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THE ROLE OF STOCK MARKET IN THE GROWTH OF THE NIGERIAN ECONOMY

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THE ROLE OF STOCK MARKET IN THE GROWTH OF THE NIGERIAN ECONOMY

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THE ROLE OF STOCK MARKET IN THE GROWTH OF THE NIGERIAN ECONOMY

CHAPTER ONE

1.1 BACKGROUND TO THE STUDY

Primarily, a stock market is the place where companies can raise money to make their businesses bigger and better. Companies raise money by selling shares or stocks to investors. At the same time, the stock market gives investors an opportunity to invest in

these companies and benefit from any profit they can make.

A stock market can also be called a capital or securities market as it encompasses the stock exchange, the branches, and the stockbrokers. An organized securities market requires a securities exchange, a securities commission or other regulatory agency, and intermediaries such as dealers, brokers, securities analysts, etc. Virtually all costs are borne by those who benefit. The intermediaries receive their fees from the issuers or investors to whom they provide a service. The stock market is usually funded through fees paid by investors and issuers; even the expenses of the securities commission may be partially paid for by registration fees rather than being a major burden on the government budget. Companies which go public are subject to continuous cost of providing financial information, transferring shares, paying dividends, and other aspects of shareholder relations.

The stock market is the aspect of the financial system which mobilizes and channels long term funds for economic growth. The stock market embraces trading in both new issues (primary) and old issues of stocks (secondary). Securities are primarily of 2 types: debt and equity.

Debt securities include federal government development stock (GDS), industrial loans, preference stocks, bonds etc, while equity securities mainly concern ordinary stocks which impose higher liabilities on the holders. Portfolio investment in the capital market deals with an institutional arrangement involving the Securities and Exchange

Commission (SEC), the Nigerian Stock Exchange (NSE), the operators, and the investors.

Stock market is viewed as a medium to encourage saving, help channel savings into productive investment, and improve the efficiency and productivity of investment. The emphasis on the growth of stock markets for domestic resource mobilization has also been strengthened by the need to attract foreign capital in non- debt creating forms. A viable equity market can serve to make the financial system more competitive and efficient.

Without equity markets, companies have to rely on internal finance through retained earnings. Large and well established enterprises are in a privileged position because they can make investment from retained earnings and bank borrowings, while new companies do not have easy access to finance. Without being subjected to the scrutiny of the stock market, big firms get bigger, and for the emerging smaller companies, retained earnings and fresh cash injections from the controlling shareholders may not be able to keep pace with the needs for more equity financing which only an organized market place could provide. The corporate sector would also be strengthened by the requirements of equity markets for the development of widely acceptable accounting standards, disclosure of regular, adequate, and reliable information. While closely held companies can camouflage poor investment decisions and low profitability, at least for a while, publicly held companies cannot afford this luxury. The availability of reliable information would

help investors make comparism of the performance and long term prospects of companies; corporations to make better investment and strategic decisions; and provide better statistics for economic policy makers.

The capital market in any country is one of the major pillars of long term economic growth and development. The market serves a broad range of clientele including different levels of government, corporate bodies, and individuals within and outside the country. For quite some time now, the capital market has become one of the means through which foreign funds are being injected into most economies, and so the tendency towards a global economy is more feasible/ visible there than anywhere else. It is, therefore, quite valid to state that the growth of the capital market has become one of the barometers for measuring overall economic growth of a nation.

Historically, the financial sector in the developing world has been primarily bank based. But, in recent years, there has been a gradual shift to a more holistic approach which, alongside the banks, seeks to develop the securities market. Some of the strength of the securities market which makes them the focal point of the shifting emphasis is their ability to:

mobilize long term savings for financing long tenure investments;

provide risk capital (equity) to entrepreneurs;

encourage broader ownership of firms; and

Improve the efficiency of resource allocation through competitive pricing mechanisms.

Provision of alternative sources of finance other than taxation and foreign loan to fund public projects.

Apart from these primary benefits, a developed securities market in the sense of efficient financial intermediation further brings additional gains to the economy. These gains arise through:

lower cost of equity capital for firms;

imposition of discipline on corporate managers as share prices react to right and wrong judgment in firm’s investment decisions;

existence of mechanisms for appropriate pricing and hedging against risk; and

Increased flow of funds to the domestic economy as international capital responds to the thriving stock market.

The development of securities market could help to strengthen corporate capital structure and efficient and competitive financial system. The stock market encourages savings by providing households with an additional instrument which may better meet their risk preferences and liquidity needs.

In well developed capital markets, share ownership provides individuals with a relatively

liquid means of sharing risks in investment projects. To the extent that securities and bonds are a viable and relatively secure form of investment with an attractive long term return, they serve two functions:

stocks provide an incentive to save and invest; and

Financial savings are promoted and domestic savings rate increase as whole.

Economic growth encompasses a sustained rise in the productive capacity of any economy and real output per capita as a basis for sustained improvements in the living standards and quality of life of the entire population over a period of time. A build up of productive capacity is a necessary pre- requisite for growth. It is this capacity that determines the level of output of goods and services in the economy. Investment is said to represents net increase in an economy’s capital stock, and it leads to growth. If this is so, then it can be said that there is a relationship between capital accumulation and economic growth.

1.2 STATEMENT OF THE PROBLEM

Mobilization of resources for national development has long been the central focus of development. To this end, various papers, research works, seminars, e.t.c. have been written and held to find the best way to mobilize resources for economic growth. It is now increasingly being recognized that the growth process of the Nigerian economy

depends to a considerable extent on the effects of stock market. Whether this effect is positive or negative is a research problem to be solved. In the light of the research problems, this study attempts to answer the following:

Does the market capitalization have a positive effect on GDP?

Does growth rate of per capita income have a positive effect on GDP?

What are the effects exchange rates on GDP?

1.3 SCOPE OF THE STUDY

In an attempt to analyze the role of the stock market in the Nigerian economy, the data covering the period of study is between 1975– 2004 i.e. a period of thirty (30) years. The reason being that, a study period this long will, probably, reduce any form of bias in the results of estimates.

1.4 OBJECTIVES OF THE STUDY

The main objective of this study is to examine the role which the stock market plays in the growth process of the Nigerian economy.

However, the other objectives include:

to determine if the stock market can lead to economic growth by boosting international investment climate;

to evaluate major determinants of investment in stock market;

to find out if the stock market, in growing the Nigerian economy, relates to the privatization exercise;

to find out the major problems of the stock market;

to find out the measures that have been put in place to enhance the efficiency of the stock market;

to make constructive recommendations on how to increase stock market efficiency, hence, economic growth

1.5 JUSTIFICATION OF THE STUDY

Due to the fact that there are no viable equity markets, the capital structure of firms are generally characterized by heavy reliance on international finance and bank borrowings which tend to raise debt/ equity ratios.

Thus, the development of an active market for stocks could provide an alternative to the banking system for both savers and users of funds.

Several interactive studies have revealed the positive role the stock market plays in leading an economy to growth, which is a prerequisite for development. For instance, DemirgucKunt and Levine (1993) have observed that increased flow of funds to the domestic economy as international capital responds to the thriving stock market is one of the gains accruable.

In view of the above facts, the need arises to study how developed the Nigerian Stock market is and the role it plays in leading this economy to growth, hence development. It is expected that this study will attempt to make some contributions along this line spelt out of the aforementioned.

1.6 RESEARCH QUESTIONS

. In the light of the research problems, this study attempts to answer the following:

1. Does the market capitalization have a positive effect on GDP?

Does growth rate of per capita income have a positive effect on GDP?

3. What are the effects exchange rates on GDP?

1.7 HYPOTHESIS OF THE STUDY

H0: there is a negative relationship between market capitalization ratio and GDP

H1: there is a positive relationship between market capitalization ratio and GDP

H0: there is a negative relationship between investment and GDP

H1: there is a positive relationship between investment and GDP

1.8 RESEARCH METHODOLOGY

To carry out an econometric analysis of the study, the Ordinary Least Square (OLS)

estimating techniques will be used because it possesses a unique property of Best Linear Unbiased Estimator (BLUE) when compared to other estimating techniques. The OLS method also possesses the desirable properties of un-biasness, consistency, and efficiency.

1.9 SOURCES OF DATA

Data used in this research project are secondary data. The data used were gotten form authentic sources, some of which are listed below:

The Nigerian Stock Exchange

Nigerian Stock Exchange fact book;

Nigerian Stock Market annual;

Publications and journals from reputable scholars;

Statistical Bulletin of the Central Bank of

National Bureau of statistics

1.10 STRUCTURE OF THE STUDY

The structure of the study includes five chapters, each chapter deals with different aspects of the study. Chapter one is basically an introductory chapter, it includes the background of the study ,statement of problem , objectives of the study, justification of study,

objective of the study , research hypothesis , scope of the study.

Chapter two deals with theoretical framework as well as the literature review of relevant literatures on the role of stock markets in growing ’s economy. This chapter also considers the history and the development of ’s stock market over the years.

In Chapter three we considered the research methodology. In this chapter the model that captured the relationship between economic growth and the stock market was specified and estimated .It also defines relevant variables used in study.

Chapter four also includes analysis and presentation of the results of our estimated model.

Chapter five summarizes the major findings emerging in this study.

1.11 DEFINITION OF TERMS

Prospectus: Any notice, circular advertisement or any document which offers to the public for subscription or purchase, any shares or debenture of a company and includes a document which saves to the extent that it offers for securities for a consideration other than cash.

It is also a legal document issued when raising finance for a public company through a share issue, the content of which are subject to strict regulation.

Equity: The residual right of ownership over the asset of a company. It is a right that can be enforced only when everyone else has been paid. Specifically, the ordinary shares of a company.

Central Security Clearing System (CSCS): A computerized system of trading stock at the stock exchange. It makes the market most efficient, very transparent, fair, and simple.

Insider Dealing: Illegal dealings in shares by person with knowledge obtained from his position in the company.

Bears: Are value or long term investors.

Bulls: Speculative or short term profit takers.

Issuing houses: Are mainly stock broking firms. It describes the corporate finance activity of merchant banks and stockbrokers. Members of the exchange need expertise to act as issuing houses, while companies need to be dealing members of the Nigerian stock exchange to become stockbrokers.

Market Capitalization: A firm’s value as determined by the market price of its issued and outstanding common stock.

Automated Trading System (ATS): It is a system whereby the Nigerian Stock Exchange operates with dealers’ trading through a network of computers connected to a server. The automated trading system (ATS) has facilities for remote trading and surveillance. The exchange is in the process of connecting with dealers to commence trading from their offices or any part of the world.

Primary Market: It is a market where entirely new shares are offered for the first time. The modes of offer include:

right issues

offer for subscription

offer for sale

private placements

Secondary Market: It is a market where existing securities are traded after their issuance in primary markets. In this case, over the counter market and organization market are available to rapid liquidity to investors. Securities traded here include:

preference shares

debenture stocks

federal government development stocks

state and local government bonds and equities

Only licensed stock brokers of the stock exchange are allowed to transact business i.e. buy and sell shares on behalf of their customers.

Derivative Market: this market is still at the infant stage. It does not trade in issued securities but on the basis of future title to the security. Right offer is, probably, the only derivative being actively traded on the floor of the exchange. However, global depository receipts have been issued.

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