FIRMS’ SPECIFIC CHARACTERISTICS AND STOCK MARKET RETURNS A STUDY OF LISTED NON-FINANCIAL FIRMS IN NIGERIA

CHAPTER ONE

INTRODUCTION

1.1              Background to the Study

Security or stock markets comprise a myriad of securities from government bonds to corporate common stock.  These markets are influenced by global variables such as interest rates, investors’ confidence, economic growth, global crisis and more.  It was demonstrated in 1997 and 1998 that the U.S economy and markets are impacted by events around the world.  In the summer of 1997, Thailand started having currency problems as the Thai Baht currency lost almost 50 percent of its value.  This currency devaluation spitted over into Thai banking system and economy, eventually causing an economic crisis that required help from the International Monetary Fund (IMF).  Indonesia’s currency and economy collapsed next followed by those in Malaysia and then that were contingent upon banking and economic reforms.  During all this economic instability, Japan was unable to do much to help because it was struggling with its own banking crisis and seven years of economic stagnation.  This Asian crisis was responsible for a lack of investors’ confidence around the world.  The U.S stock market crashed in October 1997 in the aftermath of the news, but it quickly recovered (Block & Hirt, 2000).

In August 1998 just when the world was feeling some relief from the Asian crisis, Russia defaulted on its sovereign debt, setting off a financial crisis for the world’s major financial institutions and western governments.  Lenders became so risk averse that many companies, even those with investment grade credit ratings could not borrow money.  Initial public offerings dried up, the stock market retreated more than 15 percent from its peak, and Wall Street lay off thousands of financial employees including the analysts, traders and international market workers.  Corporations come to these international markets for short term sources of funds or long term capital.  When the markets are good, money is cheap and easy to find, and when the markets are bad, money is hard to find and often relatively expensive.  The world economic markets often move back and forth between the two extremes (Block &Hirt,2000).

Equity accounts for a company’s ownership stake (Onuorah, Oboro & Agbogun, 2022). Investors or shareholders would desire adequate returns for their investments.  As the case may be, common stock holders have the right to attend and vote at general meetings as well as to receive declared dividends and their share of the residual assets, if any, if the business goes bankrupt.  The firms that want to receive capital in the market and are coming public are known as common stock issuers.  When compared to other potential sources, issuing common stock and selling it in the market allows the corporation to raise more equity capital more readily.  As a result, many corporations issue common stocks that are traded in financial markets, and investors have a wide range of options for selecting these types of assets for investment. There are three main methods of raising shares.  These are public offer, share placement and right issue.  Public offer involves issuing new shares for purchase by the general investing public.  Put differently, a public offer is an offer of new shares to the general investing public. 

In many countries, including Nigeria, U.K and U.S.A, a company whose shares are already traded on the stock market cannot make a public offer of new shares without shareholders permission (which is unlikely to be obtained, because existing shareholders would suffer a dilution in their shareholding in the company and would own a smaller proportion of the company).  Instead, companies whose shares are already traded on the stock market will use a rights issue or a placing when it wishes to issue new shares for cash. 

Furthermore, a public offer might be used to bring the shares of a company to the stock market for the first time.  The term for this type of share issue is an Initial Public Offering (IPO). The company comes to the stock market for the first time in a stock market flotation.  In Nigeria and the U.K, the terms Prospectus Issue and Offer for Sale are also used to describe a public offer.  A distinction is often made between an offer for subscription and an offer for sale.  Unlike in the case of the former, an offer for sale does not bring about an increase in the share capital of the company and the proceeds go to the vendor and not the company as it involves mere redistribution of shares from the current owner or vendor (who is selling) to the public (Onuorah, Oboro & Agbogun, 2022).

The traditional approach to the analysis of risky projects entails the evaluation of a project in terms of two characteristics viz: risk and return.  It is assumed that investors are rational, that is they prefer more returns to less returns, and risk averse (they prefer less risk to more risk).    To achieve the goal of wealth maximization for its shareholders, the firm must aim to maximize its share price.  In this case, the financial manager must learn to assess the two key determinants of price: risk and returns.  Each financial decision presents certain risk and return characteristics, and all major financial decisions must be viewed in terms of expected risk, expected return and their combined impact on share price (Isenmila, Eragbhe & Ogiedu, 2010).   The main thrust of this study therefore is to ascertain to what extent some firm specific characteristics are linked to stock market returns.  It is therefore of interest to the researcher to investigate the impact and importance if any, of firms’ specific characteristics on stock market returns; using some non-financial firms in Nigeria as a population of study.

Managers of companies, investors in shares, researchers would find this study useful in broadening their horizon on the mechanics of the stock exchange market and as a guide to making informed decisions on their investment in companies.

1.2              Statement of the Problem

Up to date there is no consensus as to which single or combination of variables best explain stock return.  This allows for the interested researchers to find out which research setting in term of countries environment are best proxies for their situation that determine stock returns.  Some characteristics are shown to have a strong ability in forecasting stock returns.  This is an indication that degree of explanation of variables on stock market returns depends on the country of stock, period of study and sector of study. Bhandari (1998) pointed out that the leverage ratio compared to beta must be strong explaining variation of stock market return.  While Azam (2011) stated that previous studies conflicts EPS and dividends as firm specific variables that affect stock returns.  Fama and French (1992) show variables of firm characteristics – firm size and B/M ratios pooled together can take the place of explaining the cross sectional variation in stock returns. 

Some of the available literatures in Nigeria have some short-comings that are left to be filled. Osisanwo and Atanda (2012) focused on macroeconomic variables (not firm characteristics) that affect stock prices as well as stock market returns. The variables they used include: interest on stock returns levels, money supplied and exchange rate.   Uwubamwen and Obayagbona (2012) used total assets as proxy for firm size, while in the contemporary literature firm size has low measured in terms of market capitalization of stock (i.e in a study that involves the determination of returns and or share price). In Okoro and Stephen (2014), the proxies used are only performance.  Market capitalization and capital structure were not captured in the model of the study.  Further studies drew sample from all the listed firms on the NSE, the study did not concentrate on sector and the findings appear too general.  There is a need to consider industry specific common characteristics attributed to each sector.

Because of the mix opinion in the literature, the mix of empirical findings, and the limited empirical survey, the relationship between firm characteristics and stock market returns particularly with reference to non-financial firms in Nigeria, it is not out of place to conduct further research on this to ascertain position.

1.3              Objectives of the Study

The main objectives of this study was to ascertain the extent firms specific characteristics can impact or influence stock market returns or gains to the investing public; using some selected non-financial companies in Nigeria as a case study.  In line with this, the following specific objectives will guide this study:

1)      Assess the effect of firm size on stock market returns of non financial firms in Nigeria.

2)      Ascertain whether firm age affects stock market returns of non-financial companies in Nigeria.

3)      Assess the effect of price earnings ratio on stock market returns of non-financial companies in Nigeria.

4)      Examine the effect of leverage on stock market returns of non-financial firms in Nigeria.

5)      Ascertain whether sales growth rate has influence on stock market returns of non-financial firms in Nigeria.

6)      Determine if productivity growth rate has influence on stock market returns of non-financial firms in Nigeria.

1.4              Research Questions

Based on the research problems the following questions were raised to guide the study and they are as follows;

1.         To what extent does firm size affect stock market returns of listed non-financial    firms in Nigeria?

2.         What effect does firm age have on stock market returns of listed non-financial       firms in Nigeria?

3.         To what extent does price earnings ratio affect stock market returns of listed non   financial companies in Nigeria?

4.         What effect does firm’s financial leverage have on stock market returns of listed    non financial firms in Nigeria?

5.         To what extent does sales growth rate affect stock market returns of listed non      financial companies in Nigeria?

6.         What effect does productivity growth rate have on stock market returns of listed   non financial firms in Nigeria?

1.5              Research Hypotheses

In line with the research objectives, six hypotheses which were formulated in the null forms were  tested.

Ho₁- Firm size has no significant effect on stock market returns of non-financial firms in Nigeria.

Ho₂ – Firm age has no significant effect on stock market returns of non-financial firms in Nigeria.

Ho₃ – Price earnings ratio has no significant effect on stock market returns of non-financial firms in Nigeria.

Ho₄ – Financial Leverage has no significant effect on stock market returns of non-financial firms in Nigeria.

Ho₅ – Sales growth rate has no significant effect on stock market returns of non-financial firms in Nigeria.

Ho₆– Productivity growth rate has no significant effect on stock market returns of non-financial firms in Nigeria.

1.6              Significance of the Study

The study will be beneficial to the following:

Stockbrokers: Stockbrokers who act as speculators of shares to their clients who may rely on their expert counsel as to which firm(s) possesses the requisite attributes (characteristics) that are likely to boost investment returns for their shareholders.

Managers of Companies: Who would desire to be abreast with the features of the enterprise that are likely to boost stock market returns for their firms, which would help in maintaining their market share in the industry.

Investors in shares: Who desire adequate returns for their investment. This is possible when they watch out for specific features of firms that are likely to enhance their market returns potential.

Academia:  This study would be useful to researchers, academicians, students of Management and Business Sciences as a reference material in their further study/research.

1.7              Scope of the study

This study is focused on the examination of relationship between firms’ specific characteristics and stock market returns of listed non financial firms in Nigeria.   The independent variables adopted are firms’ specific characteristics that have explanatory variables of firm size, firm age, price-earnings ratio, financial leverage, sales growth rate and productivity growth rate.  The dependent variable is stock market returns. The study covers a 12 year period of 2011 – 2022.  The choice for this study was based on the need to present an up-to-date report, in line with our investigation of how firms’ specific characteristics of firm size, firm age, price-earnings ratio, financial leverage, sales growth rate and productivity growth rate could impact and or propelled stock market returns of the investing public.

The study covers listed non financial firms in Nigeria. Nigeria is a federal republic comprising 36 states and the Federal Capital Territory, where the capital, Abuja, is located. Nigeria is a large, densely populated West African country on the Gulf of Guinea. Its neighbours are Benin, Niger, Chad and Cameroon. Nigeria's 356,669 square miles stretch across several climatic regions: a narrow coastal belt of mangrove swamps; a somewhat wider section of rolling hills and tropical rain forests; a still larger dry central plateau, with open woodlands and savanna; and a strip of semi-desert on the fringes of the Sahel. In general, the topography of Nigeria consists of plains in the north and south interrupted by plateaus and hills in the centre of the country. The Sokoto Plains lie in the northwestern corner of the country, while the Borno Plains in the northeastern corner extend as far as the Lake Chad basin. Nigeria is a multi-ethnic and culturally diverse federation. Nigeria is a country located on the western coast of Africa that has a diverse geography, with climates ranging from arid to humid equatorial.

1.8              Limitations of the Study

A number of obstacles were encountered by the researcher in the course of conducting the study.  They are as follows:

i.                    The study was limited to non-financial companies in Nigeria. It may be difficult to apply its findings and results to firms in other sectors of the Nigerian economy.

ii.                  The researcher was constrained to focus only on the measurable attributes of the firms under study.  This limitation however, does not affect the results obtained.

1.9       Operational definition of terms

i.                    Stock market is a contact between buyers and sellers of shares through the stockbroker in a stock exchange arrangement e.g the Nigerian Exchange Group.

ii.                  Returns are the financial rewards gained as a result of making an investment. The nature of the return depends on the form of the investment.  In the secondary market an investor could earn stock market return by buying a stock at lower price and selling it at a higher price.

iii.                Non-financial firms are incorporated legal entities that largely produce goods and services for the market.  They principally engage in the production of non-financial goods and services.  The non-financial sector includes retailers, manufacturers, utility businesses, service providers, caterers, haulage companies, airlines, construction companies and farms, amongst others.

iv.                A blue chip company is a nationally or internationally well established company that is financially sound and publicly traded.

v.                  A stock refers to a share in the ownership of a company.  Stock represents a claim on the company assets and earnings.

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