Impact of Investment on Stock Market Development in Nigeria

International Journal of Financial Economics Vol. 5, No. 1, 2016, 1-11 Impact of Investment on Stock Market Development in Nigeria Ebele Sabina Nsofo...
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International Journal of Financial Economics Vol. 5, No. 1, 2016, 1-11

Impact of Investment on Stock Market Development in Nigeria Ebele Sabina Nsofor1 Abstract This paper empirically examined the impact of investment on stock market development in Nigeria from 2001-2010. Investment was proxy by gross fixed capital formation and stock market development proxy by market capitalization. The study employed Secondary data from Central Bank of Nigeria Statistical Bulletin. The study employed Ordinary least square regression (OLS) technique. The study revealed positive and significant impact on stock market development within the year covered. The government should therefore formulate some investor friendly policies that will attract more investment inflow into stock market. Keywords: stock market, investment, development 1. Introduction Investment is an important factor in stock market development and the entire economy. The overall sustenance of stock marketlies on the amount of investment fund, without which the existence of stock market will be meaningless. Investment is the steady process by which the productive capacity of the economy is increased overtime to bring about rising levels of national income. Remarkably, investment expands productive capacity, which is also a contributory factor to long run growth in the economy The promotion of stock market is intimately tied up with the goal of increasing investment. Investment requires accumulation of funds over time. The accumulation of fund usually is a product of savings. Savings and investment is a function of income. Investment function is the relationship between income and savings. It is an economic concept which explains how the changes in national income induce changes in investment patterns. Thus, increase in income induces individual propensity to consume, save and invest. The larger the investment, the higher the capital flow to stock market investment. Inversely, retarded investment results in stagnation and poor acceleration in stock market growth. Nigerian stock market is developing market requiring massive investment to boost economic growth. One of the problems that investors face when investing in developing countries is political risk. The huge challenges of instability in the country are a major constraint for domestic and foreign investments. The escalation of the Boko Haram threat and other terrorists’ activities including the incessant killings, bombing by these sects poses a serious threat to investors. The amount of investment to stock market is influenced by a lot of factors among which are Availability of other investment outlets, low level of awareness and ignorance of the operations and benefits of the stock market in most developing countries. Investors’ decision on choice of investment (real estate or financial securities), financial institution and portfolio option depends to a large extent on investors’ perception, monetary policy actions and expected risk and return. A good perception of a company will attract investment. Poor perception definitely would impact adversely in the level of investment. Goetzmann and Massa (2003) noted that investors’ portfolio choice depends on expectations of risk as well as return and their response to expert advice and opinion. Interest rate which forms part of monetary policy in Nigeria is managed by Central bank. Central bank sets the deposit and lending rates of the financial intermediaries; if these rates are high, investors will shone banks and patronize capital market. Conversely, if 1

Department of Banking and Finance Caritas University Amorji-nike Emene, Enugu State

© 2016 Research Academy of Social Sciences


E. S. Nsofor the rate paid by banks to depositors is high, investors will patronize bank more than capital market and this will lead to decrease in capital market investment (Ologunde, et. al. 2006). According to Ioannidis and Kantonikas (2006) monetary policy actions affect stock prices, which themselves are linked to the real economy through their influence on savings, consumption spending and investment. The rest of the paper is organized as follows; part II provides a brief theoretical and empirical review. Part III presents the methodology and describes the data for the analysis. Empirical results are discussed in part IV. Part VI concludes the paper. 2. Theoretical and Empirical Review One of the aims of establishing stock market is to serve as a facility for investment in government and firms’ financial securities such as options, futures, and other derivatives traded for improved specialization that supports growth and to act as the space where those who have a demand are matched with the supply Saksouk and Pires (2007). It has been argued that more companies’ entrance in 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, et. al. 2004). In affirmation to this, Donwa and Odia (2009) remarked that investment expands productive capacity, which is also a major explanation of and contributory factor to long run growth in the economy. Investment provides needed money for creative capital development and acts as a reliable medium for broadening the ownership base of firms. More so, investment enhances acquisition of shareholdings in domestic as well as in foreign companies, and thus supplements the low levels of income of individual household. The increased wealth of local investors is likely to induce an expansion of their consumption, encourage savings and investment which will no doubt enhance volume and trading in varieties of financial asset and leads to stock market development (llmolelian, 2005).As investors channel their funds into investment instruments of big corporations with a promising return (in the form of dividends and appreciation of stock prices), more people are encouraged to invest (Alajekwu,et. al. 2013). Edo (1995) asserts that securities investment is a veritable medium of transforming savings into economic growth and development and that a notable feature of economic development in Nigeria since independence is the expansion of the stock market thereby facilitating the trading in stock and shares. Empirical evidence shows that investment is expected to accelerate stock market development and increase economic growth. For instance, the work Aduda, et. al. (2012) found that investment is significant in the development of Nairobi Stock Exchange. Their study made use of secondary data for the period 20052009 to model the influence of investment on development. Osinubi and Amaghioneodiwe (2010), used secondary data from 1970-2005 to assess the effect of foreign private investment on Nigerian economic growth. Empirical results show that foreign private investment, domestic investment growth and net export growth have significant positive impact on Nigerian economic growth. Billmeier and Massa (2007) assessed the macroeconomic determinants of stock market capitalization using a fixed-effect panel regression on pooled data from 17 economies across the Middle East and Central Asia region from 1995 to 2005 for a maximum 141 year observations. Dependent variable is (the log of) stock market capitalization as a share of GDP and investment as one of the regressors. Result show that investment is significant and positive on stock market capitalization. Ibrahim (2011) utilized a 4-variable framework and quarterly data from 1993 to 2007 to examine the stock market and macroeconomic performance relation for Thailand. He used market capitalization as a ratio of gross domestic product to reflect the level of stock market development. The model of investment to stock market development show that investment also contributes positively to stock market development in Thailand. Using pooled date from 15 industrial and developing countries from 1980 – 1995,Liu and Garcia (1999) examined the macroeconomic determinants of stock market development. Stock market capitalization was used as a proxy for stock market development. Gross domestic investment was modeled on stock market 2

International Journal of Financial Economics development. Result revealed that investment ratio is a good predictor of stock market development. When investment increases by one percentage point, market capitalization increases by 1.043. Bolbol and Omran (2004) examine the role stock returns play in determining investment. Using a sample of 83 firms from five Arab countries during 1996-2001, they find that debt financing is the channel through which the stock market affects investment, The result further reveal that firms size does not matter much in making the stock market a better predictor of investment since stock market developments tend to facilitate financing for young and small firms. Ali and Aamir (2014) modeled domestic investment and foreign direct investment on growth. Using panel data from five East Asian countries for the period of 1991 to 2011, he concluded that GDP per capita is significantly explained by independent variables, which include foreign direct investment and domestic investments as percentage of GDP. Employing a vector error correction model (VECM) technique on the commonly used stock market development indicator - market capitalization among other variables, Adenuga (2010) examined short run and long run effect of investment on growth using quarterly data from 1990 to 2009.The result shows that in the short run, a unit change in the first and second lags of investment ratio will induce 7.4 and 4.2 units change in economic growth in the current period and they both are positive and significant at the 1.0 and 5.0 per cent levels of significance. Adefeso,et. al (2013) study examines the long run and causal relationship between both stock market development and economic growth in Nigeria. The study made used of secondary data which were obtained from both World Indicator Index and Statistical Bulletin published by Central Bank of Nigeria for the period of 1980-2010. They modeled investment on growth. Vector Error Correction Model (VECM) and Cointegration technique of analysis were employed to analyze the data. The study found that, there is a long run relationship between investment and growth in Nigeria. Kanu and Ozurumba (2014) regressed the impact of capital formation on growth for the period 19812011. Using multiple regressions technique, It was ascertained that in the short run, gross fixed capital formation had no significant impact on economic growth; while in the long run; the VAR model estimate indicates that gross fixed capital formation, had positive long run relationships with economic growth in Nigeria.Ita and Duke II (2013) investigated macroeconomic factors that influence stock market development. A co-integration and error correction model was employed on macroeconomic data from Nigeria. The calculated ADF statistic for investment is insignificant or non-stationary in residuals, when comparing their respective residual values of ADF Statistic with the critical values at 10% (critical value being 2.6103, in absolute value). Ezeoha, et. al. (2009) conducted a study on nature of relationship between stock market development and levels of domestic or foreign private investment flows in Nigeria. This research revealed a positive link between capital market development and domestic private investment while a negative relationship is found between stock market development and foreign private investment in Nigeria. Ikechi and Anayochukwu (2014) investigated the impact of capital formation on the economic growth of Nigeria using multiple regression technique. It was ascertained that in the short run, gross fixed capital formation had no significant impact on economic growth; while in the long run; the VAR model estimate indicates that gross fixed capital formation had positive long run relationships with economic growth in Nigeria. Ugwuegbe and Uruakpa (2013) investigated the impact of capital formation on economic growth in Nigeria for the period of 1982 to 2011. Data for the study were collected from Central Bank of Nigeria (CBN) Statistical Bulletin. To analyze the impact of capital formation, stock market capitalization, inflation rate and interest rate was modeled on economic growth, the study employed Ordinary least square (OLS) technique. To test for the properties of time series, phillip-perron test was used to determine the stationarity of the variables and it was discovered that gross fixed capital formation and economic growth are integrated of order zero I(0), Johasen co integration test was employed to determine the order of integration while error correction model was employed to determine the speed of adjustment to equilibrium. The empirical results suggest that capital formation has positive and significant impact on economic growth in Nigeria for the period under review. 3

E. S. Nsofor Obiakor and Okwu (2011) employed Ordinary Least Square to analyze the impact of capital market development on Nigerian Economy Growth from 1981 to 2008 using gross capital formation as one of explanatory variables. Results show that while market capitalization, gross capital formation and foreign private investment individually exerted statistically insignificant impact during the year under review, the variable jointly exerted statistically significant impact on growth of the economy. Ugwuegbe, et. al. (2013) investigated the impact of foreign direct investment on the Nigerian economy from 1981 to 2009 employing Ordinary Least Square method in order to derive the relationship between them. The study found a positive but insignificant relationship between foreign direct investment and growth of Nigerian economy for the period studied and the same hold for interest rate while domestic investment is positive and significant. Abdelbaki (2013) attempted to investigate the relationship between macroeconomic variables and Bahraini stock market development using the Autoregressive Distributed Lag model. He found that income level, domestic investment, banking system development, private capital flows and stock market liquidity are important determinants of Bahraini stock market development. Oluitan and Henry (2013) examined the importance of capital market to the development of the Nigerian economy with data covering 1992 to 2010. The result shows that the value of shares traded is positively correlated to the GDP with the level of significance ranging from 1% to 5%. The coefficient for value of shares traded is large; the result shows that a unit change in value of shares traded will lead to over 18.96units change on the proxy for development. Yartey (2008) examined on the determinants of stock market development in emerging economies, using South Africa as a case study. He examines the institutional and macroeconomic determinants of stock market development using a panel data of 42 emerging economies for the period 1990 to 2004. The paper finds that macroeconomic factors such as income level, gross domestic investment, banking sector development, private capital flows, and stock market liquidity are important determinants of stock market development in emerging market countries. Adetiloye and Adeyemo (2012) examined whether investment and capital formation aids growth in Nigeria using secondary data from Central Bank of Nigeria. The linear estimation regression models confirm that investment has not translated into capital formation and has not aided growth in Nigeria. The result revealed that growth exists but is found to be insignificant. Theories of Investments Existing literature revealed theories that explain investment behavior of corporations and the government. Prominent among them are; Marginal efficiency of capital hypothesis, Tobin Q theory of investment and the Accelerator theory of investments. Marginal Efficiency of Capital Hypothesis Marginal Efficiency of Capital Hypothesis is based on Lord Maynard Keynes presumption that insists on the rate of discount which equates present value of net expected returns from an investment capital to its cost. This is an important concept in investment technique. Keynesian theory is based on the premise that the level of investment is determined by marginal efficiency of capital relative to interest rate. The concept is based on the simple arithmetic technique of computing present value of a given series of returns discounted at a specified discount rate. If the marginal efficiency rate of return is higher than the rate of interest, investment will be encouraged; if not, investment will be discouraged. Tobin Q-Theory of Investment Tobin in postulated the Tobin Q-Theory of investments which states that investment is made until the market value of assets is equal to the replacement cost of assets. The Q-theory of investment was foretold by Keynes in 1936 by arguing that stock markets will provide guidance to investors and that: there is no sense in building up new enterprise at a cost greater than at which an existing one can be purchased. Tobin Q values encourage companies to invest more in capital because they are worth more than the price they paid for them. The accelerator and the neoclassical theory of investment hold that the adjustment of the capital stock, to its 4

International Journal of Financial Economics desired level, is instantaneous and complete each period. This can be resolved by the addition of an adjustment cost function to the optimization problem. It was also believed that expectations play no role in the neoclassical and accelerator theories which is in contrast to Tobin Q theory that incorporates future expected profits. It provides an explanation of a link between stock prices and the real economy; higher stock prices encourage firms to invest. Inclusion of marginal adjustment cost function to the profit function logically made the neoclassical theory becomes equivalent to the Q- theory (Brainard and Tobin 1968, Tobin 1969). The Accelerator Theory of Investments The Accelerator theory of investment suggests that changes in demand or income in an economy, moves in the same direction with the level of net investment made by firms. If national income is rising, at an increasing rate then net investment will also grow, but when the rate of growth is slow, net investment will fall. The theory also holds that when demand levels increases such that there is excess in demand, firms can meet demand either by raising prices to cause demand to drop or to increase investment to match demand. The theory suggests that most companies often choose to increase production to increase their profits. Review of Investment Flow to Stock Market in Nigeria within the year under study Nigerian stock market is developing markets requiring accelerated investment to boost economic development. Despite the global financial crisis which shook the market confidence across the world and demonstrated high rate of integration of financial markets worldwide, it is on record that phenomenal improvements were recorded in the Nigerian capital market with increased liquidity through portfolio investment (Nwaoba, 2009, Okeke 2008)). The graph above portrays the trend of investment as a percentage of GDP in Nigeria over the period under review. A cursory look at the graphical representation indicates that investment as a percentage of GDP in Nigeria has witnessed a sustained increase with a slight oscillatory over the years. In 2001 the value stood at 104.241 and rose to 163.592 in 2004 representing 56.94% increase and decrease slightly by 12.5% in 2005. Meanwhile, from 2008 to 2010 the economy witnessed a great increase in investment of about 69.42%, from 305.081 in 2008 to 516.883 in 2010. Figure 1: Trend of Gross Domestic Investment Between 2001 and 2010

INVESTMENT as a % of GDP 600 400 200


0 2000 2002 2004 2006 2008 2010 2012

Plotted with data from CBN Statistical Bulletin However, these exceptional improvements are attributed to a number of reasons. The Nigerian stock market witnessed significant growth since the uninterrupted democratic rule from 1999 and measures taken by the government guaranteed reasonable human rights and socio economic development which exposed investors and companies to the significance of the stock market. Companies, organizations and other institutions operate in a relatively conducive environment which serves as a platform for investment (Wapmuk and Oshinowo, 2007).Discarding of institutional distinction in the banking industry with the universal banking mandate of 2000 marked the beginning of the sustaining rapid growth in 2001. Before this period stock exchange restricts commercial banks to undertake investment banking business. With the 5

E. S. Nsofor change in the policy, commercial banks that controlled the banking industry flooded the capital market leading to explosive expansion in the market (Uzor, 2007). The federal government returned to the capital market in 2003 after 17 years of absence with four tranches of N150 billion federal government bonds contributed to the increase. The federal government got N72.56 billion from the issue (Al- Faki, 2007, Aguwamba, 2005). Between 2001 and 2004 the stock market development increased by 115.78%. From 2004 – 2008, there was steady upsurge in oil prices; the economy was not able to absorb the excess liquidity from oil revenues and foreign investments in productive sectors. This lead to significant flows to the capital markets in form of margin loans and proprietary trading camouflaged as loans. This resulted in increase in stock market capitalization by 5.3times. Notably, market capitalization of banks stocks increased by 9 times setting a stage for a financial asset bubble especially in banks stock (Sanusi, 2010). According to him, in 2007 the Nigerian stock exchange was the best ‘performing bourse’ in the world even though there was no evidence to suggest a commensurate improvement in the fundamentals of the real sector corporations. The investment activities of the pension funds in 2004 also influenced the market performance. According to Okeke (2007), N300 billion was contributed by the public and private sectors under their management. At the end of 2006 the market boomed with total market capitalization of 859.485 billion as against 400.416 billion in 2004 representing 53.41% increase. The frantic and aggressive efforts of banks in raising money from the public through the capital market in the wake of recapitalization policy served as a trigger that set off the boom in the market. A total of N2.2 trillion was raised through various public offer dominated by the banks in 2007 following the recapitalization (Adekunle, 2010). As shown in the graph, stock market development leaped from 516.096 in 2005 to 2096.109 in 2007 representing 306.14% increase. Following the bubble in the Nigerian stock exchange, the exchange for the first time in its history celebrated N1trillion transaction value on 23rd July, 2007. All share index which measures capital gain increased from 337,219.7in 2006 to 605,096.4 in 2008 (Okereke - Onyeuke, 2007). In 2004, Banks were required to increase their capital base fromN2b to N25b, representing 1150% increase. Many banks as well as insurance companies that were required to recapitalize by the end of 2007 went to the capital market to raised fund in order to meet the recapitalization requirement (Okereke Onyeuke, 2007). This was intended to bring change to the Nigerian economy through the banking industry. The expected change was restricted by the fact that such significant increase in capital was not matched by comparative increase in domestic economic opportunities. The equity market experienced unprecedented expansion within the span of three years but huge amount of the fund raised went out through capital flight (Udom, 2009). The N25b bank recapitalization unleashed the outflow of Nigerian bank capital to smaller African countries with less sophisticated financial systems and regulation. Total of 10 out of 24 licensed banks in Nigeria own a full-fledged licensed bank in foreign land (Uche, 2010). Such unprecedented capital flight poses a threat to a developing economy with developing capital market. There was significant growth in capital market; market capitalization rose from N1.36b in 2003 to N2.1b in 2004. 3. Methodology The study examines the impact of gross domestic investment on stock market development in Nigeria with reliance on annual data from CBN Statistical Bulletin for the period of 2001 – 2010. Stock market development proxy by market capitalization as a percentage of GDP was use as dependent variable. Independent variable - gross domestic investment was proxied on market capitalization. We employed Gross fixed capital formation as a measure for gross domestic investment. (Yartey and Adjasi, 2007, Ita and Duke II, 2013, Ben Neauer et. el, 2007) all used this measure. Our model for the study is; SD = f (INV)



This can be written as: 6

International Journal of Financial Economics Y = b0 + bx

…………..………. ……………………………………..

sd /gdp = b0 + b1Inv + ut ………. ……………………………………

(2) (3)

Where, sd /gdp = stock market development as a percentage of GDP inv/gdp= gross domestic investment as a percentage of GDP ut

= error term

bo is the coefficient of the regression and a priori expectation is that b1> 0 The variables are explained below: Gross Fixed Capital Formation Gross fixed Capital Formation is expenditure on fixed assets such as building and machinery; either for replacing or adding to the stock of existing fixed assets. It is a component of the expenditure on gross domestic product (GDP), and thus shows something about how much of the new value added in the economy is invested rather than consumed (kanu and Ozurumba, 2014) Market Capitalization Ratio This measure equals the value of listed shares divided by GDP. The rationale behind this measure is that the overall market size is positively correlated with the ability to mobilize capital and diversify risk on economy wide basis (Zafar, 2013, Ibrahim, 2011, Kemboi and Tarus, 2012) used market capitalization as a measure of stock market development. 4. Discussion of Results Figure 2: OLS Regression Result Dependent Variable: SD Method: Least Squares Variable Coefficient Std. Error t-Statistic


C INV R-squared Adjusted R-squared S.E. of regression Sum squared resid Log likelihood Durbin-Watson stat

0.9405 0.0282 820.1330 632.5704 15.43491 15.49543 7.152253 0.028171

25.78217 3.152935 0.672026 0.606029 487.5190 1901398 -74.96696 1.760759

334.6498 0.077042 1.178945 2.674370 Mean dependent var S.D. dependent var Akaike info criterion Schwarz criterion F-statistic Prob(F-statistic)

The estimated function is stated below as: SD = 25.782 + 3.153 INV In the estimated regression line above, the constant term is 25.782 meaning that holding the value of investment constant, the value of stock market development will be about 25.782. The coefficient of investment in the estimated regression line is 3.153 which imply that a unit increase in investment as a percentage of GDP will increase Nigerian stock market development (SD) by 3.153. This result is consistent with ‘a priori’ expectation which hypothesizes that increase in investment will lead to increase in stock market development. The coefficient of determination (R2) is 0.672. This shows that 67.2% of variation in stock market development (SD) is explained by variations in investment while the remaining 32.8% of the 7

E. S. Nsofor variation in the model is captured by the error term. This shows that the line of best fit is moderately fitted. The Durbin-Watson statistic is 1.76 which shows that there is no autocorrelation in the model. The value of F-statistics is 7.152 and the value of the probability of F-stat is 0.028. This result implies that the overall regression is statistically significant at 5% level of significant given that probability of F-stat is 0.028 is less than 0.05. From the regression result above the calculated t-statistics for the parameter estimates of investment ratio is 2.674370 while the tabulated t-statistics (under 8 degree of freedom) is 2.306. Since the calculated tstatistics is greater than the tabulated t-statistics we reject the null hypothesis and accept the alternative that investment has a significant and positive impact on stock market development in Nigeria within the period of study. The result is also in consistent with the studies of Billmeier and Massai (2007), Liu and Garcia (1999). 5. Conclusion and Recommendations The study has empirically proven that Gross domestic investment has a significant positive impact on stock market development in Nigeria for the period 2001- 2010 and desires to be given adequate attention for accelerated economic growth. The regression result show that coefficient of determination (R2) is 0.672. This shows that 67.2% of variation in stock market development (SD) is explained by variations in investment while the remaining 32.8% of the variation in the model is captured by the error term. Based on this we recommend that the government should create public awareness to encourage investors’ influx in stock market investment. Also, policy makers in Nigeria need to formulate some investor friendly policies that will attract more capital inflows and to provide a conducive and enabling infrastructure for investment capital. High incidence of capital flight in Nigeria by politicians and company’s seeking to open branches abroad should be checked. Udom, 2009 and Uche, 2010 affirms that the equity market experienced unprecedented expansion within a span of few years but huge amount of the fund raised went out through capital flight to smaller African counties with less sophisticated financial market and regulation . Reduction in the level of such unprecedented capital flight out of country will further boost stock market investment. Company executives should stop their greediness and dubious attitude of not declaring dividend to shareholder even when the company made profit because most investors are attracted by divided than capital gain. It is believed that these measures will, if given adequate attention attract more investors to stock market. References Abdelbaki, H. H. (2013). Causality Relationship between Macroeconomic Variables and Stock Market Development: Evidence from Bahrain, the International Journal of Business and Finance Research, 7(1), 69 - 84. Adefeso, H. A., T. Egbetunde and I. Alley (2013) Stock Market Development and Growth in Nigeria: A Causal Analysis, Arabian Journal of Business and Management Review (OMAN Chapter), 2(6) 7894. Adekunle, P.A. (2010) “Impact of Banking Sector Reforms on the Nigerian Capital Market (Equities)” Bullion, Vol. 34. No. 4, October- December, 8-20. Adenuga, A. O. (2010). Stock Market Development Indicators and Economic Growth in Nigeria (19902009): Empirical Investigations. Economic and Financial Review, 48(1). Adetiloye K. A. and K. A. Adeyemo(2012).Domestic Investment, Capital Formation and Population Growth in Nigeria, Developing Countries Studies, 2(7).


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