EMPIRICAL ANALYSIS OF THE SEMI-STRONG FORM MARKET EFFICIENCY OF THE NIGERIAN STOCK EXCHANGE
ABSTRACT
An efficient market hypothesis
asserts that all stocks are perfectly priced according to their inherent
investment properties, the knowledge of which all market participants
possess equally. In semi-strong-form efficiency, it is implied that
share prices adjust to publicly available new information very rapidly
and in an unbiased fashion, such that no excess returns can be earned by
trading on that information. Among these market events, bonus issues
from twenty-five companies decomposed into different sizes of small and
high bonus, were selected after adjusting for daily stock and market
returns for a period of one year to empirically test the semi-strong
form efficient market hypothesis of the Nigerian Stock Exchange. Our
study used the Event Study Methodology. The abnormal returns were
calculated using the Market Model and T-test were conducted to test the
significance. Results showed that bonus issues have signaling impact on
share prices on announcement date. The result supports the signaling
hypothesis, which states that managers often resort to bonus issues in
order to signal positive information about the firm. As a result, we
reject the null hypothesis and accept the alternative hypothesis. Despite the positive signaling,
shareholders lost more value in the ex-bonus period than the value
gained on event date. The different sizes of bonus issues do not matter
to shareholders rather any increase on their shareholdings suffices. The
cumulative abnormal returns (CARs) are statistically not significant.
On the whole, the study found evidence that the Nigerian Stock Exchange
is semi-strong inefficient. Consequently, the market should be
deregulated to allow for foreign participation so as to have a more
healthy competition. Also the buy-and–hold attitude of Nigerian
shareholders should be discouraged.
CHAPTER ONE
1.0. INTRODUCTION
1.1. BACKGROUND OF THE STUDY
According to the Efficient Market
Hypothesis (EMH), as prices respond to information available in the
market, and because all market participants are privy to the same
information, no one will have the ability to out-profit anyone else. The
nature of information does not have to be limited to financial news and
research alone; indeed, information about political, economic and
social events, combined with how investors perceive such information,
whether true or rumoured, will be reflected in the stock price (Reem,
2008). In efficient markets, prices become not predictable but random,
so no investment pattern can be discerned. A planned approach to
investment, therefore, cannot be successful.
Accepting the EMH in its purest form may
be difficult; however, Fama (1970) identified three classifications of
efficiency which are aimed at reflecting the degree to which it can be
applied to markets: weak form, semi-strong form and the strong form. The
weak form version claims that all past prices of a stock are reflected
in today’s stock price.
Therefore, technical analysis cannot be
used to predict and beat a market. The Semi-strong form efficiency
version, implies that announcement of all public information are
reflected in stock prices instantaneously and without bias. Neither
fundamental nor technical analysis can be used to achieve superior
gains. The Strong-form efficiency known as the strongest version, states
that all information in a market, whether public or private, is
accounted for in a stock price. Not even insider information could give
an investor an advantage. Fama (1991), however, changed the three
classifications; the weak form now called ‘test for return
predictability’; semi-strong form now called ‘event study’ and the
strong form he called ‘test for private information’.
Generally, the investigation of
semi-strong form market efficiency has been limited to the study of well
developed stock markets. Over the past half century, event studies have
been employed in much research and their sophistication has been
greatly improved by authors such as Fama, et al (1969) and Brown and
Warner (1980, 1985). Examples of events under semi-strong form
consideration include; stock splits, stock issuance (bonus issue, public
offerings), earnings announcements, merger or takeover announcements,
regulatory change, hiring or firing of high level officers, among
others. However, this study is on the public information/announcement of
bonus issues. In this study; we employ event study methodology, which
was first applied by Dolley in 1933 to examine this event for the stock
market of a transition economy, Nigeria.
Event study analysis is typically used
for two different purposes: as a test of semi-strong form market
efficiency; and assuming that the market efficiency hypothesis holds, as
a tool for examining the impact of some events on the wealth of firms’
shareholders. This study provides an initial empirical evaluation of
semi-strong form market efficiency of the Nigerian Stock Exchange, using
event study techniques.
In practice, ipso facto, there
may be an increase in share price following the announcement of a bonus
issue. Such increase can occur because the announcement of a bonus issue
may have beneficial information content (Peterson, 1989). Shareholders
are aware that, after the bonus issue, companies usually increase total
dividend payout. This, in turn, indicates the confidence of management
in the company’s future. Consequently, the share price may increase in
response to this information and affect shareholders’ wealth. The
informational link between dividends and earnings is supported
empirically by Healy and Palepu (1988). They show that firms that
initiate dividends have significant increases in earning for at least
one year after the announcement. See similar work of foster and vickrey
(1978).
Also, management may believe that
reducing the market price per share to a reasonable level facilitates
trade in the company’s shares and that this in turn may increase the
demand (the so-called “trading range hypothesis”). If this were true,
the market value of the company’s equities and hence shareholders’
wealth again would increase. An alternative way to reduce market price
per share is a stock split, which represents a reduction in the par
value. The essential difference between a bonus issue and a stock split
need not be accompanied by a book entry to relocate earnings or
accumulated reserves into paid up capital in the shareholders’ funds
section of the company balance sheet.
According to the tax authority,
shareholders must pay tax for a cash dividend but not for a stock
dividend. In other words, they need not pay tax on the bonus, which
makes the bonus more favourable than a cash dividend. In addition to
this institutional advantage and to the retained-earnings hypothesis,
there is some anecdotal evidence pertaining to Nigeria that suggests
bonus issues signal that management is confident about the company’s
future growth opportunities. However, this may not mean that in Nigeria,
shareholders/investors welcome all bonus issues. A research and
development director of one of Nigerian’s leading financial institutions
affirmed that this is indeed the case, and that high bonus issues
signal potential expansion of the company, whereas not so much with
small-bonus issues.
1.2 STATEMENT OF PROBLEM
In developed countries, many research
studies on semi-strong form efficiency have been conducted to test the
efficiency of stock market with respect to information content of events
whereas in Nigeria, very few studies have been conducted to test the
efficiency of the stock market with respect to bonus issue announcement.
Bonus issues continue to generate interest in the country, yet have no
direct valuation implications. As such these events are sometimes
described as “cosmetic” events as they simply represent a change in the
number of outstanding shares. The reason for the interest is therefore
to understand why managers would undertake such (potentially costly)
cosmetic decisions.
Empirical research on semi-strong form
market efficiency has been carried out in so many countries, such as in
America, Germany, Australia, Denmark, China, India on bonus issues and
results has shown that the market react positively to the announcement
[McNichols and Dravid (1990), Lijleblom (1989), Dhar and Chhaochharia
(2007), Ma and Barnes (2002), Obaidullah (1990)]. Numerous studies on
semi-strong form of efficient market in Nigeria have dealt with
information content of various types of announcements (Adeleyan (2001),
Kolo (2004), Omoruyi (2007)). However, to the best of my knowledge, no
contemporary study has investigated the information content of bonus
issue announcement in the Nigerian context. This deficiency provided the
raison d’etre and primary impetus for this study.
1.3 OBJECTIVES OF THE STUDY
The objectives of this study has been summarized and stated as follows:
- To investigate whether the announcement of bonus issues in Nigeria have significant signaling impact on share prices.
- To determine whether there are significant abnormal returns occurring on and around the announcement date.
- To test for the semi-strong form efficient market hypothesis of the Nigerian Stock Exchange.
1.4 RESEARCH QUESTIONS
From the objectives lined out above, this research will attempt to answer the following questions:
- To what extent does bonus issue announcement in Nigeria has significant signaling impact on share prices?
- What are the significant abnormal returns occurring during and around the announcement date?
- To what extent is the Nigerian Stock Exchange semi-strong form market efficient?
1.5. STATEMENT OF HYPOTHESES
To actualize the objectives of this study
and in attempt to answer the research questions above, the following
hypotheses stated in the null form are tested;
HYPOTHESIS I
Ho: Bonus issue announcement in Nigeria has no significant signaling impact on share prices.
HYPOTHESIS II
Ho: There are no significant abnormal returns occurring during and around the announcement of event date.
HYPOTHESIS III
Ho: The Nigerian Stock Exchange is not semi-strong form efficient
1.6. SCOPE OF THE STUDY
This study intends to test the semi
strong form market efficiency of the Nigeria Stock Exchange using public
information of bonus issues. The time frame for the study is one year (
240 trading days on the floor of the Exchange) covering from April 1,
2007 to March 31, 2008. The reason for the period is due to the nature
of the data, using daily stock returns and daily market returns.
Twenty-five (25) quoted companies that issued bonuses within the period
were sampled across fourteen (14) industrial sectors of the economy.
1.7. SIGNIFICANCE OF THE STUDY
This study is significant as it intends
to throw more light on bonus issues syndrome in Nigeria with emphasis on
its impact on stock price of firms in the market. More importantly, to
measure the resultant effect, the abnormal returns from investors’
reaction.
The research is also significant, as it
will provide information on several aspects of bonus issue in the
Nigerian stock market, and its activities as a whole.
The study is also important, in that it will serve as a magnum opus and
go a long way in assisting analysts, planners, policy makers and market
regulators, accounting standard setters, government, managers of firms
in formulating policies that will ensure a more efficient and dynamic
bonus issue management approach in Nigeria. This would guard against
possible future bonus shares problems in the future. This research is
expected to provide to the academic sector, a new horizon of
enlightenment, as it will serve as a basis for further research work by
other researchers who may wish to research into related topics.
1.8 LIMITATION OF STUDY
This study has been limited by a number of factors, which are as follows;
Lagged Nature: While
some companies may announce their bonus issue in a period, others in
different periods. Therefore, the lag in the period of announcement is a
constraint in collating of data, considering the number of days in
focus.
Literature: Almost
scanty of literature exist on the subject matter in Nigeria. Empirical
studies on bonus issues and stock prices in Nigeria are still scanty.
Foreign literature with different economic and political background
exist more on the subject matter.
Finance: Finance is a
major constraint, as the researcher studying in Enugu has to travel
outside the state in search of data. The cost of accessing materials
from the internet is astronomically much.
Performance Measures:
The proxies for the performance measures are derived from the Nigerian
Stock Exchange (NSE) All–Share Price Index and the companies’
financials.
Given the variety of data represented in
the study, and the difficulties in computing abnormal returns manually,
the researcher resorted to systems computation in line with
international works.
1.9. DEFINITION OF TERMS.
All-Share Price Index: It
is a composite index used to measure changes in financial market. In a
stock market, it reflects changes in market price and number of shares
outstanding of the companies in the index.
Asymmetric Information:This
is when an information that is known to insider of company and those
that have relationship with the company and is not known to outsiders
(the public) and vice versa.
Bonus issue: Bonus issue
is a “free’’ issue of shares without a subscription price, made to
existing shareholders in proportion to their current investment.
Bonus Ratios: Bonus ratio is the number of bonus shares in the issue/number of existing shares applicable for the bonus issue.
Bullish: Bullish is a situation where higher prices in the market appear warranted.
Emerging Markets: These are financial markets of developing economies or developing capital markets.
Estimation window: The period of data used in the estimation of parameters is known as an estimation window.
Events: An event is what
the investigator would like to study and it conveys information that
potentially influences stock prices. The event defined for this study is
the announcement of bonus issue.
E- bonus: E-bonus refers
to the electronic issuance of bonus, such that after the bonus issue,
the accounts of investors (beneficiaries) will be directly credited at
the CSCS (Central Security Clearing System) and no certificate are
issued unless investors demand for them.
Fundamental analysis: This
involves using market information to determine the intrinsic value of
securities in order to identify those securities that are undervalued.
Insiders: Insiders are
principal officers and directors of a company and those with business
relationship with it such as auditors, reporting accountants and lawyers
as well as those holding a specified percentage (in most countries 5%
or above) of the outstanding share of a company.
Listed Companies: These
are companies, whose securities are traded on the floor of the Stock
Exchange, having met all the requirements of the Exchange that qualifies
it to be quoted.
Market-Maker: A
market-maker is a dealer who stands ready to buy and sell securities for
his own account at his own risk. By so doing, a market–maker provides
liquidity to and maintains stability in the market.
Portfolio: This is the
totality of the various types of securities and other financial
instruments (stock, bonds, treasury bills etc) held by investors.
Although it mostly refers to financial instruments, real estate
investments are often included.
Registrar: A registrar
is a capital market operator appointed by a public company to prepare a
comprehensive list of its bond/shareholders. They are responsible for
dispatching annual reports, dividend warrants and return monies and
documents to shareholders.
REH: Retained Earnings
Hypothesis is a hypothesis, whereby given stock dividends, the value of
the newly issued share is subtracted from retained earnings and added to
the firm’s capital accounts.
Share-buy back: This is a
situation when some quoted companies get involved in buying up their
stocks when there is massive drop in price and lend the impression that
the stocks are well sought after by the public.
Technical analysis: Technical
analysis uses past patterns of price and the volume of trading as the
basis for predicting future prices. The random-walk evidence suggests
that prices of securities are affected by news. Favourable news will
push up the price and vice versa.
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