http://www.mbainfoline.com/
Source:
E-mail:dt.10.6.2011
The
Effects of Market Volatility on Corporate Survival in a Developing Capital
Market
Mr Bala Suleiman Dalhat
Senior
Lecturer,
Accounting and Finance
Technology, Programme,
School of Management,
Technology,
Abubakar Tafawa Balewa
University,
Bauchi, Nigeria.
Abstract
Corporate survival depends
to a great extent on the stability of some micro and macro economic variables.
Fundamentally, the level of awareness of the investing populace counts a lot in
resisting market volatility. Similarly, the rate of savings by individuals
contributes immensely to the absorption of effects of price fluctuations.
Nigeria’s capital market is not well developed to accommodate consistent price
volatility. However, if the volatility of stock market prices is to be
understood in terms of the efficient markets hypothesis, then there
should be evidence that true investment value changes through
time sufficiently to justify the price changes. Three indicators
of change in true investment value of the aggregate stock market
are considered: changes in dividends, in real interest rates,
and in a direct measure of inter-temporal marginal rates of
substitution. Although there are some ambiguities in interpreting the
evidence, dividend changes appear to contribute very little toward
justifying the observed historical volatility of stock prices. The
other indicators contribute some, but still most of the volatility of
stock market prices appears unexplained. Yet this determines the
relevance of a company or otherwise in the market.
Bala Suleiman Dalhat and
Aminu K. Kurfi Ph. D
Full
Paper
Introduction
You often hear
about stock market volatility, and how bad it is, but have you wondered how to
compare volatility? Is it just something you know when you see it, or can it be
quantified? Well, like most things, there are ways to quantify volatility so you
can make the comparisons you want. First, we need to agree on definition of
volatility. It's basically the variation from the average value over a
measurement period. If a price varies a great deal from day to day, the
volatility will be high, and conversely if the day to day variation is low, the
value of volatility will be low as well. Another definition of volatility by
Adeyi (2008) is, "Volatility" refers to the frequency of price turnarounds in a
stock or the entire stock market, and the degree of these price reversals. It is
a measure of uncertainty in the marketplace. Many industry professionals refer
to volatility as a study of "fear" in the stock market. When investors become
more skeptical of economic success or individual corporate growth, a stock or
entire market can fluctuate with greater volatility than during times of
relative normalcy. A stock that moves in a consistent direction without much
deviation is said to have low volatility.
While it get
pretty complicated in a hurry when you burrow into the statistics, and you
factor in things like lognormal returns, and stationary processes, it can be
approximated by saying that if the volatility is calculated by the standard
deviation of the asset prices, then approximately two third of the time the
price will be within one standard deviation of the average price over time. In
most cases, one considers a high level of stock price volatility an indication
of greater risk and, and therefore, this reduces value, all other factors being
equal. In the case of call options on a stock, the opposite is true; there is a
positive relationship between the volatility f the underlying stock and the
value of the call option. This is because with greater volatility, there is
greater potential for gain on the upside, and the downside protection of the
option is also worth more (Reilly, 2002).
Risk is
prevalent everywhere in life, but business risk can be managed and to some
extent reduces volatility of products and share prices. Risk originate from a
variety of sources including the physical environment of the business, the
technology it employs for its operations, its people, organizational structure
and strategy, and the political environment. How best to manage these risks is a
major responsibility of managers. Effective risk management requires
identification of the risks and developing strategies to mitigate them. The
objective of risk management is to reduce the different risks related to any
given activity to an acceptable level (Ayininuola;2007).
Investors
generally conduct series of analyses to avoid risk. Where there are fluctuations
in prices, investors became scared to invest so that they cannot fall victims of
loss. This study intends to assess the effects of volatility on corporate
survival in a growing capital market. An analysis of the prices of shares of
companies that survived the period of global economic crises and those that
crippled along the line will be conducted. Other companies that experience
steady fluctuations in the last five years (2005-2009) in Nigeria will be
conducted. A sample of fifteen (15) companies will be taken out of the
population of 245 listed companies in the Nigerian Stock Exchange (NSE). A
comparative study of the market prices of the stocks of the companies for the
said period will be conducted. By implication, the study is going to rely mostly
on secondary data.
Related
Literature
Those who are
new to stock market investing might be primarily concerned with the price of
stock over a period of time. After all, it is the price that ultimately
generates profits. But many factors affect how stock prices move. The concept of
volatility plays an important role in market analysis. Those who are constantly
aware of volatility have an advantage in predicting stock prices. It is an
important component of the financial system that can lead to better investing
decisions.
Definition
"Volatility"
refers to the frequency of price turnarounds in a stock or the entire stock
market, and the degree of these price reversals. It is a measure of uncertainty
in the marketplace. Many industry professionals refer to volatility as a study
of "fear" in the stock market. When investors become more skeptical of economic
success or individual corporate growth, a stock or entire market can fluctuate
with greater volatility than during times of relative normalcy. A stock that
moves in a consistent direction without much deviation is said to have low
volatility (Highland; 2010).
Causes
The tight
interrelationships between different areas of the financial system are often
displayed in the behavior of the stock market. The Great Bear Market of 2008 was
a textbook example of how problems in the real estate and loan industries can
have dramatic consequences on stocks in entirely unrelated sectors. Whenever a
general crisis threatens an entire economy, volatility in the stock market is
sure to increase. Even in stable times, threats against a particular sector,
such as pharmaceutical stocks, can become more volatile because of changes in
regulatory practices, such as policies by the National Agency for Food and Drug
Administration and Control (NAFDAC).
In addition,
every three months the stock market enters an "earnings season" in which the
overall economic climate is quantified by corporate earnings reports. This, too,
can lead to increased volatility.
Measurements
The volatility
of the stock market is closely watched and quantified in several ways. One of
the most prominent measures of volatility is the Chicago Board Options Exchange
Volatility Index, commonly called VIX. Many refer to the VIX as the "fear
gauge," as it is a direct measure of how investors see the stock market outlook
over a short period into the future. When the VIX rises, volatility increases.
This is usually accompanied by larger swings in stock prices and ultimately a
decline in the stock market. Individual stocks can be compared against market
volatility by studying their "beta" values. These are calculated by comparing a
stock's price action with the overall action of a major index.
Profiting from
Volatility
When the stock
market becomes more volatile, it can be dangerous to buy into stocks. However,
there are other ways to profit from the increased volatility. There are exchange
traded funds, or ETFs, that correspond to all kinds of stock market behavior.
These are traded like regular shares of stock, but they do not actually
represent any corporation. Instead, they offer returns that correspond to their
particular measurement. Some funds, increase in share price when the stock
market decreases from increased volatility. Those who trade stock options often
benefit from increased volatility as well. Most stock options increase in price
even if their underlying stock remains unchanged, so long as volatility in the
market rises.
Periodic
fluctuation in the rate of economic activity, as measured by levels of
employment, prices, and production signifies volatility. Economists have long
debated why periods of prosperity are eventually followed by economic crises
(stock-market crashes, bankruptcies and unemployment). Some have identified
recurring 8-to-10-year cycles in market economies; longer cycles have also been
proposed, notably by Nikolay and Kondratev (2010). Apart from random shocks to
the economy, such as wars and technological changes, the main influences on the
level of economic activity are investment and consumption. An increase in
investment, as when a factory is built, leads to consumption because the workers
employed to build the factory have wages to spend. Conversely, increases in
consumer demand cause new factories to be built to satisfy the demand.
Eventually the economy reaches its full capacity, and, with little free capital
and no new demand, the process reverses itself and contraction ensues. Natural
fluctuations in agricultural markets, psychological factors such as a bandwagon
mentality, and changes in the money supply have all been proposed as
explanations for initial changes in investment and consumption. Many governments
used monetary policy to moderate the business cycle, aiming to prevent the
extremes of inflation and depression by stimulating the national economy in
slack times and restraining it during expansions.
The recurring
and fluctuating levels of economic activity that an economy experiences over a
long period of time scares investors due to fear of prolonged risk of loss. This
is more common in developing economies. The five stages of the business cycle
are growth (expansion), peak, recession (contraction), trough and recovery. At
one time, business cycles were thought to be extremely regular, with predictable
durations. But today business cycles are widely known to be irregular - varying
in frequency, magnitude and duration due to business
dynamics.
Investopedia
Says
A business cycle
is a sequence of economic activity in a nation's economy that is typically
characterized by four phases—recession, recovery, growth, and decline—that
repeat themselves over time. Economists note, however, that complete business
cycles vary in length. The duration of business cycles can be anywhere from
about two to twelve years, with most cycles averaging about six years in length.
In addition, some business analysts have appropriated the business cycle model
and terminology to study and explain fluctuations in business inventory and
other individual elements of corporate operations. But the term "business cycle"
is still primarily associated with larger (regional, national, or industry wide)
business trends.
Stages of a
Business Cycle
RECESSION: A
recession—also sometimes referred to as a trough—is a period of reduced economic
activity in which levels of buying, selling, production, and employment
typically diminish. This is the most unwelcome stage of the business cycle for
business owners and consumers alike. A particularly severe recession is known as
a depression.
RECOVERY: Also
known as an upturn, the recovery stage of the business cycle is the point at
which the economy "troughs" out and starts working its way up to better
financial footing.
GROWTH: Economic
growth is in essence a period of sustained expansion. Hallmarks of this part of
the business cycle include increased consumer confidence, which translates into
higher levels of business activity. Because the economy tends to operate at or
near full capacity during periods of prosperity, growth periods are also
generally accompanied by inflationary pressures.
DECLINE: Also
referred to as a contraction or downturn, a decline basically marks the end of
the period of growth in the business cycle. Declines are characterized by
decreased levels of consumer purchases (especially of durable goods) and,
subsequently, reduced production by businesses.
Factors That
Shape Business Cycles
For centuries,
economists regarded economic downturns as "diseases" that had to be treated; it
followed, then, that economies characterized by growth and affluence were
regarded as "healthy" economies. However, many economists had begun to recognize
that economies were cyclical by their very nature, Today, economists, corporate
executives, and business owners cite several factors as particularly important
in shaping the complexion of business environments (Soludo;
2004).
Volatility of
Investment Spending
Variations in
investment spending are one of the important factors in business cycles.
Investment spending is considered the most volatile component of the aggregate
or total demand (it varies much more from year to year than the largest
component of the aggregate demand, the consumption spending). Increases in
investment spur a subsequent increase in aggregate demand, leading to economic
expansion. There are several reasons for the volatility that can often be seen
in investment spending. One generic reason is the pace at which investment
accelerates in response to upward trends in sales. This linkage, which is called
the acceleration principle by economists, can be briefly explained as follows.
Suppose a firm is operating at full capacity. When sales of its goods increase,
output will have to be increased by increasing plant capacity through further
investment. As a result, changes in sales result in magnified percentage changes
in investment expenditures. This accelerates the pace of economic expansion,
which generates greater income in the economy, leading to further increases in
sales. Thus, once the expansion starts, the pace of investment spending
accelerates. In more concrete terms, the response of the investment spending is
related to the rate at which sales are increasing. In general, if an increase in
sales is expanding, investment-spending rises, and if an increase in sales has
peaked and is beginning to slow, investment-spending falls. Thus, the pace of
investment spending is influenced by changes in the rate of sales (Ibe;
2008).
Politically
Generated Business Cycles
Many economists
have hypothesized that business cycles are the result of the politically
motivated use of macroeconomic policies (monetary and fiscal policies) that are
designed to serve the interest of politicians running for re-election. The
theory of political business cycles is predicated on the belief that elected
officials (the president, members of congress, governors, etc.) have a tendency
to engineer expansionary macroeconomic policies in order to aid their
re-election efforts ( Ibe; 2008).
Monetary
Policies
Variations in
the nation's monetary policies, independent of changes induced by political
pressures, are an important influence in business cycles as well. Use of fiscal
policy—increased government spending and/or tax cuts—is the most common way of
boosting aggregate demand, causing an economic expansion especially in a
developing economy. Moreover, the decisions of the Federal Reserve, which
controls interest rates, can have a dramatic impact on consumer and investor
confidence as well.
Fluctuations in
Exports and Imports
The difference
between exports and imports is the net foreign demand for goods and services.
This is also called net exports. Because net exports are a component of the
aggregate demand in the economy, variations in exports and imports can lead to
business fluctuations as well. There are many reasons for variations in exports
and imports over time. Growth in the gross domestic product (GDP) of an economy
is the most important determinant of its demand for imported goods—as people's
incomes grow their appetite for additional goods and services, including goods
produced abroad, increases. The opposite holds when foreign economies are
growing. Growth in incomes in foreign countries also leads to an increased
demand for imported goods by the residents of these countries. This, in turn
causes exports to grow in Europe and the U.S. Currency exchange rates can also
have a dramatic impact on international trade and hence, domestic business
cycles as well.
Effects of
Volatility
FAS 123 (R)
states that an entity's estimate of expected volatility should be reasonable and
supportable. Factors to consider in estimating expected volatility includes:
a.
Volatility of the share price, including changes in that volatility and
possible mean reversion of that volatility, over the most recent period that is
generally commensurate with (1) the contractual term of the option if a lattice
model is being used to estimate fair value or (2) the expected term of the
option if a closed-form model is being used. For example, in computing
historical volatility, an entity might disregard an identifiable period of time
in which its share price was extraordinarily volatile because of a failed
takeover bid if a similar event is not expected to recur during the expected or
contractual term. If an entity's share price was extremely volatile for an
identifiable period of time, for instance, due to a general market decline, that
entity might place less weight on its volatility during that period of time
because of possible mean reversion.
b.
The implied volatility of the share price determined from the market
prices of traded options or other traded financial instruments such as
outstanding convertible debt, if any.
c.
For public companies, the length of time an entity's shares have been
publicly traded. If that period is shorter than the expected or contractual term
of the option, the term structure of volatility for the longest period for which
trading activity is available should be more relevant. A newly public entity
also might consider the expected volatility of similar entities. A nonpublic
entity might base its expected volatility on the expected volatilities of
entities that are similar except for having publicly traded securities.
d.
Appropriate and regular intervals for price observations. If an entity
considers historical volatility in estimating expected volatility, it should use
intervals that are appropriate based on the facts and circumstances and that
provide the basis for a reasonable fair value estimate. For example, a publicly
traded entity would likely use daily price observations, while a nonpublic
entity with shares that occasionally change hands at negotiated prices might use
monthly price observations.
e.
Corporate and capital structure. An entity's corporate structure may
affect expected volatility (paragraph A21). An entity's capital structure also
may affect expected volatility; for example, highly leveraged entities tend to
have higher volatilities.
ASX (2010)
states that, to the pure chartist this indicator can be employed as an initial
filter, which can be applied over a selection of markets, to arrive at the most
suitable individual market that will fit a particular style or method.
The section
highlighted to us the concept of volatility and its relative effects on the
success or otherwise of companies. Volatility is a measure of how wild or quiet
the market is relative to its history. It can be more accurately defined as the
standard deviation of a series of price changes measured at regular
intervals.
Volatility is
generally measured using price changes expressed in logarithmic form, but can
also be assessed using percentage changes in price. Price percentage changes
would appear to reflect a more accurate picture of the market, despite the
assumption that prices change at fixed intervals, which isn't necessarily how it
is. On the other hand, logarithmic price changes assume prices are changing
continuously, but that doesn't necessarily depict the market as it really is
either.
A different
approach at calculating historical volatility is to use the range between the
high and the low and measure how it changes, rather than using standard
deviation.
Methodology
The study adopts
the use of secondary source of data where published financial statements of the
selected companies serve as the major source. The indices to be used by this
study to measure the volatility of the companies are share price, earnings and dividend. A
simple analysis of deviations from the previous period’s outcome will give an
insight of the effect on the company. The population is the entire listed
companies in Nigerian Stock Exchange (NSE), but the sample is just fifteen
companies selected based on geographical locations across the
country.
Analysis
of Data
S/N |
NAME
OF THE COMPANY |
2009 |
2008 |
2007 |
2006 |
2005 |
REMARK |
1. |
UNILEVER
NIGERIA PLC |
N |
N |
N |
N |
N |
|
|
Price |
16 |
28 |
20 |
25 |
18 |
Fluctuations
occur |
|
Earnings |
10 |
5 |
- |
- |
- |
“ |
|
Dividend |
7 |
3 |
- |
- |
- |
“ |
2. |
FLOUR
MILLS NIG. PLC |
|
|
|
|
|
|
|
Price |
21 |
22 |
35 |
15 |
12 |
“ |
|
Earnings
|
1.12 |
2.59 |
2.78 |
1.45 |
2.86 |
“ |
|
Dividend
|
- |
0.5 |
1.00 |
1.20 |
0.85 |
“ |
3. |
CADBURY
NIGERIA PLC |
|
|
|
|
|
|
|
Price |
8.65 |
4.85 |
12.5 |
21.5 |
28.0 |
“ |
|
Earning
|
(2.44 |
(6.6) |
(4.28 |
2.70 |
2.81 |
“ |
|
Dividend
|
16 |
13 |
- |
- |
- |
“ |
4. |
ASHAKA
CEMENT PLC |
|
|
|
|
|
|
|
Price |
13.5 |
10.9 |
8.51 |
4.78 |
1.54 |
“ |
|
Earning
|
3 |
3 |
3 |
0.5 |
0 |
“ |
|
Dividend
|
|
|
|
|
|
“ |
5. |
BCC/DANGOTE
CEMENT |
|
|
|
|
|
|
|
Price |
42.9 |
15.4 |
14.5 |
10.7 |
11.2 |
“ |
|
Earning
|
6 |
11 |
14 |
12 |
10 |
“ |
|
Dividend
|
0 |
0 |
0 |
2,4 |
3.5 |
“ |
6. |
NESTLE
NIGERIA PLC |
|
|
|
|
|
|
|
Price |
212 |
233 |
220 |
282 |
280 |
“ |
|
Earning
|
12.6 |
14.3 |
9.62 |
15.7 |
19.3 |
“ |
|
Dividend
|
12.5 |
9.5 |
2.5 |
16.0 |
18.5 |
“ |
7. |
FIRST
ALUMINIUM PLC |
|
|
|
|
|
|
|
Price |
6.5 |
11.4 |
4.6 |
11.3 |
14.6 |
“ |
|
Earning
|
1.2 |
1.8 |
1.00 |
3.2 |
6.10 |
“ |
|
Dividend
|
0.60 |
0.60 |
0.75 |
0.80 |
0.85 |
“ |
8. |
NORTHERN
FLOUR MILLS |
|
|
|
|
|
|
|
Price |
4.0 |
5.20 |
3.5 |
6.2 |
7.4 |
“ |
|
Earning
|
0.86 |
1.10 |
0.52 |
1.8 |
1.86 |
“ |
|
Dividend
|
- |
- |
0.50 |
0.80 |
1.00 |
“ |
9. |
DIAMOND
BANK PLC |
|
|
|
|
|
|
|
Price |
12.0 |
10.5 |
6.75 |
14.8 |
21.5 |
“ |
|
Earning
|
3.2 |
4.8 |
2.8 |
4.5 |
5.4 |
“ |
|
Dividend
|
- |
0.50 |
0.80 |
1.5 |
1.5 |
“ |
10. |
NATIONAL
SALT PLC |
|
|
|
|
|
|
|
Price |
2.50 |
1.80 |
1.75 |
3.50 |
3.85 |
“ |
|
Earning
|
1.00 |
1.00 |
0.85 |
1.80 |
2.10 |
“ |
|
Dividend
|
0.20 |
0.40 |
0.30 |
0.75 |
1.00 |
“ |
11. |
VITAFOAM
NIG. PLC |
|
|
|
|
|
|
|
Price |
3.31 |
5.98 |
3.51 |
7.00 |
7.31 |
“ |
|
Earning
|
0.51 |
0.92 |
0.66 |
1.86 |
1.96 |
“ |
|
Dividend
|
0.12 |
0.15 |
0.10 |
0.27 |
0.50 |
“ |
12. |
UNION
BANK PLC |
|
|
|
|
|
|
|
Price |
12.0 |
10.8 |
10.5 |
22.0 |
20.0 |
“ |
|
Earning
|
2.0 |
1.88 |
2.62 |
2.31 |
2.10 |
“ |
|
Dividend
|
0.75 |
1.25 |
1.35 |
1.40 |
1.4 |
“ |
13. |
WEMA
BANK PLC |
|
|
|
|
|
|
|
Price |
4.70 |
4.40 |
3.90 |
3.85 |
3.80 |
“ |
|
Earning
|
1.20 |
1.22 |
1.05 |
1.70 |
1.68 |
“ |
|
Dividend
|
0.50 |
0.80 |
1.10 |
1.15 |
1.10 |
“ |
14. |
ABC
MOTORS PLC |
|
|
|
|
|
|
|
Price |
2.50 |
3.60 |
3.85 |
6.50 |
6.48 |
“ |
|
Earning
|
1.22 |
1.05 |
0.95 |
1.65 |
1.72 |
“ |
|
Dividend
|
- |
0.40 |
- |
0.75 |
0.60 |
“ |
15. |
P.
S. MANDRIDES |
|
|
|
|
|
|
|
Price |
4.50 |
4.90 |
3.95 |
6.25 |
6.50 |
“ |
|
Earning
|
0.90 |
0.92 |
0.86 |
1.02 |
1.10 |
“ |
|
Dividend
|
0.20 |
0.20 |
0.25 |
0.40 |
0.55 |
“ |
SOURCE:
NSE FACTBOOK 2010
From
the responses in the above table, it is vividly clear that the prices of shares
of the various companies under review have suffered during the economic crisis
which had constantly manifested either a decline in earnings or fall in prices
over time. The variables used have not been stable and steady throughout the
period of the study. For instance, some companies have suspended the payment of
dividend due to low earnings following the global economic crisis (Flour Mills,
Diamond Bank and Northern Nigeria Flour Mills). An unstructured interview was
conducted on some individual investors selected randomly to express what they
feel is the basic factor hindering full capacity patronage to the stock
exchange. The obvious reason proffered by all the respondents was that the
prices of shares cannot be predicted with accuracy, and risk cannot be easily
quantified especially where alternative investment outlets are available. Again,
some respondents testified that availability of alternative investment avenues
which gives more confidence on the side of the investors coupled with high risk
and uncertainty are the basic factors that scares investors. This eventually
inhibits corporate growth and survival. To this effect, companies in the recent
years have suffered low turnover, price decline, low earnings and in some
instance inability to pay dividend.
Findings
The
study found that volatility affects the chances of companies to enjoy the
patronage of investors. In Nigeria, the level of awareness of investors is very
low compared with advanced economies. The low level of basic infra structure
makes production and service delivery very expensive which subjects competition
very harsh to the existing companies. Importation has made the local companies
to lose patronage despite series of campaign by the government upon the citizens
to be patriotic. The period of global economic crisis has affected almost every
economy in the world but developing economies such as Nigeria which is highly
dependent have suffered much more than others. The inability of companies to
maintain the payment of dividends and effective growth in dividend is a
deviation from the norms expected by investors to enjoy. This is an index that
non expert use to measure the
performance of companies before deciding whether to invest or remain as
investors or to divest. Whenever shareholders divest, the prospect of the
company declines and the chances of growth and survival becomes
bleak.
Conclusion
Volatility
of share prices indicates instability of prices which is caused by many factors
both quantitative and qualitative. To a risk averse and rational individual,
investment becomes a bit difficult, since the person will be scared with the
trend in which the prices changes overtime. Whenever investors are scared, the
level of investment becomes very low and the companies suffer low capital
volume. Hence, economy of scale cannot be easily achieved. This leads to low
turnover, low profitability, low earning, low dividend and eventually loss of
investor and/or shareholder confidence. Nigeria’s companies suffer series of
predicaments ranging from lack of infra structure to lack of proper management.
The global economic crisis had affected well developed economies especially the
capital market operations. Nigeria being a growing economy coupled with the
menace of illiteracy and corruption have a bitter experience of the situation.
Many listed companies could not pay dividends in the last five years. Inadequate
growth potentials have stunted corporate survival leading to closure of many
companies and subsequent divestment into the other sectors of the
economy.
The
study recommends improved infrastructure and a sensitization to make citizens
and other investors aware of the relevance of the stock exchange so that
adequate capital would be provided to maintain steady growth and development of
companies and the economy at large. Fiscal measures should be taken to give tax
concessions to companies that are not performing as a result of the difficulties
they found themselves in due the economic recession.
References
Adeyi,
J. A. (2008) Profiting with Stocks,
GO-GO Publishers, Jos, Nigeria
ASX
(2010) Charting Library, Historical price
volatility, Australian Securities Exchange.
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