II. STOCK MARKET AND ECONOMIC GROWTH: THEORETICAL AND ANALYTICAL ISSUES
II. STOCK MARKET AND ECONOMIC GROWTH: THEORETICAL AND ANALYTICAL ISSUES
to domestic savings and increasing the quantity and the quality of investment (Singh, 1997).
The stock market is expected to encourage savings by providing individuals with an
additional financial instrument that may better meet their risk preferences and liquidity
needs. Better savings mobilization may increase the savings rate (Levine and Zervos, 1998).
Stock markets also provide an avenue for growing companies to raise capital at lower cost. In
addition, companies in countries with developed stock markets are less dependent on bank
financing, which can reduce the risk of a credit crunch. Stock markets therefore are able to
positively influence economic growth through encouraging savings amongst individuals and
providing avenues for firm financing.
The stock market is supposed to ensure through the takeover mechanism that past
investments are also most efficiently used. Theoretically, the threat of takeover is expected to
provide management with an incentive to maximize firm value. 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 more efficient firm. Thus, a free
market in corporate control, by providing financial discipline, is expected to provide the best
guarantee of efficiency in the use of assets. Similarly, the ability to effect changes in the
management of listed companies is expected to ensure that managerial resources are used
efficiently (Kumar, 1984).
Efficient stock markets may also reduce the costs of information. They may do so through
the generation and dissemination of firm specific information that efficient stock prices
reveal. Stock markets are efficient if prices incorporate all available information. Reducing
the costs of acquiring information is expected to facilitate and improve the acquisition of
information about investment opportunities and thereby improves resource allocation. Stock
prices determined in exchanges and other publicly available information may help investor
make better investment decisions and thereby ensure better allocation of funds among
corporations and as a result a higher rate of economic growth.
Stock market liquidity is expected to reduce the downside risk and costs of investing in
projects that do not pay off for a long time. With a liquid market, the initial investors do not
lose access to their savings for the duration of the investment project because they can easily,
quickly, and cheaply, sell their stake in the company (Bencivenga and Smith, 1991). Thus,
more liquid stock markets could ease investment in long term, potentially more profitable
projects, thereby improving the allocation of capital and enhancing prospects for long-term
growth. It is important to point out, however, that, theory is ambiguous about the exact
impacts of greater stock market liquidity on economic growth. By reducing the need for
precautionary savings, increased stock market liquidity may have an adverse effect on the
rate of economic growth.
Critics of the stock market argue that, stock market prices do not accurately reflect the
underlying fundamentals when speculative bubbles emerge in the market (Binswanger,
1999). In such situations, prices on the stock market are not simply determined by
discounting the expected future cash flows, which according to the efficient market
hypothesis should reflect all currently available information about fundamentals. Under this
condition, the stock market develops its own speculative growth dynamics, which may be
guided by irrational behavior. This irrationality is expected to adversely affect the real sector
of the economy as it is in danger of becoming the by-product of a casino.
Critics further argue that stock market liquidity may negatively influence corporate
governance because very liquid stock market may encourage investor myopia. Since
investors can easily sell their shares, more liquid stock markets may weaken investors’
commitment and incentive to exert corporate control. In other words, instant stock market
liquidity 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 (Bhide, 1994).
Critics also point out that the actual operation of the pricing and takeover mechanism in well
functioning stock markets lead to short term and lower rates of long term investment. It also
generates perverse incentives, rewarding managers for their success in financial engineering
rather than creating new wealth through organic growth (Singh, 1997). This is because prices
react very quickly to a variety of information influencing expectations on financial markets.
Therefore, prices on the stock market tend to be highly volatile and enable profits within
short periods. Moreover, because the stock market undervalues long-term investment,
managers are not encouraged to undertake long-term investments since their activities are judged by the performance of a company’s financial assets, which may harm long run
prospects of companies (Binswanger, 1999). In addition, empirical evidence shows that the
takeover mechanism does not perform a disciplinary function and that competitive selection
in the market for corporate control takes place much more on the basis of size rather than
performance (Singh, 1971). Therefore, a large inefficient firm has a higher chance of survival
than a small relatively efficient firm.
These problems are further magnified in developing countries especially sub-Saharan African
economies with their weaker regulatory institutions and greater macroeconomic volatility.
The higher degree of price volatility on stock markets in developing countries reduces the
efficiency of the price signals in allocating investment resources. These serious limitations of
the stock market have led many analysts to question the importance of the system in
promoting economic growth in African countries.
IMF Working Paper
African Department
Stock Market Development in Sub-Saharan Africa: Critical Issues and Challenges
Prepared by Charles Amo Yartey and Charles Komla Adjasi
August 2007
II STOCK MARKET AND ECONOMIC GROWTH THEORETICAL AND ANALYTICAL ISSUES - To learn more about this author, visit International Monetary Fund's Website.
Like this article? Share it with your friends
In principle, the stock market is expected to accelerate economic growth by providing a boost
to domestic savings and increasing the quantity and the quality of investment (Singh, 1997).
The stock market is expected to encourage savings by providing individuals with an
additional financial instrument that may better meet their risk preferences and liquidity
needs. Better savings mobilization may increase the savings rate (Levine and Zervos, 1998).
Stock markets also provide an avenue for growing companies to raise capital at lower cost. In
addition, companies in countries with developed stock markets are less dependent on bank
financing, which can reduce the risk of a credit crunch. Stock markets therefore are able to
positively influence economic growth through encouraging savings amongst individuals and
providing avenues for firm financing.
The stock market is supposed to ensure through the takeover mechanism that past
investments are also most efficiently used. Theoretically, the threat of takeover is expected to
provide management with an incentive to maximize firm value. 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 more efficient firm. Thus, a free
market in corporate control, by providing financial discipline, is expected to provide the best
guarantee of efficiency in the use of assets. Similarly, the ability to effect changes in the
management of listed companies is expected to ensure that managerial resources are used
efficiently (Kumar, 1984).
Efficient stock markets may also reduce the costs of information. They may do so through
the generation and dissemination of firm specific information that efficient stock prices
reveal. Stock markets are efficient if prices incorporate all available information. Reducing
the costs of acquiring information is expected to facilitate and improve the acquisition of
information about investment opportunities and thereby improves resource allocation. Stock
prices determined in exchanges and other publicly available information may help investor
make better investment decisions and thereby ensure better allocation of funds among
corporations and as a result a higher rate of economic growth.
Stock market liquidity is expected to reduce the downside risk and costs of investing in
projects that do not pay off for a long time. With a liquid market, the initial investors do not
lose access to their savings for the duration of the investment project because they can easily,
quickly, and cheaply, sell their stake in the company (Bencivenga and Smith, 1991). Thus,
more liquid stock markets could ease investment in long term, potentially more profitable
projects, thereby improving the allocation of capital and enhancing prospects for long-term
growth. It is important to point out, however, that, theory is ambiguous about the exact
impacts of greater stock market liquidity on economic growth. By reducing the need for
precautionary savings, increased stock market liquidity may have an adverse effect on the
rate of economic growth.
Critics of the stock market argue that, stock market prices do not accurately reflect the
underlying fundamentals when speculative bubbles emerge in the market (Binswanger,
1999). In such situations, prices on the stock market are not simply determined by
discounting the expected future cash flows, which according to the efficient market
hypothesis should reflect all currently available information about fundamentals. Under this
condition, the stock market develops its own speculative growth dynamics, which may be
guided by irrational behavior. This irrationality is expected to adversely affect the real sector
of the economy as it is in danger of becoming the by-product of a casino.
Critics further argue that stock market liquidity may negatively influence corporate
governance because very liquid stock market may encourage investor myopia. Since
investors can easily sell their shares, more liquid stock markets may weaken investors’
commitment and incentive to exert corporate control. In other words, instant stock market
liquidity 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 (Bhide, 1994).
Critics also point out that the actual operation of the pricing and takeover mechanism in well
functioning stock markets lead to short term and lower rates of long term investment. It also
generates perverse incentives, rewarding managers for their success in financial engineering
rather than creating new wealth through organic growth (Singh, 1997). This is because prices
react very quickly to a variety of information influencing expectations on financial markets.
Therefore, prices on the stock market tend to be highly volatile and enable profits within
short periods. Moreover, because the stock market undervalues long-term investment,
managers are not encouraged to undertake long-term investments since their activities are judged by the performance of a company’s financial assets, which may harm long run
prospects of companies (Binswanger, 1999). In addition, empirical evidence shows that the
takeover mechanism does not perform a disciplinary function and that competitive selection
in the market for corporate control takes place much more on the basis of size rather than
performance (Singh, 1971). Therefore, a large inefficient firm has a higher chance of survival
than a small relatively efficient firm.
These problems are further magnified in developing countries especially sub-Saharan African
economies with their weaker regulatory institutions and greater macroeconomic volatility.
The higher degree of price volatility on stock markets in developing countries reduces the
efficiency of the price signals in allocating investment resources. These serious limitations of
the stock market have led many analysts to question the importance of the system in
promoting economic growth in African countries.
IMF Working Paper
African Department
Stock Market Development in Sub-Saharan Africa: Critical Issues and Challenges
Prepared by Charles Amo Yartey and Charles Komla Adjasi
August 2007
II STOCK MARKET AND ECONOMIC GROWTH THEORETICAL AND ANALYTICAL ISSUES - To learn more about this author, visit International Monetary Fund's Website.
Like this article? Share it with your friends
 | |
 |
No article feedback found. |
| |
Leave Your Feedback |
 | |
| |||
Joe DagerJoe Dager is President of Business901, a progressive coaching company providing no-nonsense direction in areas such as Lean Six Sigma Marketing and organized referral marketing. What others say: In the past 20 years, Joe and I have collaborated on many difficult issues. Joe’s ability to combine his expertise with “out of the box” thinking is unsurpassed. He has always delivered quickly, cost effectively and with ingenuity. A brilliant mind that is always a pleasure to work with.” - James R. If you want to learn more about Business901, start a conversation with us. We can be found @ Web/Blog: Business901.com Web/Blog: FundingYourNonprofit.com LinkedIn Profile Follow me on Twitter - Visit Joe Dager's Website |
|||
Kim CastleWith nearly two decades in the advertising and design business, with clients like Domino's Pizza, General Motors, Direct TV, Pedigree, Wolfgang Puck, Higher Octave Music, Hollywood Celebrity Products, Disney, and Paramount, as well as thousands of entrepreneurs around the world define, structure, communicate, and position their business for greater profits, BrandU(R) co-creators Kim Castle and W. Vito Montone discovered that entrepreneurs could experience the same power that big brands command for a fraction of the cost with the world's only process-based results-drive Integral approach to business creation. BrandU(R) is helping entrepreneurs grow with the power of extreme clarity from idea...to brand...to market(TM) and helping one million entrepreneurs become successful and whole so that they can make a difference in the world. Are you one of them? If you want to experience clarity all the way to the bank(TM), get started now at http://www.brandu.com. - Visit Kim Castle's Website |
|||
Jeff FosterWebBizIdeas.com is a Minneapolis website design company founded to help people start an internet business by providing them with website, business, and internet resources that help foster the growth of successful online businesses and develop innovative Internet business ideas. We specialize in internet consulting & internet marketing. - Visit Jeff Foster's Website |
|||
|
To learn more about the Evan Elite Author Program please contact us. | |||
 | |
|  |
Subscribe to International's articles
 | |
|
|  |
 | |
|
| |
 | |||||||
|
 | ||
 |
||
 |
||
 |
||
|
| ||
 |
| Have you written articles that would be of value to entrepreneurs? Become an expert on our site by publishing them! Expose yourself to a wide audience, drive more traffic to your website and get more sales! Click Here for details. |
|
|
 |
| Modeling the Masters: Learn the true secrets behind Walt Disney's business success factors & grow your company! Video produced by Phanta Media |
|
|
 |
"Learn straight from Evan how you can Make a Full Time Income (And More) from a Website"
Click Here To Learn More |
|
|
|
|
Get advice & tips from famous business owners, new articles by entrepreneur experts, my latest website updates, & special sneak peaks at what's to come!
|
|
|
 Instant Direct Mail Purpose of Value Propositions Emotions Drive Behavior Canadian Leadership Romance to the Dance |
|
 | ||
 |
Top 50 Raising Capital Blogs
Top Blogs To Watch In 2008 | |
 |
Top 50 Debt Blogs
Learn To Get Out Of Debt | |
| ||
 | ||||
| ||||
|
| ||||
| ||||
|
|
|
|
|
||||||
|
Email us your ideas on how to make our website more valuable! Thank you Sharon from Toronto Salsa Lessons / Classes for your suggestions to make the newsletter look like the website and profile younger entrepreneurs like Jennifer Lopez and Sean Combs!
|
|
|
