Stock Market Development: Its Impact on the Economic Growth in Nigeria

Stock Market Development: Its Impact on the Economic Growth in Nigeria

In examining the relationship between stock market development and economic growth, it is important that we throw light on some key concepts that will enhance a better understanding of the study.  These are the concept of stock market and the concept of economic growth and development.
The Stock Market
The Collins Dictionary of Economics (2005) defines a stock market as a market that deals in the buying and selling of company stocks and shares and government bonds.  Similarly, according to the Wikipedia free encyclopedia, a stock market is a mutual organization which provides trading facilities for stock brokers and traders, to trade stocks and other securities.  Additionally, Armstrong (1977) describes the stock exchange as “a market wherein to buy and sell the world’s capitalized values”.  According to him, “it is the citadel of capital, the temple of values, the axle on which the whole financial structure of the capitalist system revolves.”  The purpose and duty of a stock exchange is to organize security trading so that process may be found in the best possible condition (Urban, 1990).

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The evolutionary process of exchanges began in 12th and 13th century Europe in Italian towns such as Lucia, Genoa, Florence, Venice and Milan.  However, the term “exchange” began to be used first in Bruges, a Belgian town situated in Flounders, where Florentine, Venetian and Norwegian merchants used to had periodical meetings called “de beurse”.  According to Osazee (2007), the oldest stock exchanges include those of Antwerp in Belgium established in 1531, Frankfurt (1588), Berlin (1685), London (1773) and New York (1792).  The oldest in Africa are those of Cairo, established in 1883 and Johannesburg which came on-stream in 1887.
According to the Wikipedia free encyclopedia, stock exchanges play multiple roles in the economy and this may include:
i.    Raising capital for business.
ii.    Mobilizing savings for investment.
iii.    Facilitating company growth through merger and acquisition.
iv.    Creating investment opportunities for small investors.
v.    Raising capital for government development projects.
vi.    Serves as a barometer of the economy.
The development of a stock market simply implies improvement over time in the services/roles of the stock market.  It is characterized by growth in stock market size; improvement in market liquidity, infrastructure and regulatory framework, greater risk diversification and integration with world capital market.  Theoretically the more developed a stock market is, the greater its contribution to economic growth.  Yartey and Adjasi (2009), Garcia and Liu (1999) and Yartey (2007), have identified several factors which determine stock market development.  These include:
a.    Macroeconomic Stability:  a stable macroeconomic environment with low and predictable rates of inflation, consistent and sound monetary, fiscal and exchange rate policies is more likely to contribute to stock market development because both domestic and foreign investors will be unwilling to invest in the stock market where there is high macroeconomic volatility.
b.    Banking Sector Development:  This is important to stock market development because at the early stage of its establishment, the stock market is a complement rather than substitute for the banking sector (Yartey and Adjasi, 2007).  Hence, support services from the banking system contribute significantly to the development of the stock market.
c.    Institutional Quality:  Institutional quality is important for stock market development because efficient and accountable institutions tend to broaden appeal and confidence in equity investment.  Equity investment thus become more attractive as political risk is resolved overtime.
d.    Shareholder Protection:  Stock market development is more likely in countries with strong shareholders protection because investors do not fear expropriation as much. In addition, ownership in such market can be relatively dispersed, which provides liquidity to the market (Shleifer and Vishny, 1997).
Economic Growth and Development
Economic growth can be defined as the sustained increase in the output of an economy over a period of time.  According to Todaro and Smith (2006), it is the process by which the productive capacity of the economy is increased overtime to bring about rising levels of national output and income.  On the other hand, economic development refers to the sustained increase in an economy’s output over time plus a transformation in the method of production and in the attitude and values of the people.  In the words of Ai-Faki (2006), economic development is a sustained increase in standard of living that implies increase in per capita income, better education and health as well as environmental improvement.  Thus, while economic growth is related to quantitative sustained increase in a country’s per capita income, economic development encompasses both economic growth and the upward movement of the entire social system (Jhingan, 2006).  However, for the purpose of simplicity, both terms will be used inter-changeably in this study.
Generally, the growth of an economy is determined by a number of factors which can be grouped into economic and non-economic factors.  The economic factors include increase in resources of an economy, increase in capital stock of the economy and technological development.  The non-economic factors include social attitudes, values and structure, effectiveness of political and administrative machineries, etc.


Following the celebrated works of Gurley and Shaw (1973), Shaw (1973) and McKinnon (1973) which recognized the important role played by financial institutions in economic development, there has been increasing interest among economists and policy makers on the role of the stock market in economic growth.  As part of the financial system, the stock market is in the focus of economist and policy makers because of the perceived benefits it provides to the economy.  Hence, in recent times, research interests have focused on investigating whether stock markets, especially in developing countries, have achieved the development oriented goals for which they were originally conceived.
Recent researches have identified various channels through which the stock market may influence economic growth.  According to Levine and Zervos (1996), Levine (1996, 1997), Bakaert and Harvey (1997), Yartey and Adjasi (2007), Osinubi (2004) and Ezeoha et al (2009), stock market may affect economic growth through the following channels:
a.    Creation of liquidity.
b.    Risk diversification
c.    Corporate control
d.    Information acquisition about firms;
e.    Savings mobilization
a.    Creation of Liquidity:  Basically, liquidity refers to the ease with which an asset (in this case securities) can be turned into cash.  The liquidity role stands out clearly as the most significant among the numerous functions provided by the stock market.  In the words of Levine (1991, 1997), without a liquid stock market, many profitable long term investment would not be undertaken because savers would be reluctant to tie up their investments for long periods of time.  However, as shown by Levine (1991) and Bencivenga, Smith and Starr (1996), liquid stock markets reduces the downside risk and cost of investing in projects that do not pay off for a long time, thus making such investment attractive.  This is because with a liquid equity market, the initial investors do not lose access to their savings for the duration of the investment since they can quickly, cheaply and confidently sell their stake in the company.  Thus more liquid stock markets ease investment in long run, potentially more profitable projects thereby improving the allocation of capital and enhancing prospects for long run growth (Levine, 1996).
b.    Risk Diversification:  Without efficiently run stock markets, investors have limited means to diversify their portfolios.  As a result, investors may avoid equity stakes because they are too risky.  Hence, corporations may find it difficult to raise equity capital.  However, with creation of stock markets, individuals can diversify firm-specific risks, thus making investment in firms more attractive (Bakaert and Harvey, 1997).  According to St. Paul (1992), Deverreux and Smith (1994) and Obstfeld (1994), greater risk diversification can influence growth by shifting investment into higher-return projects.  Intuitively since high expected return projects also tend to be comparatively risky, better risk diversification through internationally integrated stock markets will foster investment in higher return projects.  The resultant effect is a boost in the economy, leading to economic growth.
c.    Corporate Control:  Stock market development may also influence corporate control through the take-over mechanism.  Laffont and Tirde (1983), Schartein (1988) and Ezeoka et al (2009) argue that take-over threats induce managers to maximize firm’s equity price.  The presumption is that, if management does not maximize firm value, another economic agent may take control of the firm, replace management and reap the gains from the efficient firm.  Such consciousness which is likely to cause a company to be better managed may not doubt be transmitted into the wider macroeconomic management and consequently lead to economic development in the country.
d.    Information Acquisition about Firms:  In larger, more liquid markets, it will be easier for an investor who has gotten information to trade at posted prices.  This will enable the investor to make money before the information becomes widely available and price change.  The ability to profit from information will stimulate investors to research and monitor firms.  Better information about firms improves resource allocation and spurs economic growth.
e.    Saving Mobilization:  At any stage of a nation’s development, both the government and the private sectors would require long term capital.  By agglomerating savings, stock market provide long term capital to both the government and the private sector, thereby enabling them to embark on worthy projects which require large capital injections and enjoy some economies of scale.  Thus, stock markets that ease resource mobilization can boost economic efficiency and accelerate growth (Levine and Zervos, 1996).
Critics of Stock Market Development and Economic Growth
A number of economists have suggested that the existence of stock market has little relevance to real economic activity.  Wai and Patrick (1973) argue that securities markets have generally not contributed positively to the economic development of those countries that created the markets.  In a similar vein, Calamati (1983) posits that securities markets increases economic fluctuations and therefore hinder economic growth.
Arguing against the impact of stock market liquidity on economic growth, Bhide (1994) contends that stock market liquidity may negatively influence corporate governance because very liquid stock market may encourage investor myopia.  This is because, instant stock market liquidity (i.e. the ease with which equity can be disposed off) may discourage investors from having long term commitment with firms whose shares they own and therefore create potential corporate governance problem with serious ramifications for economic growth.  Moreover, critics of stock market further argue that the actual operation of the take over mechanism in well functioning stock market may not influence corporate control.  As explained by Stightz (1985), outsiders will be reluctant to takeover firms because they generally have worse information about firms than existing owners.  Thus, the takeover threat will not be a useful mechanism for exerting control; stock market development, therefore will not importantly improve corporate control and thus growth.
Various empirical studies have been conducted to ascertain whether stock market development actually promotes economic growth.  Atje and Jovanovic (1983) tested the hypothesis that the stock market has a positive impact on growth performance.  By studying a relatively large set of 40 countries in the period 1979 – 88, and focusing on the dynamics of market size, they find a strong positive relationship between stock market development and economic growth.  Beck and Levine (2001) in another study confirmed the significance of stock market development in the process of economic growth.  By applying novel econometric procedures, they tested the independent impact of banks and stock markets on growth.  Their finding was that the expansion of banks and stock markets significantly affects growth. Furthermore, the results of a study carried out by Adjasi and Biekpe (2006), which examined the effect of stock market development on economic growth in 14 African countries, revealed a positive relationship between both variables and indicated that stock market development played a significant role in growth only for moderately capitalized markets.
Particularly, empirical studies by Oke and Mokolu (2004) to examine whether stock market promotes economic growth in Nigeria confirm the existence of a positive relationship between stock market development and economic growth.  A similar study by Osinubi (2004) to examine the association between stock market development and growth performance in Nigeria reveal that a positive relationship existed between economic growth and measures of stock market development used.  Additionally, Ezeoha et al (2009) conducted a study to examine the nature of the relationship existing between stock market development and private investment growth in Nigeria.  The result indicated that the Nigerian Stock Market over the years, very significantly encouraged the growth of private domestic investment.
Contrary to the above findings, Nyong (1997) who developed an aggregate index of capital market development which he used to determine the relationship with long run growth in Nigeria from 1970 – 94, found that capital market development is negatively and significantly correlated with long run growth in Nigeria.  In the same vein, a study by Osinubi and Amaghonyeodiwe (2003), using Nigerian data, provided some dissenting evidence that stock market development statistically had no significant effect on economic growth in Nigeria during the period 1980 to 2000.  They interpreted the result to mean that the Nigerian stock market was unable to make significant contribution to rapid economic growth because of the existence of certain policies that blur the effectiveness of the transmission mechanism through which stock market activities influence economic growth.  This result confirms the position of Singh (1999) that the stock market might not perform efficiently in developing countries and that it may not be feasible for all African markets to promote stock markets given the huge cost and the poor financial system.
The genesis of the Nigerian Stock Exchange (NSE) can be traced to the issue of the first Nigerian government registered stock in 1946, under the ten-year plan local loan ordinance, promulgated by the British Colonial administration (Ogumike and Omole, 1997).  However, the actual establishment of the stock exchange as a formal and specialized capital market institution in Nigeria took place on September 15, 1960 when the Lagos Stock Exchange was established.  The Lagos Stock Exchange which was established following the recommendation of the R.H. Barbock Committee set up to examine the viability of securities exchange in Nigeria, was incorporated under the companies ordinances as a non-profit organization limited by guarantee (Osazee, 2007).  Having been incorporated on September 15, 1960, the stock exchange opened its doors for business on its first trading floor in Lagos on June 5, 1961, with 19 securities value at N80 million listed on it.
On December 1977, the Lagos Stock Exchange was recognized and renamed the Nigerian Stock Exchange (NSE) following the recommendations of the industrial enterprise panel that branch exchanges be established.  As a result of this, new branches and trading floors of the NSE were established in some major commercial cities in the country (Kaduna, Port Harcourt, and Kano).  Today, the NSE has twelve functional trading floors, namely:  Lagos (1961), Kaduna (1980), Port-Harcourt (1980), Kano (1981), Onitsha (1990), Ibadan (1990), Abuja (1999), Yola (2002), Benin (2005), Uyo(2007), Ilorin (2008) and Abeokuta (2008).
The Nigerian stock exchange is governed by a council (Board) of the stock exchange, which is the highest policy making body of the exchange (Alile and Anao, 1986).  While the Council is responsible for policy-making, the day-to-day affairs or administration of the exchange is vested in the office of the Director-General.  The powers and functions of the council include:
a.    Enforcing the articles as well as the rules and regulations of the exchange.
b.    Taking disciplinary measures against erring members and policing the market.
c.    Granting quotations to companies and decisions to delist, suspend or withdraw quotation from any quoted company as it may deem fit.
d.    Protecting the interests of the investing public.
Objectives of the Nigerian Stock Exchange
The objectives of the Nigerian Stock Exchange as stated in its memorandum of Association are as follows:
i.    To create an appropriate mechanism for capital formation and efficient allocation of resources among competing projects.
ii.    To maintain discipline in the capital market.
iii.    To broaden share ownership practice.
iv.    To provide special financing strategies for those projects with long term gestation periods.
v.    To maintain fair prices for securities.
Functions of the Nigerian Stock Exchange
According to the NSE, the primary functions of the Exchange are:
i.    To support the capital raising process by providing the best quality, most efficient, most effective market place for the trading of financial instruments.
ii.    To promote confidence in and understanding the process.
iii.    To serve as a forum for discussion of relevant national issues.
iv.    To serve as a broad communication area for its constituencies and the dual role of overseeing the markets and their member-firm participants.
v.    To maintain broad, liquid secondary markets for corporate securities, and thereby help to build public confidence and participation in the market, enhancing issuer’s ability to raise capital in the primary market and underscoring the importance of efficient capital management (NSE, 1990).
Regulation of the Nigerian Stock Exchange
The Nigerian Stock Market, like elsewhere, is a regulated market.  Government oversight of the stock market in Nigeria is achieved through two basic frameworks – the legislative and the institutional.
a.    Legislative Regulation of the NSE
By legislative regulation, we imply the relevant laws regulating the operation of or transactions on the Nigeria Stock Exchange.  These include:
i.    The Companies and Allied Matters (CAMA) Act of 1960.
ii.    Investment and Security Act (ISA) of 2007.
iii.    Nigerian Investment Promotion Council Act of 1995.
iv.    Foreign Exchange (Monitoring and Miscellaneous Provision) Act of 1995.
v.    The Pension Act of 2004.
vi.    The Trustees Investment Act of 1990.
It should be noted that among the legislations listed above, the Investment and Securities Act (ISA) 2007, is the major law regulating the operations of the stock market in Nigeria.
b.    Institutional Regulation of the NSE – The Securities and Exchange Commission

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According to Akamiokhor (1984) and Ogunmike and Omole (1997), the Nigerian Stock Exchange itself is a self-regulatory organization.  However, besides its self-regulatory actions, the regulation of the Nigerian stock market is achieved through the operations of the Securities and Exchange Commission (SEC).  The Commission formerly known as the Capital Issues Commission (CIC) is the apex regulatory body for the Nigerian capital market.  It was set up under the securities and exchange decree of 1979, but is currently empowered legally to carry out its functions by the investment and securities Act (ISA) of 2007.  The two basic objectives of the SEC include:
i.    To attend to and accelerate the orderly growth and development of the Nigerian capital market.
ii.    To protect investors against fraudulent practices.
Functions of the SEC
According to SEC (2004), the Commission was set up to perform two broad functions – the regulatory and developmental.  The Regulatory functions of the SEC include:
i.    Valuation: To approve the price, amount, and time which securities of a company are to be sold;
ii.    Allotment:  To oversee the basis of allotment of Securities in a public offering to ensure wider spread of shares ownership;
iii.    Surveillance:  To monitor the activities of the Nigerian Stock Exchange Trading floors in order to ensure orderly, fair and equitable dealings in securities to forestall illegal deals;
iv.    Investigation/Enforcement:  To investigate complaints and suspected violations of securities laws and to impose penalties and remedial action.
v.    Registration:  To register all securities proposed to be offered for sale to or for subscription by the public or offers privately; stock exchanges and their branches, persons and institutions involved in securities dealing – stock brokers, registrars, issuing houses, fund managers, etc.
On the other hand, the developmental functions of the SEC involve:
i.    Stimulating ideas, initiating policy changes and innovation for the growth of the securities market;
ii.    Advising the Nigerian government on capital market issues.
iii.    Conducting researches and providing general education about securities.
iv.    Supporting a nation-wide system for securities trading including modern communication and data processing facilities.
Structure of the Nigerian Stock Market
According to Olugunde, Elumilade and Asaolu (2006), the activities of the Nigerian Stock Exchange fall into two broad categories: the primary market and the secondary market.
The primary market also known as the new issues market is concerned with the offering of new shares or the initial issue of securities in the exchange. Hence it provides the avenue through which the government and corporate bodies raise fresh funds for development purposes.  Issuance of securities in the primary market can take the form of offer for subscription, offer for sale, private placement, right issues, stock exchange introduction, America depository receipts/global depository receipt.
The secondary market also known as the after-market, is a financial market where previously issued securities and financial instruments such as stock, bonds, and options are bought and sold.  In other words, the secondary market operates after the issues had been completed and the securities listed on the Stock Exchange.  In Nigeria, licensed stockbrokers of the Nigerian Stock Exchange carry out secondary market transactions in the quoted securities on its trading floors.

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In examining how well a stock market performs in relation to other stock markets and primarily in relation to the role it is expected to play in facilitating economic growth and development, certain measures are employed.  The body of theoretical work suggests that stock market development is multi-faced, involving issues of market size, market liquidity, market concentration and integration with world capital markets (Levine and Zervos, 1996).  Hence, previous studies have utilized the above measures (i.e. market size, market liquidity, market concentration and market internationalization) in analyzing and evaluating the performance/growth of the stock market (Levine, 1997; Yartey and Adjasi, 2007; Kumo, 2008).
In the light of the above, the following are the measures which will be used to examine the growth and performance of the Nigerian Stock Market:
a.    Market Capitalization
b.    Trading Value
c.    New issues
d.    Listings
e.    Stock index
f.    Market Concentration
g.    Regulatory and infrastructural development.
h.    Integration with world capital market (internationalization)

a.    Equity Marty Capitalization
Market capitalization is perhaps the most widely used indicator in accessing the size of the stock market to an economy and in relation to other markets.  It equals the value of all listed shares on a stock exchange.
The market capitalization of the Nigerian Stock Exchange recorded remarkable growth during the period, 1981 – 2008.  It grew from N4.84 billion in 1981 to N6.4 billion and N15.9 billion in 1985 and 1990 respectively.  Between 1995 and 2000, the stock market capitalization witnessed 179.7% increase from N171.1 billion in 1995 to N478.6 billion in 2000.  In 2003, market capitalization hits its 1 trillion mark of N1.3 trillion and recorded an all time high of N13.2 trillion in 2007, representing 878.2% increase over its 2003 figure.  However, in the face of the global financial crisis, market capitalization dropped by 28.1% to reach N9.5 trillion by December 2008.  As at September, 2009, the market capitalization was N7.81 trillion, representing 18.3% decline over its 2008 closing figure.  The trend is shown in column 2 of table 2.1 and illustrated in figure 2.1 below.

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