CHAPTER ONE
INTRODUCTION
1.1 BACKGROUND
OF THE STUDY
It is a known fact that investment promotes economic
growth and development requires long- term funding far longer than the duration
for which most savers are willing to commit their funds. Capital market is a
collection of financial institution set up for the granting of medium and long
term loans. (Ologunde, Eilumilade and Asadu, 2006). It is a market for
government securities, for corporate bonds, for mobilization and utilization of
long- term funds for development=the long- term end of the financial system.
The capital market is the prime
motor that drives any economy on its path to growth and development because it
is responsible for long-term growth capital formation. The money market only
complement the capital to support gross fixed capital formation. Unfortunately
the Nigeria capital market has not fully performed its natural function of
funding investment. One of the major indicators of capital market development
is the proportion of long term fixed capital that is raise in relation to gross
domestic product. Between 1999 and 2004, capital formation in terms of long-
term funds raised from the market through new issues of securities to the gross
domestic product averages only 1.36 percent while the new issues to gross fixed
capitalization averages 16 percent market capitalization to gross domestic
product averaged 14.25 percent during the same period ( Adedinran, 2012)
Thus, capital market is a market
where medium and long- terms finance can be raised. It is a market that offers
a variety of financial instruments that enable economic agents to pool, price
and exchange risk. In this market, lenders (investors) provide long term funds
in exchange for long- term financial assets offered by borrowers. The market
covers both new issues of stocks in the primary market and the sale of existing
stocks in the secondary market. Such securities might be raised in an organized
consortium under writing. Syndicated loans and project financing. It is a
mechanism where by economic unit desirous to invest through surplus funds
interact directly or through financial intermediaries with those who wish to
procure funds for their businesses.
The capital market is therefore very
important to any economy because it encourages savings and real investment in
any healthy economic environment. Through the market, aggregate savings are channeled
into real investment that increases the capital stock and economic growth of
the country. More so, the capital market synchronize the divergent preferences
for portfolio manager and financial institutions and those of savers by mobilizing
long term funds for portfolio managers and financial institutions while
providing avenues for savers to invest when the need arises through the secondary
market without effecting the operation of the firms, their savings had earlier
financed .
Although a small market by
international standard, the Nigeria capital market is one of the leading market
in sub-Saharan Africa and has made some notable strides in recent years. With a
history of over 67 years when the fist public issue was floated at N 600,000
(more than 300,000 pounds sterling) worth of government stocks and 59 years of
stock exchange, equity listings and market capitalization and still relatively
small, standing at 216 and united states $0.7billion, a much lower figure than
market capitalization. As a result of this, federal government of Nigeria
development loan stock was issued in line with its role of fostering economic
and financial development. In 1986, Nigeria embraced the international monetary
fund (IMF) structural adjustment programme (SAP) which influenced the economic
policies of the Nigerian government and led to reforms in the late 1980s and
early 1990s. The programme was proposed as an economic package to rapidly and
effectively transform the Nigeria economy within two years ( Yusufu, 1996,
Oyefusi and Moghalu, 2003, Umah, 2010).
However, the turnover ratio of 7.9
percent was recorded at the end of 2002, higher than the average turnover ratio
for 1998- 2002 (Ndanusa, 2003, Ozoh, 2011). From a historical perspective, this
figure excepting for 2011 is an improvement, evidencing the continued rise in
activities of the market. According to Central Bank of Nigeria (2011), the
market has been quite active improvement with traded equities of N 19.8 billion
(US$178 million) in January 2009 which represented about 28 percent of the
total equity value in 2008.
The depreciation of the currency,
the naira has continued to impact on the size of the market in dollars terms. Between
1997 and 2002, the naira lost over half of its value to the dollar. As a
result, while capitalization witnessed impressive growth in Local country
terms, this was not the case in dollar terms as a much slower growth was
registered.
The capital market has not been a
popular source of funds because of the instability in the economy, low yields
to investors in capital market instrument and government’s overbearing presence
in economic matters. The introduction of Structural Adjustment Programme (SAP)
in Nigeria has resulted in significant growth of the financial sector and the
privatization exercise which exposed investors and companies to the
significance of the stock market. The liberalization of capital market led to
the growth of the Nigeria capital market yet its impact at the macro-economic level
was negligible. Again, the capital market was instrumental to the initial twenty-five
banks that were able to meet the minimum capital requirement of N25 billion
during the banking sector consolidation in 2005. The stock market has helped the
government and corporate entities to raise long-term capital for financing new
projects and expanding and modernizing industrial/commercial concerns.
Financial institutions have not
contributed much in financing capital investment but they have contributed towards
market development (Mary et al; 2012). Equity market capitalization grew by
over N100 billion (US$16.1 billion) or 15 percent and has remained on the
upward swing this year. This trend has continued such that following
recapitalization of the banking sector, the market capitalization has doubled its
2002 value by the end of 2006.
1.2 Problem
Statement
There is now a growing evidence that
the Nigerian capital market has witnessed tremendous growth over the past few
decades. The central bank of Nigeria (2012) notes that the Nigerian stock exchange
all sector index recorded a significant improvement during the years (2004,
2006 and 2010). At 21, 222-6 (1984=100), the index grew by 74.8 percent at the
end of 2004, compared to 10.7 percent in 2003, with all sectors contributing to
the increase. In 2003 alone, the market considered and approved 26 applications
for new issues valued at N185.0
billion, as against 27 applications for new issues valued at N68.6 billion in 2002. Between 1999 and
2005, there was a phenomenal increase in total market capitalization of quoted
companies. For example, total market capitalization was N294,104,956.9 in 1999 and by 2005, it had risen to N1,324, 897, 998.7 (CBN, 2006). In 2010,
there was a clear indication that a long- run relationship exists between
capital market and private investment in
Nigeria. The Nigeria stock exchange was to play a key role during the
offer for sale of the shares of the affected enterprises. This resulted in the
significant growth of the financial sector. For example, the recapitalization
to meet the minimum capital requirement of N25
billion by the commercial banks with the central bank of Nigeria and the
privatization exercise that exposed investors and companies in the country to
the significance of the stock exchange.
Our study is therefore informed by two
main reasons, first, now that the Nigeria capital market has come a long way
for the past two and half decades, what effects does it have on private
investments in Nigeria? Unfortunately, data on private investment in Nigeria have
failed to show convincing correlation with the unprecedented growth of the
capital market. For example, the ratio of private fixed capital formation to
GOP has shown a downward trend since 1980. the ratio was 0.19 in 1970, 0.25 in
1973 and decreased to 0.18 in 1980. Since 1984, the ratio has been less than 10
percent for most of the period between 1984 and 2010. One therefore wonders if
there is any link between capital market development and the growth of private fixed
capital formation in Nigeria.
Second, though available literatures
both theoretical and empirical have failed to agree on the impact of capital
market on investment and consequently on economic growth, few studies have
related capital market development to private investment growth in Nigeria. The
most recent study (Kolapo and Adaramola, 2012) focus on stock market
capitalization and economic growth in Nigeria.
The study is, therefore, using
econometric techniques aimed to address the above issues raised namely, the
impact of capital market on the growth of private investment in Nigeria and the
controversy surrounding the growth of capital market and economic growth via the
growth of private investment.
1.3 Objectives
of the Study
The broad objective of the study is
to investigate the relationship between market variables and private investment
in Nigeria. More specifically,
a. To
determine the variables that affects the growth of private investment in
Nigeria.
b. To
ascertain if the growth of capital market has impacted on the growth of private
investment in Nigeria
c. To
ascertain alternative policies for the growth of private investment in Nigeria.
1.4 Research
Hypotheses
One major hypothesis that will be tested by this study
is as follows
1. Ho1: The growth of capital market variables such as, market
capitalization, liquidity etc does not have any significant effect on the
growth of private investment.
2. Ho2: The growth of capital market has not impacted positively on the
growth of private investment in Nigeria.
1.5 Significance
of the Study
Previous studies conducted which are similar to our study
have devoted much attention on developed countries as well as other developing
countries of Asia (Lynch, 1995, Pilgrim and Schich, 2010, Omoke, 2012). However,
results from these studies cannot be attributed to such sub-Saharan Africa which
has unique institutional and structural characteristics. Moreover, few studies
that exist in sub-Saharan Africa are mostly based on cross-country evidence
(Mary et al; 2012, Misati 2006) which have tended to capture the effect of the
entire financial system on investment. Our study empirically distinguishes the role
played by capital market variable on the growth of private investments as a
component of total investment controlling for country specific circumstance.
More importantly, this work is premised
on the need to examine the relationship between capital market variables and private
investment in Nigeria. We believe therefore, that the outcome of this research
will contribute to the field of knowledge. We also underline its importance to
policy formulation and implementation for governments at all levels.
The findings of this research and
the recommendations contained therein will form a robust working materials for
researchers, government agencies, private institutions as well as academics.
The study will help the policy maker
to draw a conclusion on where to strengthen the effort of capital market in
areas of private investment in Nigeria. This work will be a major contribution
to existing empirical literature in this area of study.
1.6 Scope
and Limitations of the study
The study shall make use of quarterly
data from 1990 to 2010, a total of 64 observations. The study will focus only
on private investment and not on the overall gross investment.
The
study is also constrained by many factors. One of the factors is the continuing
strike by the Academic Staff Union of Universities (ASUU). Finance is another
hindering factor that led to the delay of this work. Against all odds, the
researcher was able to conclude before the required period.
CHAPTER TWO
REVIEW OF LITERATURE
2.1 Theoretical
Literature:
The literature on investment abounds with the
description of the determinates of private investment and channels which such
variables affect investment, prominent among these are the traditional
neoclassical theory, as formulated by Jorgenson (1963,1971), which postulate
the role of cost of capital, the accelerator model which postulated the role of
rate of change of output, the Tobin Q theory which argues a role for the value
of the firm, the financial repression framework due to Mckimon (1973), shaw
(1973) and Onah (2011) and so on. The standard model of business fixed
investment is called the neoclassical model of investment (Mankiw, 2003).
Jorgenson (1983), examines the
benefits and cost of firms of owing capital goods. The model shows how the
level of investment in addition to the capital stock is added to the marginal
product of capital, the investment rate and the tax rules affecting firms. The
model shows the economic incentives that lie behind the firm’s investment
decision. According to the model, the firm’s decision regarding its capital
stock depends on whether owning and renting out capital is profitable. The
model holds that the charge in the capital stock called net investment depends
on the difference between the marginal product of capital and the cost of
capital. If the marginal product of capital exceeds the cost of capital, firms
find it profitable to add to their capital stock. If the marginal product of
capital falls short of the cost of capital, they let their capital stock
shrink.
There are a number of hypothesis
about the speed at which firms plan to adjust their capital stock overtime. We
single out the gradual adjustment hypothesis or flexible accelerator model
(Dornbush, 1990, Samuelson, 1939, Hicks, 1950, Godwin 1951). The basic notion
behind the gradual adjustment hypothesis is that the larger the gap between the
existing capital stock and the desired capital stock the more rapid a firm’[s
rate of investment. The hypothesis is that the firm plans to close a fraction, l, of the gap between the desired and actual capital
stocks each period, denoting the capital stock at the end of the last period by
K,. The gap between the desired and actual capital stocks is K*_ K1. The firm
plans to add to last periods capital stock (K-1), a fraction (l) of the gap (K*-K-1) so that the actual capital stock
at the end of the current period K will be K= K_1+ l (K*_ K_1). This equation states that the
firm plans to have the capital stock at the end of the period, K be such that a
fraction l of the gap between the
desired capital stock, K*, the capital stock, K_1 that existed at
the end of the period, is closed.
To increase the capital stock from
K-1 to the level of K indicated by the equation, the firm has to
achieve an amount of net investment, 1 = K – K, indicated by the equation.
Hence, net investment can be specified as 1=l (K*-K-1) which is the gradual formulation of net investment.
Many economists (example, Tobin 1982)
see a link between fluctuations in investment and fluctuations in the stock
market. Stock price tend to be high when firms have many opportunities for
profitable investment, since these profit opportunities mean higher future
income for share-holders-thus, stock prices according to Tobin reflect the
incentives to invest. This is captured in the famous Tobin’s Q definition as,
Q= Market value of installed capital
Replacement cost of installed capital.
Tobin
reasoned that net investment should depend on whether Q is greater or less than
1. If q is greater than 1, then the stock market values installed capital at
more than its replacement cost. In this case, managers can raise the market
value of their firm’s stock by buying more capital. Conversely, if q is less
than 1, the stock market values capital at less than its replacement cost. In
this case, managers will not replace capital as it wears out (Mankiw, 1997).
That financial structure and economic
development are interrelated is a well known hypothesis (see Goldsmith, 1969,
Mckinnon,, 1973, show, 1973, Kuznets 1971, Cameroon 1967 and Townsend, 2008.
see also Gertler, 2010 an excellent survey of the background and Greenwood and
Jovanovich, 2010 for a recent contribution).
In a recent book of Mckinnon (2011),
real firms the views he first advocated in his money and capital (1973) that
financial liberalization in which real deposit rates are brought to a market
clearing level can and indeed does lead to rapid financial deepening measured
by the M2 to GDP ratio and financial growth can add, does contribute
to higher GNP growth. As for the channels through which financial growth exerts
a positive effect on output growth, Mckinnon (1973 and 2011) and others (world
Bank, 2012, CBN, 2012), put emphasis on the saving incentives and investment
efficiency generated by financial Deepings.
Overtime, more variables have been
observed to affect corporate investment in one way or the other. (Busari and
Omoke, 2010). For details on these variables, readers are referred to studies
like Greene and Villanueva 91991) Delong and Summers (1991), Chibber, Dailamir
and Shatik (1992), serven and Solimano (2009), Bleaney and Greenaway 1993) and
Ibara (2006).
2.2 The
Capital Market
Nwankwo (1998), capital market comprises the complex
of institution and mechanism through which intermediate term funds and
long-term funds are pooled and made available to business, government and
individual. There also asserted that the capital market comprises the process
by which securities already outstanding are transferred. This expression
contains the fact that the capital market has no fixed location and deal on
medium and long-term funds, has government, individual and business firms as
participants and ensures liquidity at it provides market for both new and old
securities.
Also, the central task of the
capital market is the mobilization of funds in the hands of individuals who
save pool and channel such funds into productive uses.
2.2.1 Capital Market Instruments
The instruments can be categorized into three major
groups of securities. These are, ordinary shares, preference shares and Debt instruments.
1. Ordinary
Shares
Herbert (2004), ordinary share are
issued to owners of the company. They are long-term financing with a nominal
value or face value. The memorandum and article of association of a company
specified the number of authorized ordinary shares a company can issue. The
ordinary shareholders of the company, their claims to income and assets come
after the creditors and preference shareholders have been paid in full. As a
result, a shareholder return on investment is less than the return to a lender
or preference shareholder. However, there is no limit to the return of ordinary
shares.
2. Preference
Shares
Ukpata (2012), preference shares are
major source of long-term financing of a company. The holders of preference
shares are entitled to a fixed percentage dividend before any dividend is paid
on ordinary shareholders. However, preference dividend can only be paid if
sufficient distributable profits are available, although with cumulative
preference shares the right to an unpaid dividend is carried forward to later
years. The arrears of dividend on cumulative preference shares must be paid
before any dividend is paid to ordinary shares. For credibility sake, companies
always try to pay the fixed dividend regularly,
3. Debt
Instrument
Akpeti (2012), A bond represents a method of long-term
borrowing by corporation of government agencies, when a corporate bond is
issued, it is a legal contract that goes with it which contains the provision
of loans in terms of its amounts, interest and maturity period. Bonds are sold
in multiples. They are purchased by commercial banks, insurance companies,
pension fund and even individuals. This form of financing is usually reserved
for target companies or corporation. This is why they have prior claims on the
firm’s asset in the event of liquidating.
2.3 Types
of Capital Market
1. Primary
Market
Soyede (2005), primary market is a
market for new securities. It is a platform where the company or government can
raise fresh funds for expansion. Both the securities and exchange commission
(SEC) and the Nigerian stock exchange (NSE) are involved in primary market
activities. The issuing houses and stock brokers also play prominent roles.
Until 1993, when deregulation of the capital market commenced, Securities and
Exchange Commission was responsible for pricing and allotment of new issues in
the Nigerian capital market while the quotation committee of the Nigerian stock
exchange approved only issues which is to be listed on the exchange’s official
list. The issuing houses and stockbrokers package issues for government and
public companies.
However, the central bank of Nigeria
acts as issuing issues for federal government stocks when company wishes to
sell such shares. If the company is already listed, the price is technically
suspended to forestall any insider. This situation holds true reason for
companies going into mergers and acquisition, or re-arrangement that may
potentially have bearing on their price and the suspension is sustained by the
Nigerian stock exchange until such exercise is completed (Onoh, 2013).
For companies seeking listing for
the first time, the securities are listed with the offer price soon after the
offer exercise is completed, instrument representing ownership are dispatched to
the shareholders. Securities and Exchange commission was the sole body giving
approval to offer price proposed by the issues in conjunction with issuing houses
(Emenike, 2012). However, under the present dispensation, the issuing house
proposes and defends a price at which it is willing to underwrite the entire
securities to be issued. This becomes the offer price and entirely conforms to
the price, while SEC examines the offer documents with a view to ascertaining
the adequacy of price and conformity with statutory requirements among other
things. The Nigerian stock exchange reviews the same documents to ensure that
company or institution meets its listing requirements.
Alice (1997), primary market takes
into representation the issuance which could be in form of any of the following
1 Offer
for Sale
Public offers for shares in a
company by existing shareholders proceeds of which goes to the vendors for
publications. This is a system by which existing shareholders offer their
shareholders or part of them for public subscription. In other words, offer for
sale is a transfer of ownership of shares from existing shareholders to new shareholders
2. Offer
for Subscription
This is a direct issue to the public
by floating a number of shares of debenture stock. It carries the supposition
that the company is a public one and the proceeds of the issues go to the company
to finance expansion or/and modernization. Again, the company issues a
prospectus inviting the public to its shares and it should be noted that the
company cannot dictate who subscribes to its shares.
3. Stock
Exchange introduction
Where a company seeking quotation
already has enough shares held in public hands, the council of stock exchange
may permit its security to be introduced into and listed on the market, no new
or existing shares to be sold. The added marketability to raise fresh funds in
the future invariably at a lower price.
4. Private
Placement
Securities are sold to the client of
the issuing houses handling the issue instead of being offered directly to the
general public. This is often necessitated by the desire to save time and cost
of issue. The council of the stock exchange seldom grants such permission and
this method is utilized by quoted public limited company’s. This differs from
offer from the subscription and offer for sale in that it is not an invitation
to the public to subscribe, rather, the share or stocks are placed with a
broker who then seeks out for the prospective purchasers.
5. Right
Issue
This involves offer to buy more
shares generally made to existing shareholders and at concessionary price.
Applications are considered by quotations committee of the exchange for
ratification and avoid excruciating interest rate charged in the money market,
the approval of the council gives the go ahead for the primary market
activities before the commencement of the primary market activities, the
securities and exchange commission is given the application to determine the
offer price of the security.
ii. Secondary
Market
Secondary market enhances the new
issue market in many ways. It provides the means by which investor can monitor
the value of their shares and liquidate them when they wish to do so. Pandey
(2006), it is a type of market where existing securities of a market are traded
on daily and continuous basis. It is the market for the existing securities.
This consists of exchanges and over the counter market where securities are
bought and sold after their issuance in the primary market. It has little to do
with influencing the way an economy allocates its capital resources or the way
in which sailing surplus and savings deficit united with one another.
However, events in the secondary
market frequently provide the basis for the terms and conditions that will
prevail in the primary market. If there were no secondary market in which
investors could turn investments in new issues back into cash when they choose,
many investors would not buy new issues in first place. If any investor truly
intend to make any irrevocable commitment of their funds, the availability of a
secondary market is an absolute pre-requisite to the existence of a primary
market in common stock.
Hamilton (2012), The secondary
augmentation of the flow of funds into the new issue market makes it possible
for the economy to make long-term commitment in real capital. This point is
best illustrated if the financial claims issued by firms and individuals could
not be traded in the secondary market. The secondary market makes it possible
for those who desire to make long-term real investments to obtain the money
capital of savers who have no intension of committing themselves for long.
Thus, they provide the economy with the opportunity to consider entirely new
approaches to building its capital stock. Market capitalization is the market
value of company’s issued shares capital. It is the product of the current quoted
prices of shares and the number of shares outstanding.
2.4 Conditions
for Establishing a capital market
Ekiran (2013), the environment of a country plays a
major role in the success or failure of a capital market development because if
an environment is conducive, it will give room for the rapid growth of a
capital market than in an environment that is hostile.
Inoga
(2010), described the following as conditions to be considered in establishing
a capital market.
1. Political
Environment.
Political environment is considered in establishment
of capital market. If there is political stability, it gives the investors
confidence that national policies will permit overtime and that this policies
will appropriate uneasiness to encourage private savings of both the
entrepreneurship and investors. But in an unstable short term view, this causes
a volatile market and does not encourage long term planning
2. Economic
Environment
In an economy where market development becomes a
priority, government enterprise should not be predominant, otherwise capital
market development becomes difficult.
3. Legal
and Regulatory Environment
Regulation is necessary to protect the investors and
in process increase their confidence. It is also necessary to ensure a fair and
orderly security in the market to achieve these objectives. Company laws must
be modernized and the conditions granting the listing to companies seeking quotation
must be clear and positive. There must be rules and regulations for the
brokers, directors and operators of the stock market. Also, there must be code
of conduct for brokers, directors and managers of the stock exchange, stock
broking firms and quoted companies.
2.5 Roles of capital market.
The main function of the capital market is to transfer
from surplus (savings) sectors to the deficit (capital investment) sector of
the economy.
Mohammed (2011), stated the function
of an active market to include the following:
1. The promotion of rapid formation
2. The
provision of sufficient liquidity for an investor or group of investors.
3. The
mobilization of servings to numerous economic units for economic growth and
development
4. The
provision of an alternative growth source of fund other than taxation for
government.
5. The
creation of a built in operational and recreational efficiency within the
financial system to ensure that resources are optimally utilized at relatively
little costs
6. The
encouragement of a more deferent allocation of new investment through the
pricing mechanism.
7. The
broadening of the ownership base of asset and the creation of a healthy private
sector
8. Provision
of efficient mechanism for the allocation of savings among competing productive investment projects.
9. The
encouragement of a more efficient allocation of a given amount of tangible
wealth through changes in wealth ownership and composition
10. It is an avenue for effecting payment on
debt
11. It is a
necessary liquidity mechanism for investors through a formal debt and equity
mechanism.
12. It is a
machinery for mobilizing long term financial resources for industrial
development.
2.6 Development in the Nigerian Capital Market.
The finance and insurance sector is the one that has
experience about the highest growth on the Nigeria economy especially since
after the introduction of the Structural Adjustment Programme (SAP). This has a
positive implications on the activities of the capital market in Nigeria.
The total number of securities
transacted in the capital market (both the first and second tier) was 334 in
1961. Of this, government securities were 92, a total of (27.5%) while
industries were 242 (72.5%) of the total. In 1965, the total number of transaction
increased to 1018 (204.79%) over the 1961 figure. Of this, industrial
securities dominated with a percentage share of 61.6%.
The number of transactions however
dropped in 1970 to 643 (47.8%) of which were government securities. Again, the
value of total transactions in the year was N16.6 million with government
securities accounting almost the total value of (98.78%). Industrial securities
through more in number were valued at only N0.2 million. From 1976, industrial
share of both in number and value of transactions increased tremendously from
97.0 and 2.03% for 1990 to 97.3 and 3.29% for 1985 and 98.85 and 11.11%
respectively in 1987%.
The sudden growth both in the total
number and value of transaction in the market and in the share of industrial
securities during these period can be attributed to the positive effect of the
Nigerian enterprises promotion decree of 1977 on the development of the private
enterprise in Nigeria.
In 1980’s, the share of government
securities in the number and value of transaction fall from 1.44 percent and
92.6 in 1985 to 1.15 and 88.9 percentage respectively in 1987, falling further
to 0.39 and 65.13 percent in 1990, 0.10 and 10.4 percent in 1993 and 1995. This
development is in line with SAP policy of allowing greater private sector
participation in the economy. The trend in the total number and value of
securities traded in the capital market over the same period as being erratic
which declined in the year 1990, 1993 and the value in 1995. Both the secondary
and primary market recorded massive growth in 1996 as a result of the relative
calm in industrial environment compared with 1993 and 1994, the repealing of
the Nigeria enterprise promotion (NEP) decree and Exchange Countries Act (ECA)
of 1962. Another development that aided positive growth in 1995 was the promulgation
of the Nigeria investment promotion commission (NIPC) Decree No 16 and the
foreign exchange provision decree No 17 of 1995. The stock exchange began its
generation on 6th June with 8 securities listed on it. Activities in
the year 2001 shows that exchange as 282 securities made up of 19 government
stock and bond, 49 industrial loan (debentures) or preferences. Sex companies
were listed on this segment of the stock market by 1988 and by 2002 over twenty
three companies had availed themselves of the opportunities offered by this
market.
In 1985, there were 20 securities on
the exchange official list and increasing to 290 as at the end of April, 2007.
Although a small market is one of the heading market in sub Saharan Africa and
has made some notable strides in recent years. With a history of over 50 years
when the first public issue was floated and 42 years of a stock exchange,
equity listings and market capitalization are still relatively small, standing
at 196 and US $ 7.0 billion respectively at the end of March, 2003. The value
of the equities traded at year end 2002 was US $ 0.5 billion, a much lower than
market capitalization. Turnover ratio of 7.9 percent was recorded at the end of
2002, higher than the average turnover ratio for 1998 to 2002.
The market has been quite active
with traded equities of N10.8billion (US $ 86 Million) in January, 2003, which
represented about 18 percent of the total equity value in 2002. By the end of
March, 2003, N24 billion (US 188.9 Million) equities had been traded. Indeed,
the depreciation of the local currency, the naira has continued to impact on
the size of the market in dollar terms. Between 1997 and 2002, the naira lost
over half its value to dollar, while market capitalization witnessed impressive
growth in local currency terms. This was not the case in dollar terms as a much
slower growth was registered.
In 2002, equity market
capitalization grew by over N100 billon (US $ 794 million) or 15 percent and
has remained on the upward swing. In 2003, equity market capitalization rose by
N98.2 billion (US $ 0.8 billion) over December, 2002.
The movement in market
capitalization has been led principally by new listings and firmer prices
arising from positive market sentiments. In 2004, the stock index rose by 10.7
percent albeit lower than the price increase of 35.2 percent in 2003 and 54
percent in 2000. Thus, the five years average index growth of 33.3 percent was
higher than the growth of inflation which averaged 12.6 percent during the same
period.
The expansion of the capital market
is evident in the size of the market capitalization to gross domestic product
(GDP). This shows that market capitalization represented 14 percent of (GDP) in
2002, in contrast to 12 percent in 2005, 9.4 percent in 1999 and 5.6 percent in
1992. The rising trend indicates that market capitalization is growing faster
in percentage terms than the gross domestic product(GDP). The year 2002 was
recorded year for the capital market with total flotation of N61.3billion or US
$ 0.483 million, the highest annual record ever posted in the capital market.
This single year record surpassed the cumulative figure for the proceeding two
years. It is also significant that the total value of flotation in year 2006
represented 36.4 percent of flotation in the ten year ended 2002. the
commission actually received 46 new issue applications for N78 billion but only
33 applications had been cleaned and opened by year-end. The 33 flotation’s in
2004 compares favourably with 27 and 21 in 2001 and 2000 respectively. The
listings has increased to over 290 securities as at 2007. (See, CBN, 2012, FOS,
2012) for details.
2.7 Capital
Market Development and Investment.
In terms of
theory, a growing literature argues that stock market provides service that
boast economic growth. Specifically, Greenwood and Smith (1996), shows that
large stock market can lower the cost of mobilizing savings and thereby
facilitating investment in the most productive technologies. Bencivenga, Smith
and Stan (2010) and Levnnie (2009), argues that stock market liquidity – the
ability to trade equity easily –is important for growth specifically, although
many profitable investment require a long-run of capital, savers do not like to
relinquish control of their savings for long periods. Liquid markets easy this
tension by providing an asset to savers that can quickly and inexpensively
sell. Simultaneously, firms has permanent access to capital rise through equity
issues.
Kyle (2010), and Holmstorm and Tirole
(2005) argues that liquid stock markets can increase incentives to get
information about firms and improve corporate governance.
Theoretical disagreement exists
about the importance of stock markets for economic growth. Mayer (2008), argues
that even large stock markets are unimportant sources of corporate finance.
Stigliz (1995 and 2011) says that stock market liquidity will not enhance
incentives for acquiring information about firms or exerting corporate governance.
Moreover, Devereux and Smith (2004), emphasize that greater risk sharing
through internationally intergraded stock markets can actually reduce saving
rates and show economic growth. Finally, Shleifer and Summers (2008) and Morck,
Shleifer and Vishny’s (2000 a, b) analysis suggest that stock market
development can hurt economic growth by easing counter productive corporate
takeovers.
In terms of raising capital,
Greenwood and Smith (1996) show that large, liquid and efficient stock market
can ease savings mobilization. By agglomerating savings, stock markets enlarge
the set of feasible investment projects since some worthy projects require
large capital injections and some enjoy economics of scale, stock market that
easy resource mobilization can boast economic efficiency and accelerate
long-run growth. Disagreement exists however, over the importance of stock
markets for raising capital. Mayer (2008), for example, argues that new equity
issues account for a very small fraction of corporate investment.
2.8 Empirical Literature
There is now a large body of empirical literature by
previous writers to link the role of capital market development in the economy.
However, majority of the literatures (Levine and Zervous, 2011, Khan and
Senhadj, 2009, Choong, Yusop and Sen 2005 etc) focus on the role of capital
market in economic growth. Other studies such as (Lynch 1995, Pelgin and Schich
2006, Bano, 2009 etc) have addressed impact of capital market on investment
growth.
Levine and Zervous (2011), empirically evaluate the
relationship between stock market development and longtime growth. The data
suggests that stock market development is positively associated with economic growth.
Moreover, instrumental variables procedures indicate a strong connection
between the predetermined component of the stock market development and
economic growth in the long-run.
Reiffers (1995), has highlighted the role of factors
such as the “accelerator” profit rate, interest rate, taxation and Tobin’s Q in
explaining investment in frame between 1972 and 1991 Reiffers analysis was
based on co-integrating relationships and error correlation models. The results
of the long-run analysis underscores the predominant role of financial variables
(profit rate and interest rate). The accelerator variable also has an impact on
the rate of capital accumulation, but this impact is unstable. The Chew stability
test allowed the researcher to distinguish between three sub-periods (1972-1982,
1983-1987 and 1988-1991). For the first sub-period, it is the accelerator
variable that comes first among the explanatory variables of the capital
accumulation rate. In second position comes the real investment rate for the
second sub-period, which witnessed a soaring of stock market rates, Tobin’s Q
ratio is as much an explanatory factor of the capital accumulation rate as are
the profit rate and the accelerator variable. As for the results for the third
sub-period, which corresponds to the after-kract stock market in 1987, they
show that Tobin’s Q no longer has a significant explanatory value, contrary to
financial value and the accelerator variable. Reiffers (1995), concludes from
this that there was from 1988, a change in investment behaviour, that is, firms
no longer considered the increase in their stock market value as a criterion in
their investment decision while this criterion had been taken into account in the
preceding sub-period.
Levine and Zervous (1996), examine whether there is a
strong empirical association between stock market development and long-run economic
development. The study used pooled cross-country time series regression of
forty-one countries from 1976 to 1993 to evaluate this association. The study focused
the line of (Demirgue-Kunte and Levine 1996) by conglomerating measures such as
stock market size, liquidity and integration of the world markets into index of
stock market development. The growth rate of cross Domestic product (GDP) per
capita was regressed on the variety of variables designed to control for
initial conditions. Political stability investment in human capital and macro
economic conditions, and, then include the conglomerated index of stock market
development. The finding was that a strong correlation between overall stock market
development and result is consistent with the theories that imply a positive
relationship between stock market development and economic growth.
Pedro and Erwan (2004), asserted that financial market
development raises output by increasing the capital used in production and by
ensuring that capital is put into best uses. Ogwumike and Omole (1996), Ojo
(1998), Abdullahi (2005), Adam and Sanni (2005) also asserted the importance of
capital market in economic development in Nigeria.
Agarwal (2010) argued that financial sector
development facilitates capital market development and in turn raises real
growth of the economy. Thorton (2005), Rousseav and Sylva (2010), Calderon and
Liu (2010), supported that financial system development promotes economic growth.
In the same vein, Beckacrt et al
(2005), demonstrated that capital market development increases economic growth.
Bolbo et al (2005), indicated that
capital market development has contributed to the economic growth of Egypt.
Tharawanji (2007), observed that countries with deeper
capital market face less severe business cycle output contraction and lower
chances of an economic down turn compared to those with less developed capital
market.
Samuel (1996), carried out a comparative study of
several models that explain the evolution of firm’s investment expenditure. The
estimates in this study were based on data from a panel of 331 American manufacturing
firms over the 1972-1990 periods. The results showed that the main determinant
of investment was cash flow. Firm managers also paid more attention to the
availability of internal sources of funding and to the cost of capital than to
the evolution of their firm’s stock market.
Zenfact (2007), studied the investment behaviour of
manufacturing firms in Cameroon between 2002 and 2006. The findings revealed a
negative influence of uncertainty on investment, a high adjustment speed and a
strong-capital profitability elasticity. Demand seems to also have played a
decisive role in capital accumulation.
Using a model inspired by Bertola (2008), and a panel of
200 manufacturing firms in Ghana over two years (2004-2005), Paltilo (2009),
found that because of demand uncertainty each firm would wait for the marginal productivity
of capital to rise beyond a specific threshold before it could invest. The
level of this threshold rises as uncertainty increases.
Sen (2000), studied a panel of 30 firms in Senegal
over nine years (1988-1994) and found that private investment was mostly
influenced by the accelerator phenomenon. Most often, Senegalese firm’s
investment depended on demand fluctuations. These firm’s also had a high adjustment
speed. In a study of investment behaviour of big firms in Benin. Ghansounou
(2001), found that these firms were more influenced by the relative cost of
capital and demand variations to which manufacturing firm’s were more sensitive
in comparison with commercial firm.
Adjasi and Biekpe (2005), study the effect of stock market
development on economic growth in 14 African countries in a dynamic panel data modeling
setting. Results largely show a positive relationship between stock market
development and economic growth. Further analysis based on the level of
economic development and stock market capitalization, are also conducted. The
results reveal that the positive influence of stock market development on
economic growth is significant for countries classified as upper middle-income
economies. On the basis of market capitalization groupings, stock market
developments play a significant role in growth only for moderately capitalized
markets. The general trend in results shows that low-income African countries
and less developed stock markets need to grow more and develop their markets to
elicit economic gains from stock markets.
Benhabib and Spiegel (2004), decomposing the
well-documented relationship between financial development and growth, examine
that financial development affects growth solely through its contribution to
growth in primitives or factor accumulation rates or has a positive impact on
total factor productivity growth. Their results suggest that indicators of
financial development are correlated with both total factor productivity and
investment. However, the indicators that are correlated with total factor
productivity growth differs from those that encourage investment. In addition,
many of the results are sensitive to the inclusion of country fixed effects
which may indicate that the financial development indicators are proxying for
broader countries characteristics.
Osinubi (2012),
empirically assessed the relationship between stock market development and long-run
economic growth in Nigeria for the period of 1990-2010. The study used
secondary data while four models of multiple regressions were specified. The
regression results which were obtained using the ordinary least square (OLS)
shows that the measure of stock market development statistically has no significant
effect on economic growth in Nigeria during the periods 1990-2010. The major
implication of the findings is that if the Nigerian stock market is significantly
contributing to rapid economic growth, policies must be fashioned out to
eliminate these factors that blur the effectiveness of the variable or
transmission mechanism through which stock market activities influence economic
growth. Based on the findings, it was recommended that there should be an
improvement in the attractiveness of the market as a major source of raising
capital. This will entail improvement in the physical infrastructure, more efficient
share transfer and delivering system and provision of adequate and timely information
on the market. Also, they should be improvement in the institutional regulation,
environment and legal framework such that a balance is maintained between the
soundness and safety of the market. Finally, there is the need to
internationalize the stock market to improve the flow of savings. This will
give the market the advantages of risk diversification, improve information
flow and encourage corporate control through investment in equity.
Nieuwer et al
(2005), investigated the long-term relationship between economic growth and
financial market development, in Belgium. The authors used a near set of stock
market development indicators to argue that financial market development substantially
affects economic growth. They found strong evidence that stock market
development leads to economic growth in Belgium especially in the period between
1973 – 1993.
In Nigeria, some authors have attempted to examine the
relationship between stock market development and economic growth. Adam and
Sanni (2005), examine the role of stock market on Nigerian economic growth
using Granger causality test and regression analysis. The authors discovered on-way
causality between GDP growth and market capitalization and a two-way causality
between GDP growth and turnover rates. The authors advised that government
should encourage the development of the capital market, since it has a positive
effect on economic growth.
Obamiro (2010), investigated the roles of the Nigeria stock
market in the light of economic growth. The author reported a significant positive
effect of the stock market on economic
growth. He suggested that government should create more enabling environment so
as to increase the efficiency of stock market to attain higher economic growth.
Ezeoha et al
(2009), investigated the nature of the relationship that exists between stock
market development and foreign private investment flows in Nigeria that is
domestic private and foreign private investment flows in Nigeria. The authors
discovered that stock market development promotes domestic private investment
flows thus suggesting the enhancement of the economy’s production capacity as
well as promotion of the growth of national output. However, result shows that
the stock market development has not been able to encourage the flow of foreign
private investment in Nigeria.
Nyong (1997), developed an aggregate index of capital
market development and used it to determine its relationship with long-run economic
growth in Nigeria. The study employed a time series data from 1970 to 1994. Four
measures of capital market development, the ratio of market capitalization to
GDP (in percentage), the ratio of total value of transactions on the main stock
exchange to GDP (in percentage) and listings were used. The four measures were
combined into one overall composite index of capital market development using
principal composite analysis. A measure of financial market depth (which is the
ratio of broad money to stock of money to GDP) was also included as control
variable. The result of the study was that capital market development is
negatively correlated with long-run growth in Nigeria.
Ted et al
(2005), examine the empirical association between stock market development and
stock market in India. Whereas the authors found support for the relevance of
stock market development to economic development during pre-liberation, they
discovered a negative relationship between stock market development and
economic development for the post liberalization period.
Ewah et al
(2009), appraised the impact of capital market efficiency on
economic growth in Nigeria using time series data on market capitalization,
interest rate, total market transaction, and government stock between 1961-2004
using multiple regression and ordinary least square estimation techniques. The
result of the study reveals that the capital market in Nigeria has the
potential to induce growth, but it has not contributed meaningfully to the
economic growth of Nigeria because of low market capitalization, low absorptive
capacity, illiquidity, misappropriation of funds and many others.
CHAPTER THREE
RESEARCH METHODOLOGY
3.1 Model
Specification:
Theoretical framework and model
investment functions have been specified using various major theories,
particularly, the neoclassical models (Jorgenson, 1967, Tobin, 1969),
accelerator models (Koyek, 1954) and the financing theory (Morck, 1990). We
shall adopt our model from Misati (2006), the study of impact of capital market
on investment growth in sub-saharan Africa in which the financing theory is
used to incorporate capital market variables into accelerator model. Though the
q-theory has been popularly used to link investment and capital market variables.
Thus, assuming constant elasticity of substitution (Q) between capital and the
variable inputs, we observe the following relation between desired capital
stock (K), the expected level of output(Y) and the expected rental cost of
capital (C).
Kt = aUtCt ---------------------------------(1)
∆Kt = a∆UtCt ---------------------------------(2)
We
then use the conventional capital accumulation identify specified in equation
(3) below to define investment(1)
Kt = (1-d)Kt +
I1 -------------------------------(3)
Where
a refers to depreciation
of capital from equation (3), we obtain Kt-Kt-1 = It-dKt-I -------------------(4)
Re-arranging
equation (4), assuming d=D and solving for It yields the following expression.
∆Kt = It-1 -------------------------------------------(5)
Substituting
(5) into (2) and express the result in log form where lower cases henceforth
denote the log form of the variables;
It = a+ ∆y --------------------------------------(6)
Equation
(6) represents the basic investment function. To account for slow adjustment of
the actual capital stock to the desired capital stock, we nest this within a
dynamic regression model yielding the following model
It = Plt-1 +
l1∆yt + l2∆yt-1 + Vt
--------------------(7)
Where
the first two terms on the right hand side are lagged investment and output
growth rates, respectively. ∆y represents lagged growth rate of capital while Vt
captures the individual error components. We proceed to incorporate our capital
market variables in the equation below (Pilgril and Schich, 2008, Lynch, 2005,
Durham, 2009)
It = It-1
+ l1∆yt + l2∆yt-1
+ l3 capital Mt
+ aoXt
+ a1Dt
+ Vt ----------------------------
(8)
Where
capital M represents all the capital market development indicators, that is the
size of stock market indicators, two liquidity of the stock market indicators,
market capitalization and the vector Xt captures other factors
influencing investment in developing countries and Dt is a country
specific vector of dummy variables.
The model incorporates objectives
(1) and (2) simultaneously.
3.2. Methods
of Estimation.
We shall use the method, Ordinary least Squares (OLS)
in the model estimation since the study involves a time series. We shall test
for the existence of co-integration between private investment and the right
hand side of equation (8). Error correction model (ECM) estimations would be
used to ascertain the short run impact of capital market variables on the
growth of private investment and speed of adjustment of investment towards its
long-run equilibrium value.
In a systematic manner, the main
features of an econometric analysis are incorporated in the model
specification. This research work will employ ordinary least squares (OLS)
estimation because of its reliable traits as the best unbiased estimator. Its
error term has a maximum and equal variance. The stochastic term has a zero
mean-conditional mean value which is zero and normally distributed.
The ADL model is a highly
statistically significant approach to determine the co-integration relation in
an annual data samples for validity (Ghatak and Siddiki 2008). Provisions were
made to ensure adherence to the principle of parsimony, dynamism and model
stimulation. Provisions were also made to ensure numerical accuracy, data
stationary and co-integration elimination if co-integration exist in the model,
by the application of Error Correction mechanism (ECM).
3.4 Data
Sources
The data for the study are quarterly
data between 1990 to 2010, a period of twenty (20) years. The sources of these
data are central Bank of Nigeria, statistical bulletin and Annual Report and
statement of account, various years; Stock Exchange Bulletin. The Global
Financial Data (www.globalfindata.com), and international financial statistics.