock

market is obviously crucial to any nations economic development.

Specifically, the stock market can facilitates economic growth by, among other things,

mobilizing savings from numerous economic units such as governments, individuals and

institutional investors for users such as governments and the private sector. It also improvesthe efficiency of capital allocation through a competitive pricing mechanism. In developed

financial markets, and increasingly in developing financial markets, stock markets are taking

centre stage in financial markets. It has been argued that stock markets stimulate investments

because as organized markets, they recognize and fund productive projects that lead to

economic growth and ensure proficient allocation of capital (Caporale and Soliman, 2004).

A study conducted by Mutenheri and Green, (2003) showed that the difference between pre-

reform and post-reform era in the countrys financial system (especially stock market) is

significant and that the reform has achieved partial success in increasing the capital

mobilization and improving the development of the market.

The players of the market are the regulators and the operators who act as intermediaries

between the providers of the funds and the fund users. They include the Central Bank of

Nigeria, the Securities Exchanges Commission, Nigerian Stock Exchange, Brokers/Dealers,

Issuing Houses, and the Registrars and Investment Advisors. In pursuance of making funds

available for economic development and growth; the Securities and Exchange Commission

was established in 1979 by the Securities and Exchange Commission Decree (this decree was

re-enacted in 1988 as Securities and Exchange Commission Decree no. 29 of 1988, for the

purpose of protecting the investors as well developing the capital market). A detailed review

of the Nigerian capital market was carried out in 1996. This led to the enactment of the

Investment Securities Act (ISA) No.45 of 1999 (and the regulations made there under). This

Act replaced the Securities and Exchange Commission Decree No.29 of 1988. It was aimedat providing a more efficient and viable capital market positioned to meet the country's

economic and developmental needs.

As most stock market in the world, Nigerian stock market is also divided into primary and

secondary market. In Nigeria, the secondary stock market is divided into dealers market and

centralized auction market. Dealers market deals with the trading of unlisted securities on the

Nigerian stock exchange floor. Centralized auction market is an organized secondary market

for buying and selling of securities, known as Nigerian Stock Exchange (Odoko, Adamu,

Dina, Golit and Omanukwe, 2004).

The establishment of stock markets in Nigeria is expected to boost domestic savings andincrease the quantity and quality of investment. More generally, stock markets are seen as

enhancing the operations of the domestic financial system in general and the capital market in

particular (Kenny and Moss, 1998). Critics, however, argue that the stock market might not

perform efficiently in developing countries and that it may not be feasible for all African

markets to promote stock markets given the huge costs and the poor financial structures

(Singh, 1999). Stock markets also provide an avenue for growing companies to raise capital

at lower cost. In addition, companies in countries with developed stock markets are less

dependent on bank financing, which can reduce the risk of a credit crunch (Yartey and

Adjasi, 2007). Stock markets therefore are able to positively influence economic growth

through encouraging savings amongst individuals and providing avenues for firm financing.

The stock market is supposed to ensure through the takeover mechanism that pastinvestments are also most efficiently used (Kumar, 1984).

2.4 Regulators of the Nigerian Stock Market


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The regulatory bodies of the Nigerian stock market consist of Central Bank of Nigeria,

Securities and Exchange Commission, and Nigerian Stock Exchange (Odoko, Adamu, Dina,

Golit and Omanukwe, 2004).

2.4.1 The Role of Central Bank of Nigeria (CBN)

As with the money market, the central bank is a major player in the Nigerian stock market.Central bank of Nigeria is the apex regulatory authority of the Nigerian financial market

(money and capital markets). Also, CBN lays down terms and regulations for issuance of

Federal Government stocks thereby improving stability in the market. The CBN participates

actively in setting up the development finance institutions and is also at the forefront in

enhancing the payment and settlement system.

2.4.2 The Role of Securities Exchange Commission (SEC)

The Securities and Exchange Commission is the apex regulatory agency for the Nigerian

stock market. Originally established by SEC Decree 29 of 1988, the Commission has evolved

over the years with its current enabling law being the Investment and Securities Act (ISA) 45

of 1999. The Commission is basically charged with the dual role of developing andregulating the market. Some of its specific functions as listed in section 8 of the ISA are to:

a) Register and regulate Securities Exchanges, Capital Trade Points, Futures, Options, and

Derivative Exchanges, Commodity Exchanges and any other Recognized Investment

Exchanges. b) Register Securities to be offered for subscription or sale to the public. c)

Render assistance in all aspects including funding as may be deemed necessary to promoters

and investors wishing to establish Securities Exchanges and Capital Trade Points. d)

Facilitate the establishment of a nation-wide system for secondary trading in the capital

market. In carrying out its developmental role in the market, the Commission has taken

various steps and introduced some measures. For instance, in order to create more awareness

of the opportunities in the market and thereby enhance participation by the populace, SEC

has engaged in public enlightenment campaigns through radio and television programmes,organizing seminars, workshops and conferences and various publications.

It has also, over the years, sponsored/promoted interactive sessions that are aimed at

developing new capital market products. It has been sponsoring the introduction of capital

market studies at both secondary and tertiary educational levels. The mandate to protect

investors in the market, to minimize the risk of their becoming victims of any malpractice is a

major objective of the Commission.

According to SEC (2007) the Commission adopts the following tested and proven tools to

achieve these objectives,: a) Registration: Registration is the entry point to the Nigerian

capital market as it ensures that only proper and fit persons are admitted to operate in the

market and that only securities for which all pertinent and material information have been

provided that will enable rational investment decisions are allowed to be issued and offered toinvestors. b) Surveillance: The ISA empowers SEC to maintain surveillance over the

securities market in order to ensure orderliness, fairness and equitable dealings in securities.

Hence, the Commissions staffs are always present to monitor activities on the floors of the

Stock Exchanges as well as to monitor the activities of other operators in the market. c)

Investigation: The Commission is also empowered by the ISA to embark on the investigation

of any capital market operator as well as any company with regards to securities issuance.

Such investigations may be triggered off by petitions to the Commission, media reports etc.

d) Enforcement: The Commission, after investigating and ascertaining the veracity of any

case of malpractice by any market participant may apply sanctions against such offenders.

For instance, registration certificates of erring market operators may be suspended or the

Commission may institute a legal action to enforce compliance. e) Rule Making: Pursuant tothe ISA the Commission makes rules for operating in the market. Such rules are subject to

revision as the need arise.

2.4.3 The Role of the Nigerian Stock Exchange (NSE)


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The NSE is a self regulatory organization with overseeing responsibility on the professional

activities of its members, such as stockbrokers who trade on its floors. The Nigerian Stock

Exchange is required to provide periodic report of its activities to the Securities and

Exchange Commission. Being a non-statutory body, its rules, which must be approved by

SEC, lack the force of law. The NSE is a market where trading activities for securities take

place. Since the main interest here is to investigate the stock market, detailed examination ofthis important market will be done later.

2.5 An Account of the Nigerian Stock Exchange

The hub of Nigerian capital market is the Nigerian Stock Exchange, which was started in

1961 and was formerly called the Lagos Stock Exchange. Trading commenced in 1961 with

0.3 million shares worth N1.5 million in 334 deals and grew steadily to a value of N16.6

million in 634 deals in 1970. The implementation of the Nigerian Enterprises Promotion

Decree of 1972 and 1977 enhanced public participation in the stock market. Similarly state

government started patronizing the market to raise long term funds for long term projectssuch as Bendal state government bond in 1978. During the early 1980 to late 1980s the

market witnessed some fluctuations, which was settled around 1993, due to the participation

from private sector (Abudu, Bamidele, Okafor and Adamgbe 2004). The number of listed

company rose from 9 in 1961 to more than 200 now while new issues valued at N43.7 million

in 1971 increased to N150 billion (NSE 2008).

Another index of size is number of quoted securities, which rose from only 9, 3 equities and 6

government securities in 1961, to 153 in 1980 with 90 equities, 13 debentures, and 50

government securities. The number of listed securities rises in 1994, to 276 including 29

government stocks, 70 industrial bonds and 177 equities (NSE, 2003). In 2006 the number of

listed company was 202, number of listed securities 288, market capitalization N5.12 trillion(NSE 2006). The market capitalization as at the end of December 2008 was N 9.56 trillion up

from N4.5 billion in 1980, the NSE All-Share Index 31,450.78, Total Turnover Value N2.4

trillion, number of Listed Companies 213, number of Listed Securities 301 (NSE 2008).

According to NSE (2009) Nigerian Stock Market indicators recorded downward movements.

In addition, a significant portion of the funds that left the stock market for the Private

Placement Market in 2007/8 remained locked-in, as many of the issuers have not yet applied

to The Nigerian Stock Exchange for listing. Turnover on the Exchange closed the year at

N685.72 billion, down by 71.2% from the N2.4 trillion recorded in 2008.

Average daily activity dropped from 775.65 million shares worth N9.55 billion in 2008 to414.73 million shares valued at N2.8 billion in 2009.The bulk of the transactions were in

equities, which accounted for N685.3 trillion or 99.94% of the turnover value compared to

N2.376 trillion or 99.85% recorded in 2008. Transactions in the industrial bonds sector

accounted for N412.8 million or 0.06% compared to N3.53 billion or 0.15% in 2008, while

transactions in the State Government bonds sector were very minimal, accounting for only

N119, 530. The Preference Stocks subsector was inactive in 2009 (NSE 2009).

Furthermore, turnover on Federal Government bonds on the Exchange was idle, while a

turnover of N18.51 trillion in 134,120 deals was recorded in the over-the-counter (OTC)

market for Federal Government bonds, as against N10.44 billion in 78,248 deals recorded in

2008. Investors traded rights in two companies, compared to four companies in 2008. In all,136 deals valued at N46.04 million were executed in this market segment in 2009, down by

87.1% on the N357.05 million values of transactions in the previous year. The companies

whose rights were traded during the year are Cadbury Nigeria Plc and Eterna Oil & Gas Plc

(NSE 2009).


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The total market value of 266 securities listed on the Exchange dropped by 26.5%, from

N9.563 trillion to stand at N7.03 trillion at the end year 2009. The decline in market

capitalization resulted mainly from equity price losses, and the delisting of 64 securities, 11

equities and 53 fixed income securities. By the end 2009, the market capitalization of the 216

listed equities accounted for N5 trillion or 71.04% of the aggregate market capitalization. In

2008, 213 equities accounted for N7 trillion or 73.1% of market capitalization. Also, by theend of 2009, seven subsectors recorded increased market capitalization of between 6% and

69.3%, while 26 subsectors suffered a reduction in market capitalization of between 6.4% and

77.3%. Two subsectors (Machinery Marketing and Aviation) did not record any change in

market capitalization (NSE 2009).

The NSE-30 All-Share Index (ASI) dropped by 33.8% or 10,623.61 points to close at

20,827.17. The NSE ASI had in 2008 dropped by 45.8% or 26,539.44 points to close at

31,450.78. The performance of the Index reflects a significant reduction in prices of equities

during the year. By year end, 23 stocks recorded price appreciations and 159 stocks recorded

price declines while the prices of 35 remained constant. In 2008, 78 stocks recorded price

appreciations and 111 stocks recorded price declines while the prices of 24 remainedconstant. As expected, the new NSE-30 Index showed resilience by dropping only 25.44

points or 3% to close the year at 827.99. This is due mainly to the indexs broad-based

structure and limited exposure to any sector in particular two key requirements for products

such as Exchange Traded Funds (ETFs) and derivatives. The Exchange also introduced four

sectoral indices during the year. By year end, however, all the four sectoral indices had

depreciated, the NSE Food/Beverage Index dropped by 32.63 points or 5.83% to close at

526.71; the NSE Banking Index dropped by 159.45 points or 32% to close at 339.32; the

NSE Insurance Index dropped by 391.59 points or 61.13% to close at 249.01; and the NSE

Oil/Gas Index dropped by 433.52 points or 60.1% to close at 288.06 (NSE 2009).

When compared with the preceding five years, the Primary market was less active during2009, in terms of number of applications received and issues offered for public subscription.

This can be attributed to the liquidity crisis and the overriding pessimism of investors. The

Exchange considered and approved 30 applications for new issues valued at N279.25billion

or 1.2% of GDP, as against 70 applications for new issues valued at N2.6 trillion or 11.3% of

GDP in 2008 (NSE 2009).

Non-bank corporate issues accounted for 71.5%, with 25 applications valued at N199.65

billion while the banking sector accounted for 3.6%, with one application valued at N10.1

billion. State Government bond issues accounted for N69.5 billion or 24.9% of the total

amount approved during the year. Of the non-bank applications, the Foreign Listings and

Insurance subsectors accounted for N27.5 billion and N33.22 billion or 9.84% and 11.9%,respectively, of total applications considered. No new IPOs were approved in 2009

(compared to N1.01 trillion in 2008) while N14.7 billion was raised through supplementary

issues, N31.72 billion through rights issues, and N71.74 billion through bonds issue,

including four State Government Bonds (NSE 2009).

According to NSE, (2009) the Exchange implemented certain initiatives in 2009 to broaden

participation in our market, expand services, improve liquidity, and generally propel the

market to greater heights. These initiatives are in the important areas of capacity building,

investor education, international cooperation, and new products development.

a) Market Technology

Nigerian Stock Exchange completed an upgrade of Horizon, NSE trading platform, to the

latest version. The upgrade comes with improved functionalities that would impact positively

on trading on the Exchange, especially equities, derivatives, bond trading and surveillance.


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NSE surveillance capability currently detects any price manipulation in the market. Like a

dynamic organization, NSE already considering the transition from the current software

platform to a bigger platform, in view of expanding its operations.

In this regard, NSE has commenced negotiations with the London and New York Stock

Exchanges in the selection of a more suitable platform for implementation within the nexttwo years.

b) Dissemination of Market Information

During the year 2009, the Nigerian Stock Exchange concluded arrangements with renowned

global news media Powerhouses, such as Thomson Reuters and Bloomberg for dissemination

of real-time market data to the global investment community. This service is designed to

compliment what is provided by NSE official Website and local Data Centre. Data for

investors and market operators include the bid/ask prices, volumes, latest trades and market

depth information on equities and indices listed on the NSE. Nigeria Stock Exchange is the

second African exchange to be switched on by Reuters for real-time data, following KenyasNairobi Stock Exchange a direct acknowledgement of the development of the stock market in

Nigeria (NSE, (2009).

c) New Products

In further appreciation of the efforts by the Nigerian Stock Exchange to create products that

would take our market to a global audience, the Nigerian Stock Exchange has been

approached by Bloomberg to co-brand all the newly-created indices, i.e., NSE-30 and the 4

sector indices. The Bloomberg branding will further enhance the profile of these indices and

thereby give institutions the confidence to create products based on these indices, knowing

that they will be displayed to a global investor base via the Bloomberg screens worldwide.The arrangement will also develop a revenue stream for the Nigerian Stock Exchange in due

course.

d) Expanded Branch Network

As at December 2009 the Nigerian Stock Exchange has 13 branches across Nigeria other than

its world-class trading floor in head office at Lagos. These are: Abuja, Kaduna, Port

Harcourt, Kano, Onitsha, Ibadan, Yola, Benin, Uyo, Ilorin, Abeokuta, Owerri and Bauchi.

The Exchanges 13 branches trading in real time, while plans are in the advanced stages for

the opening of another branch in Oshogbo, Osun State.

e) Inspection of Dealing Member Firms

A total of 242 (out of 254) stock brokerage firms were inspected in the year 2009 by the

Compliance Department of the Regulation and Risk Management directorate. Several firms

reported trading losses and negative shareholders funds as a result of the financial crisis that

followed the economic downturn. These firms have been advised to inject fresh funds and

return their firms to profitability. The remaining twelve (12) firms had their inspections

rescheduled.

e) Complaints/Infractions and Violation of Rules of the Exchange

A total of 249 unresolved complaints were brought forward from 2008, mainly from inactive

dealing member firms. In 2009, a total of 417 complaints were received against dealing firms.

Out of this, 287 complaints were resolved while 130 are still being investigated and pending

resolution. Complaints received during the period under review were observed to border

mainly on the unauthorized sales of shares and failure to remit sales proceeds. This was


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attributed to the illiquidity suffered by the majority of dealing member firms, coupled with

desperation of banks to recoup outstanding margin facilities. It was further observed that the

majority of the dealing member firms do not comply with Article 102 of the Rules and

Regulations Governing Dealing Members Know Your Client. This has often resulted in

fraudulent sales of shares to persons who are not real owners of the shares. During the year,

six (6) Dealing Member firms were suspended for failure to submit audited accounts,contrary to Article 15(h) of the Rules and Regulations governing dealing members.

f) Investor Education

Though the National Essay Competition for secondary schools and tertiary institutions was

suspended during 2009, The Exchange sustained its investor education initiative, as students

from all levels continued to visit The Exchange during their excursion programmes. The

Annual meeting of Chief Executive Officers of listed Companies, stock and management of

The Exchange was held in 2009.

2.6 Stock Market Development and Economic Growth

Levine and Zervos (1998) showed a positive and significant correlation between stock market

development and long run economic growth in their study of 47 countries. However, their

study relies on a cross-sectional approach with well known empirical limitations.

Nevertheless, a debate now exists within this framework. On one side, the view is that stock

markets promote long-run growth. Greenwood and Smith (1996) argued that stock markets

lower the cost of mobilizing savings facilitating investments into the most productive

technologies and diversifying the risks. Obstfeld (1994) indicates that international risk

sharing through internationally integrated stock markets improve resource allocation and

accelerate growth. Bencivenga, Smith and Starr (1996) and Levine and Renelt (1992)suggested that stock market liquidity plays a major role in economic growth. Liquidity has

also been argued to increase investor incentive to acquire information on firms and improve

corporate governance, thereby facilitating growth (Holmstrom and Tirole, 1993). According

to Pagano (1993) theoretical literature on stock market development and economic growth

identifies three fundamental channels through which stock market and economic growth are

linked. Stock market increases the proportion of savings that is funnelled to investment.

Secondly, stock market may change the savings rate and hence affect investment. Finally

stock market increases the efficiency of capital allocation.

Capasso (2006) points out how stock market developments affect economic growth. In the

beginning financial market are rudimentary and usually dominated by banks or other similar

financial intermediaries. At this stage stock market does not exist at all or if they exist, their

size does not allow them to have any significant effect on the economy. Accumulation of

capital leads to the development of financial intermediaries and increases the number,

complexity and sophistication of the financial instruments. As a result, the size of the

financial market increases and stock market begin to grow in terms of market capitalization,

traded value and number of listed companies. Stock market and financial intermediaries

continue to develop together with the growth of the economy in general. In the economies

with relatively small size stock market, further development goes mostly through the increase

of share of the banking sector in the economy. In the economies where the size of the stock

market is relatively large, further development of the financial system goes through thedevelopment of the equity market.

Considerable amount of literature suggest that the development of stock markets is positively

related with the level of economic development and accumulation of capital. This conclusion

unequivocally supports the idea that as economies develop equity markets tend to expand


14/41

both in terms of the number of listed companies and in terms of market capitalization (Atje

and Jovanovich, 1993; Korajczyk, 1996; Demirguc-Kurt and Maksimovic, 1996; Levine and

Zervos, 1998 and Bose, 2005). However, these findings have not indicated a direct and

monotonic expansion of the share of equity markets in the financial system. In fact, the

development of equity markets always appears to be preceded and accompanied by the

general expansion of the overall efficient financial system. Therefore, the co-evolution of realand financial variables is a complex and complicated phenomenon.

In reality, the expansion of stock markets generally follows the development of other

financial intermediaries, which, in many cases, continues as equity markets expansion

(Korajczyk, 1996; Demirguc-Kurt and Maksimovic, 1996; Levine and Zervos, 1998 and

Bose, 2005). Facts about the correlation between stock development and economic growth

can be drawn from empirical literature (Levine and Renelt, 1992 and Brasoveanu, Dragota,

Catarama, Semenescu, 2007).

Furthermore, Atje and Jovanovich (1993) have concluded that there is strong positive

correlation between the level of stock market development and economic growth. Levine andZervos (1998) also emphasized on the fact that stock market liquidity measured as the value

of stock traded relative to the size of the market and the size of the economy is significantly

and positively related to the rate of economic growth. This significance in stock market

development in the course of economic growth is also confirmed by Beck and Levine (2001);

and they argued that the expansion of both banks and stock markets significantly affects

growth.

Some general facts about the development of equity markets have been drawn by Demirguc-

Kurt and Maksimovic (1996) and Atje and Jovanovich (1993) who confirmed that stock

markets lead to a relative increase of equity financing in the economy. In other words, given

that the stock market development affect growth, the bank debt/equity ratio in the economytends to increase at low levels of capital accumulation and to decrease only when stock

markets have reached a reasonable size.

Demirg-Kunt and Maksimovic, (1996) also argued that at initial stages of economic

development, the expansion of stock markets increases both the opportunity for risk sharing

and the flow of information in the market. These, in turn, allow firms easy and cheap access

to bank loans and to increase the level of leverage. However, at the later stage as stock

markets develop further, issuing equity becomes more convenient because of the declining

costs and firms substitute equity for debt. Rajan and Zingales (1998) emphasized that the

financial development is a prediction element for the economic growth, because the capital

market reflects the present value of the future growth opportunities. The ex-ante developmentof the financial markets facilitates the ex-post economic growth of the external financing

dependent sectors. Pagano (1993) concluded that because of trading externalities in the

market and the deliberate behaviour of listing companies, the size of the stock market is

critical in explaining its own development. Indeed, it will increase the risk sharing

opportunities through risk portfolio diversification when firm raise capital from equity

financing.

The role of stock market in improving informational asymmetric has been questioned by

Stiglitz (1985). He is argues that stock markets reveal information through rapid price

changes creating a free rider problem that reduces investors incentives to initiate costly

search. There are also some doubts in regards to contribution of liquidity itself to long-termgrowth. It is indicated that increased liquidity may prevent growth in three ways. Firstly, it

may reduce saving rates through income and substitution effects. Secondly, by reducing

uncertainty associated with investments, greater stock market liquidity may reduce saving

rates because of the ambiguous effects of uncertainty on savings. Thirdly, stock market


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liquidity encourages investors short sightedness, which negatively affecting corporate

governance and thereby reducing growth.

Studying the link between domestic stock market development and economic growth

Claessens, Klingebiel and Schmukler (2006) using a panel data technique concluded that

domestic stock market development as well as stock market internationalization arepositively affecting the log of GDP. Minier (2003) analyzed the relationship of the stock

market dimension and economic development by regression tree techniques; he found

evidence that the positive influence of stock market development on economic growth held

only for developed stock markets in terms of turnover, in the case of underdeveloped stock

markets the influence is negative.

Studies on the relation between stock market development and economic growth in different

countries were performed. Nieuwerburgh, Buelens and Cuyvers (2006) analyzed the long-run

relationship between stock market development (measured by market capitalization and

number of listed shares) and economic growth (measured as a logarithmic difference of GDP

per capita). They found out that that stock market development determined economic growthwith variations in time dues to institutional changes affecting the stock exchange.

Hondroyiannis, Lolos and Papapetrou (2005) found out that the relationship between

economic growth and stock market development is bi-directional.

Studying the effect of different components of financial systems on economic growth Liu and

Sinclair (2008) emphasized the positive effect of stock market development (measured by

market capitalization as percentage of GDP, turnover as percentage in GDP and stock return)

on economic growth. Bolbol, Fatheldin, and Omran (2005) analyzed the effect of financial

markets (measured by the ratio of market capitalization on GDP and the turnover ratio) on

total factor productivity and growth (the per capita GDP growth rate) they demonstrated that

stock market development had a positive influence on factor productivity and growth.

Ben Naceur and Ghazouani (2007), studying the influence of stock markets and banking

system development on economic growth, concluded that financial development could

negatively influence the economic growth in countries with underdeveloped financial

systems; they stressed the role of building a sound financial system.

2.7 Stock Market Development Indicators

Demirgc-Kunt and Levine (1993) indicated traits of characteristics of stock market

development as (a) Traditional characteristics, which include market capitalization, theamount of new capital raised through stock offerings, the number of listed companies and

turnover; (b) Institutional characteristics, which include regulations, information disclosure,

transparency rules and trading costs; and (c) Asset pricing characteristics, which measures the

efficiency of the market especially in relation to the informational content inherent in price

and pricing of risk.

A theoretical explanation of stock market development influencing the choice of finance by

firms can be found in the arguments of Booth, Aivazian, Demiguc-Kunt and Maksimovic

(2001) that as equity markets size increase and become more developed they would become a

viable option for corporate financing. This would not be the case in developing countries,

because the banking sector is the main source of debt and is far developed than the stock

markets in these countries. Organized stock exchanges would influence the process, also,

because they provide liquidity for financial assets, and make risk diversification possible

(Shahbaz, Ahmed and Ali, 2008).


16/41

Another evidence is provided by Subrahmanyam and Titman (1999) who observed that the

smaller the number of firms on the stock market the less accurate the information conveyed

by stock market to the public which discourages private firms from going public but as the

stock market improves, the information conveyed improves, and private firms are encouraged

to go public. This shows that the size of the stock market determines the accuracy of the

information conveyed by the market to the public. It has been observed by Agarwal andMohtadi (2004) that size of the stock market determines how firms would prefer equity

financing to debt financing.

The indicators of the stock market development or performance are market capitalization,

volume of shares, number of listed companies and the value of shares traded (Agarwal and

Mohtadi, 2004). Value of shares traded is important as Booth, Aivazian, Demiguc-Kunt and

Maksimovic (2001), noted because if a large amount of equity is not traded it can be

inhibiting to corporate financing. According to Tanko (2004) market capitalization is perhaps

the indicator most widely applied in assessing the size of a stock market to an economy and

in relation to other markets. It is a product of the outstanding shares and market price of

equities on a stock exchange. Thus, in a bear market when prices are generally declining, andif there are no reasonable increases in listings to compensate for the decline in prices, market

capitalization would drop. On the other hand, in a bull market when prices are on the upward

swing, with or without corresponding increases in outstanding shares, market capitalization

would rise. Bakare (2000) defined market capitalization as the discount rate used to

determine the present value of future earnings. It is one of the major determinants of the

market size of any stock exchange. The size of the market capitalization and its growth rate

pose a major influence on the growth and development of the economy. The determination of

this rate is based on the forces of demand and supply of securities.

SEC (2007) reported that stock market capitalization is perhaps the most important criterion

in assessing the size of a capital market. It is a function of market price and size of paid-upcapital of listed companies. For individual companies, the market capitalization is the product

of market price and number of outstanding. In other words market capitalization of a

company refers to the monetary value of all its shares. It gives you an idea of the size of the

company. The sum total of market capitalization for all listed equities on an Exchange gives

the aggregate equity market capitalization of a stock market. Similarly, the market

capitalization of the market gives one an idea of the size of the market that is the total value

of all the billions of shares registered on the stock exchange. Thus, market capitalization does

fluctuate with movements in the market price of company equity and changes in outstanding

shares. For instance, an increase in the outstanding shares of company with market price

either held constant or increased would enhance the market capitalization of a company.

Generally, the aggregate market capitalization of a stock market would show an upward trend

in a bullish market while the converse would happen in a bearish market situation. To a

portfolio investor, the size of market capitalization of a stock market is an important

motivating factor for investing in a particular Company or market. To most institutional

investors better company is expected to have a sizeable market capitalization for them to

consider investing in that company. To assess how big a stock market is within the national

economy, the market capitalization is usually compared with the Gross Domestic Product

(GDP) or with other country for comparison. Also, according to Booth, Aivazian, Demiguc-

Kunt and Maksimovic (2001), volume and value of transactions is equally as important as

market capitalization. The value shares traded also indicates liquidity on the stock market

(DemigucKunt and Maksimovic 1996), at the same time this variable measure the transaction

cost of the market.

Demirguc-Kurt and Levine (1995) argued that there are three indicators

of stock market development. The first measure the ratio of market capitalization to GDP


17/41

(Capitalization ratio), provides an indication of overall market size. Market size is an

indicator of market development. Countries with market capitalizations which are small

relative to their GDPs are likely to have few opportunities for raising capital via

the stock market and also less ability to diversify risk. The second measure

of stock market development is the ratio of total value traded to GDP (Value Traded ratio).

This measure provides an indication of the liquidity of the market relative to the size of theeconomy. A high Value Traded/GDP ratio indicates that market trading is a significant

fraction of the economy and should be associated with higher levels of market development.

The third measure of stock market development is the ratio of total value traded relative

to market capitalization (Turnover ratio). This ratio measures the liquidity of the market, the

higher the ratio, the more liquid the market. Higher levels of liquidity are generally associated

with higher levels of market development. It is important to note that these measures need not

all moves together. For example, a market may be small but have a high value of turnover

ratio, indicating that liquidity is high in the market. In contrast, a large market in which

stocks are traded infrequently will have a low turnover ratio.

The performance or development stock markets can be estimated through three stock marketindicators, market capitalization relative to GDP, value of shares traded relative to GDP, and

the value of shares traded relative to market capitalization (Levine and Zervos, 1998).

2.7.1 Size

According to Levine and Zervos (1998) the market capitalization ratio measures the size of

the stock market and equals the market capitalization divided by GDP. La Porta, Lopez-de-

Silanes, Shleifer and Vishny (1998) and Levine and Zervos (1998) used capitalization to

GDP ratio (capitalization ratio) in their work as an indicator of market development.

Although large markets do not necessarily function effectively and taxes may distort

incentives to list on the exchange, many observers use the market capitalization ratio as an

indicator of market development. According to Muhtadi and Agarwal (1997) market

capitalization measures the value of listed shares which determine the size of the market. The

assumption behind market capitalization ratio is that overall market size is positively

correlated with the ability to mobilize capital and diversify risk on an economy-wide basis.

According to NSE (2008) about 301 securities were listed in the market and the market

capitalization was approximately N 9.56 trillion, but Nigerian stock market is still regarded as

small. In Africa, Nigeria ranked 4th after South Africa, Egypt and Morocco in term of market

size (Standard and Poors Emerging Stock Markets Factbook, 2000 as cited in Osinubi,

2004). Alile and Anao (1986) cited in Osinubi, (2004) adduced possible reasons for the small

size. One of the reasons is that indigenous entrepreneurs were not too keen into going public

due to fear of losing control. However, an innovative move by the stock market through the

creation of secondtier securities market (SSM) tried to find solution to the problem.

Measures taken by the governments and the exchange itself are expected to boost the

resource base of the stock market in Nigeria. These measures are: Privatization of Public

Enterprises, linking up of the exchange with Reuters Electronic Contributors System for on

line global dissemination of stock information, launching of the exchanges Intranets System

(CAPNET) and the transition of the exchange from manual call-over Trading System to

Automated System (ATS) in April 1999. It is also expected that the present democratic

dispensation would impact positively on the turnover of the exchange (Osinubi, 2004).

2.7.2 Liquidity Indicators


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Liquidity generally refers to the ability to buy and sell securities easily. Liquid equity markets

allow companies on the one hand to have a permanent access to capital through equity issues

and on the other hand, to allow investors to switch out of equity if they need to access funds

or if they want to change the composition of their portfolios (Demirg-Kunt and Levine,

1996). According to Levine and Zervos (1998) there are two related measures of market

liquidity. First, the turnover ratio equals the total value of domestic shares traded divided bymarket capitalization. The turnover ratio measures the trading of domestic equities on

domestic exchanges relative to the size of the market. High turnover is often used as an

indicator of low transactions costs. Importantly, a large stock market is not necessarily a

liquid market: a large but inactive market will have a large market capitalization ratio but a

small turnover ratio.

The second measure of market liquidity is the value traded ratio, which equals the total value

of domestic shares traded on the stock market exchange divided by GDP. While value traded

ratio is not a direct measure of trading costs or the uncertainty associated with trading on a

particular exchange, but theoretical models of stock market liquidity and economic growth

directly motivate the use of value traded ratio (Levine 1991). Furthermore, the value tradedratio measures the organized trading of firm equity as a share of national output and should

therefore positively reflect liquidity on an economy-wide basis. The value traded ratio may be

importantly different from the turnover. While the value traded ratio captures trading relative

to the size of the economy, turnover measures trading relative to the size of the stock market.

Thus, a small, liquid market will have a high turnover ratio but a small value traded ratio.

According to Muhtadi and Agarwal (1997) total value of shares traded on the stock market

also indicates the size of the market in relation to its liquidity. They also argue that the total

value traded ratio complements the market capitalization ratio, although a market may be

large, there may be little trading. According to Osinubi (2004) this ratio should positively

reflect liquidity on an economy wide basis.

Total Turnover ratio equals the value of total shares traded divided by market capitalization.

Though it is not a direct measure of theoretical definitions of liquidity, high turnover ratio

indicates low transaction costs in the market. Turnover also complements the total value

traded ratio. The turnover ratio of a stock market is usually indicative of its level of activity

that is the rate at which securities are bought and sold, as well as its liquidity, which is the

ease at which securities can be converted into cash (Tanko, 2004). He argued that important

attribute of a stock market is its ability to absorb large volumes of transactions without

significant changes in prices. The Nigerian stock market value traded ratio and turnover ratio

further affirm the relative illiquidity of the market, but improving over the years, (Tanko,

2004 and Osinubi, 2004).

2.7.3 Market Concentration

Market concentration can be measured by looking at the share of market capitalization

accounted for by the large stocks. The significance of market concentration as a measure of

performance of stock market is because of the adverse effect it may have on the liquidity of

the market. In many economies such as Nigeria, a few companies dominate the market as the

market capitalization of the top ten equities listed on the Nigerian Stock Exchange accounted

for about 40 percent of the total stock market capitalization (Osinubi, 2004). In 2009, 20 most

capitalized companies, as at the year end, accounted for 69.5% of the equity market

capitalization and 49.4% of the total market capitalization of the Exchange. Consequently,

changes in the prices of these stocks impacted substantially on the total market capitalization

and the All-Share Index (NSE 2009).


19/41

2.8 Theoretical Framework

The existence of link between stock market development and economic growth has long been

debated by researchers. In some years back economic theory held that the financial structure

of any economy did not affect real economic variable, including economic growth.Theoretically, the traditional growth theory could not explore the relationship between stock

market development and economic growth (Demirguc-Kunt and Levine 1993).

A number of theories have been developed to explain the models of why people and

organization invests in capital market and the expectation of market participants. These

theories are linked with the aim of explaining stock market development and economic

growth. One of these theories is market segmentation theory which assumed that short term

and long term return are determined in separate or segmented markets. Some investors prefer

short term securities; they invest in short term bonds. Again, there are some investors who

prefer long term securities. As a result bonds having different maturity periods are not perfect

substitutes for one another. Such an argument implies that lenders and borrowers are

interested in bonds of only one maturity and even if the return on a sequence of shorter bonds

were considerably higher than the return on those bonds, they would not attempt to switch

into shorter bonds. Therefore, expectation concerning short rates would have no role in

determining long rates. Thus even if short term rate increases in any period of time this

theory implies that investors will not shift from long term bonds to short term bonds in order

to enjoy higher rate in the short run. Thus even if the short run rate of interest increases it will

not influence the long term rate of interest. This theory is based on institutional practices

followed by the commercial banks and insurance companies and investment trusts. While the

commercial banks mostly deal in short term securities, insurance companies and investment

trusts mostly deal in long term securities. This theory is however not free from defect as itoverlooks the fact that there is considerable degree of overlapping between different markets.

Same institutions operate in different markets dealing in securities of different maturities.

As per the Liquidity Preference Theory the rates of interest over a long term also admit a

premium that the investors are entitled to receive, if they possess debt instruments that have

longer term periods. They are not only concerned with what the investors may assume.

According to the Liquidity Preference Theory this premium is known as the liquidity

premium and the term premium. The term premium or the liquidity premium is supposed to

even out the financial risks the investors may have suffered from as a result of investment in

debt instruments that had longer term periods. The great price uncertainty is one of the many

risks the investors may face if they put their money in long-term debt instruments. As a resultof the term premium the yield of the debt instrument that has a longer term period is higher

compared to debt instruments having shorter term periods. The main area of concern for the

Liquidity Preference Theory is not liquidity. It deals more with the risks that are associated

with maturity. According to the Liquidity Preference Theory the risks related to maturity are

directly proportional to the length of the maturity period. This means that the debt

instruments that have longer maturity periods have more risks. As per the exponents of the

Liquidity Preference Theory the investors do not want to take risks in their investments. They

normally want to be provided with a premium for putting their money in debt instruments

with longer maturity periods.

Preferred habitat theory rejects the assertion that risk premium must increase uniformly withmaturity. This theory is explained in terms of time-bucket preferences of investors. The

investors who participate in bond market have different preferences in terms of maturities

depending upon their liability profile. For example, Insurance companies and pension funds

have long term liabilities and they prefer to invest in bonds with relatively higher maturities.
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20/41

Banks and mutual funds have short term liabilities, so they go for short-term bonds. These

distinct investment horizons create different levels of demand and supply in different time

buckets. Higher the demand for bonds in a particular time bucket, higher the price and lower

the yield.

Demirguc-Kunt, and Levine (2008) and Levine (2004) theory on the relationship betweenstock market earnings and economic growth states that financial instruments, markets, and

institutions may arise to mitigate the effects of information and transaction costs. In emerging

to ameliorate market frictions, financial arrangements change the incentives and constraints

facing economic agents. Thus, financial systems may influence saving rates, investment

decisions, technological innovation, and hence long-run growth rates. The reductions in

financial market frictions that increase expected rates of return and improve risk

diversification opportunities could increase or decrease growth rates depending on the

general equilibrium effects on aggregate saving rates.

The theory that is used in explaining this work is the Demirguc-Kunt, and Levine (2008) and

Levine (2004) theory on the relationship between stock market earnings and economicgrowth, so that the study can provide evidence as to whether theories relevant to role of stock

market in economic growth and the findings from developed and developing countries can be

applied to Nigerian economy.

CHAPTER THREE

RESEARCH METHODOLOGY

3.1 Introduction

This chapter describes the procedure employed for the conduct of this research. It contains

the research design, population, sampling technique and sample size, data to be used, sourcesof the data, and methods of data analysis.


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3.2 Research Design

The study adopted survey design through content analysis; the study therefore employed both

descriptive and inferential statistics in analysing the data. Multiple regression is used to

analyse the relationship between the dependent and independent variables. Capitalization

ratio (CAPR) Turnover ratio (TOVR) and value traded ratio (TVTR) are the independentvariables, while the GDP serves as the dependent variable from 1989 to 2008.

3.3 Population of the Study

Nigerian stock exchange is the area of study for this research work, with preference to market

capitalization and total value traded and GDP. The population of the study is the entire

transactions on the floor of the Nigerian Stock Exchange from 1989 to 2008 which is the

period of the study.

3.4 Sampling Technique and Sample Size

The sample size of the study was selected using judgmental/convenience sampling. A sample

of stock market capitalization, total traded value at the end of the year is selected from 1989

to 2008. The choice of these years is based on the fact that pre and post democratic era can

be analysed, since many economic reforms took place within the first ten years of democratic

rule. The year 1989 to 1998 constitute the pre democratic era, while 1999 to 2008 constitute

the post democratic era. The period witnessed significant increase in awareness of what stock

market is, major economic policy changes in Nigerias corporate history, more regulation and

reforms, more firms quoted and more firms issued initial public offering.

3.5 Sources of Data

Data used in this study are mainly from secondary sources. They include Central Bank of

Nigeria (CBN) annual reports and statement of account, CBN bulletins, Security and

Exchange Commission data bank and the Nigerian Stock Exchange fact books, annual reports

on market performance; and the Nigerian Stock Exchange yearly official lists for the market

capitalization and total turnover value for each of the years covered in the study. The

Nigerian Stock Exchange fact book is a reliable source of data of the market activities. Also

Nigerian Stock Exchange annual, biannual and quarterly company reports are also reliablebecause they are statutorily required to be audited by recognized auditing firms before

publication.

3.6 Method of Data Analysis

The study employed both descriptive and inferential statistics; the former is used to represent

and summarize the data and results for easy understanding and interpretation. The Multiple

Least Squares method is the one of the most popularly used statistical methods for multiple

regression analysis which quantitatively characterizes the relationship between a response

variable and one or more explanatory variables. The method describes a collection of

statistical techniques which serve as the basis for drawing inference as to whether or not a

relationship exists between two or more quantities within a system, or within a population.

More specifically, Multiple Least Square method is adopted in this analysis to quantitatively

analyse the relationship between a response variable or the dependent GDP, and independent


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or explanatory variables, CAPR, TOVR and TVTR. The strength of a relationship will be

measured by a correlation coefficient. The model is based on Demirguc-Kunt and Levine

(2008) theory on the relationship between stock market development and economic growth. It

is modified to measure the impact of stock market development on GDP. The linear

regression equation for this model is:

GDPi = 0 + 1 CAPRi + 2 TOVRi + 3TVTRi + i

Where; GDPi represents Gross Domestic Product, CAPRi represents the market capitalisation

ratio and TOVRi represent the turnover ratio, TVTRi represents value traded ratio while irepresents the error term or a disturbance term; 1 and 1,2,3 are the regression constant andregression coefficients. Statistical software for Social Sciences (Eview) is used to estimate

the linear regression model. From the software the values of the regression constant ()coefficient of regression () and the error term () are obtained. The result after running the

package gives the values of t-statistic, F-values and their respective p-values which will result

in either accepting or rejecting the null hypotheses. The variables are converted to logarithms

form, so that there will be a uniform unit of measurement between the variables. The study

uses Unit root test and Cointegration test, since the variables to be used in this study are time

series in nature and so it is necessary to analyze whether the series are stationary or not and

determine whether the series are co integrated or not.


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CHAPTER FOUR

DATA PRESENTATIONS, ANALYSES AND INTERPRETATIONS

4.1 Introduction

This chapter presents the analyses and interpretation of the data used in this study to enable

us test the hypotheses and for inference to be drawn. The chapter discusses the growth pattern

of Nigerian stock market development indicators, stationarity test, cointegration test,

regression result analysis and discussion of the outcomes of the tests.

4.2 Growth Pattern of Nigerian Stock Market Development Indicators

The market capitalization ratio (CAPR) measures the size of the stock market and equals the

value of listed domestic shares (market capitalization) divided by GDP. The turnover ratio

(TOVR) equals the total value of domestic shares traded divided by market capitalization.The turnover ratio is a liquidity indicator that measures the liquidity of the market relative to

the size of the market. High turnover is often used as an indicator of low transactions costs.

The value traded ratio (TVTR), which equals the total value of domestic shares traded on the

stock market exchange divided by GDP. The value traded ratio is a measure of liquidity of

the market relative to the size of the economy.

Table 4.1 below shows that all the indicators recorded positive increase from 1989 until 1998

when the market capitalization ratio recorded a slight decrease. All the indicators recorded

significant improvement within the period of 1999 to 2008 compared to 1989 to 1998, with

some slight downshift movement by turnover ratio in 2002 and 2005. Table 4.1 shows that in

2008 the market registered a market capitalization value of N 9516.2 billion from N12.8billion in 1989, which shows a remarkable performance of the market. In 1989 total traded

value N0.6103 billion, at the end of December 2008 total traded value was 1679.14. Despite

these improvement the percentages of the market capitalization shows that the market is still

small in size. It also indicates the relative illiquidity of the market.

Table 4.1: Development/Performance Indicators of the Nigerian Stock Market (Market

Capitalization Ratio, Turnover Ratio and Value Traded Ratio (1989-2008)

YEAR GDP

N Billion

A

MCAP

N Billion

B

TTVT

N Billion

C

CAPR%

D=B/A

TOVR%

E=C/B

TVTR%

F=C/A

1989 216.7975 12.8 0.6103 5.904 4.768 0.282

1990 267.5500 16.3 0.2254 6.092 1.383 0.084

1991 312.1397 23.1 0.2421 7.401 1.048 0.078

1992 532.6138 31.2 0.4917 5.858 1.576 0.092

1993 683.8698 47.5 0.8044 6.946 1.693 0.118

1994 899.8632 66.3 0.9859 7.368 1.487 0.110

1995 1933.212 180.4 1.8388 9.332 1.019 0.095

1996 2702.719 285.8 6.9796 10.575 2.442 0.258

1997 2801.973 281.9 10.3305 10.061 3.665 0.369

1998 2708.431 262.6 13.5711 9.696 5.168 0.501

1999 3194.015 300.0 14.072 9.393 4.691 0.441


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2000 4582.127 472.3 28.1531 10.307 5.961 0.614

2001 4725.086 662.5 57.6838 14.021 8.707 1.221

2002 6912.381 764.9 59.4067 11.066 7.767 0.859

2003 8487.032 1359.3 120.403 16.016 8.858 1.419

2004 11411.07 2112.5 225.82 18.513 10.690 1.979

2005 14572.24 2900.1 262.936 19.902 9.066 1.804

2006 18564.59 5121.0 470.253 27.585 9.183 2.533

2007 20657.32 13294.6 1076.02 64.358 8.094 5.209

2008 23842.17 9516.2 1679.14 39.913 17.645 7.

Documents

CAPITAL MARKET AND ECONOMIC GROWTH IN NIGERIA