ABSTRACT
The purpose of this study was to establish the relationship between earnings announcements and stock prices at the Nairobi Securities Exchange. The specific objectives of the study were to determine the effect of interim earnings announcements on stock prices at the Nairobi Securities Exchange, to determine the effect of annual earnings announcements on stock prices at the Nairobi Securities Exchange and to determine the relationship between the interim and annual earnings announcements on stock prices at the Nairobi Securities Exchange. This study adopted a descriptive design. Descriptive design explains the relationship between two or more variables of the study. It helps in explaining the relationship between interim and annual earnings announcement at the Nairobi Securities Exchange. The target population for this study was all the 64 companies listed at the Nairobi Securities exchange from 2012 to 2016 study period. The sample consisted of 7 companies that continuously announced interim and annual earnings during the study period. A purposeful sampling method was employed for the study. This study used secondary data from the Nairobi Securities Exchange database. This method of data collection was chosen because stock prices of listed companies were readily available at the NSE library. The study found out that at all the companies studied, both interim and annual earnings announcements had significant effects on stock prices. A conclusion was therefore drawn that both announcements carry relevant information that influences stock prices. The study found inefficiency in the stock market and therefore recommended the government to strive towards attaining sustainable levels of market efficiency. Policy makers are recommended to act as a key to determining a clear policy framework for the Kenyan stock market. The government through its regulatory bodies; Capital Market Authority and Nairobi Securities Exchange are recommended to ensure that laws governing insider trading are adhered to by all participants in the stocks market. The study also recommended the government to design training programs to create more awareness in stock markets activities. The study also recommended the companies to ensure that they release timely and accurate information to enable investors to make accurate decisions. The study further suggested more research to be done on the efficiency of Nairobi Securities Exchange by incorporating more companies, lengthening the study duration, lengthening the event window, and incorporating more emerging markets in Africa
CHAPTER ONE
INTRODUCTION
Background of the Study
The theory of stock market efficiency and how stock prices adjust to reflect new information in the market has been one of the fundamental arguments in finance literature. Fama (1970) examined efficient market hypothesis (EMH) concept and states that a market is efficient if security prices immediately and fully adjust to reflect all available information. Stock market response to information disclosure is immense and covers a wide range of information disclosures such as dividend announcements, stock splits, merger announcements and macroeconomic policy changes. The influence of earnings information release on security prices has received considerable attention. There is however consistency with the EMH amongst researchers that earnings announcements do contain value-relevant information and the stock markets react quickly and efficiently to this information.
Kipronoh (2014) argued that Earnings announcements are one of the critical components of testing market efficiency. Management further uses earnings information to inform both shareholders and investors about the state of health of a firm. In other words, earnings announcements provide a yardstick that can be utilized by the market to assess the wealth and profitability of a firm. If the market is efficient, then any new information released is instantaneously reflected in the share price. Therefore, as earnings are publicly announced, the share price should immediately reflect this announcement and therefore deny investors any above-average risk-adjusted profits.
Fabozzi and Modigliani (2009) found out that, for any economy to utilize scarce resources for development, it must have an efficient capital market. A capital market brings together investors and sellers of capital securities and, therefore, enables corporations to raise long-term capital to finance a multitude of projects. Thomas et al (1995) in their policy paper titled ‘Restructuring Economies in Distress,’ The World Bank noted that an efficient and effective capital market would result in greater resource mobilization and more productive investment. They emphasized the need to develop the non-bank financial sector, especially the capital and money market. Developing economies therefore need to develop efficient capital markets in order to mobilize savings from households and channel them to investments.
Samuel and Yacout (1981) assert that the nature of emerging stock markets in terms of information availability is such that prices cannot be assumed to fully reflect all available information. It can also not be assumed that investors in emerging markets will correctly interpret the information that is released. As a result, the corporation in such markets has a greater potential to influence its own stock market price, and there is a greater possibility that its price will move about in a manner not justified by information available. Liaw (2004) also observes that emerging stock markets are characterized by high price volatility. As a result, investors earn high returns for investing in this highly volatile market, which contradicts the basic assumption underlying the efficient market hypothesis.
The efficient market hypothesis asserts that for a market to be efficient, prices must at all times fully reflect all available relevant information. Dixon and Holmes (1996) explain that a response to new information in terms of a price adjustment must be both almost instantaneous and of a direction and size which fully reflects the significance of the information. However, Ondari (2008) argues that share prices at the Nairobi Stock Exchange (NSE) tend to react to information in a manner that does not reflect the fundamentals underlying companies. Sometimes, there are extreme price movements, as was the case of CFC Bank in January, 2008 when its shares failed to trade for a week after price shot from Ksh. 110 to Ksh. 900 in a day.
Pandey (2009) pointed out that, an inefficient stock market can distort share prices, and consequently shareholder value, and hinder the wide participation of investors. Chandra (2003) found out that the semi strong-form sub-hypothesis of the efficient market hypothesis suggests that security prices adjust rapidly and accurately to the release of all public information, and therefore speculators cannot use this information to make returns in excess of the market return. Muiruri (2009) reported that at the NSE, there have been cases of prices reacting to new information and remaining unstable for many days, raising doubts about the market's ability to instantaneously and accurately reflect the correct significance of that information. For example, after Crown Berger released its half-year results on August 30, 2008, its share price fell from Ksh. 38 to ksh.8. The price rose again and settled at around ksh.26 after about 45 days. Likewise, Eveready East Africa announced its half-year results on May 20, 2008 and its price fell from ksh.7.60 to ksh.4.85. After thirty days, its price settled around ksh.5.50.
According to Osei (2002), developed markets are highly regulated, uses sophisticated technology and have sound financial management systems contrary to emerging markets characterized with low liquidity levels, poorly informed investors, weak legal, regulatory and institutional framework, low levels of technology and unreliable accounting standards. Afego (2011) and Osei (2002) concluded that both Nigeria and Ghana’s stock markets are not efficient in relation to adjusting to new information on earnings announcements. According to Stieglitz (1981) capital markets in developing countries are characterized with low volumes of transactions. He argued that the reaction of stock prices to the release of new information may not be immediate and thus prices may not fully reflect all available information. Koech (2013) argued that, Kenyan stock market as part of developing markets is faced with problems attributed to the emerging markets. Therefore it is expected to show a mixed behavior as far as market efficiency is concerned as was evident from the above literature.
In Kenya, Governments have often tried to regulate capital markets in order to make them more efficient and to protect investors. In Kenya, the Capital Markets Authority (CMA) undertakes that role (CMA, 2009). The principal objective of the authority is to create, maintain and regulate a capital market in which securities can be issued and traded in an orderly, fair and efficient manner. The capital market is an important arm of the general financial market that provides investment opportunities, allocates savings to real investment, distributes financial resources of long term nature, offers investment advice to investors, mobilizes capital and hence help achieve real economic output, and also helps in pricing of securities.
1.1.1 An overview of the Nairobi Securities Exchange (NSE)
The Nairobi Securities Exchange is the only stock exchange operating in Kenya. It was established in the 1920’s by the British as an informal market for dealing in shares and stocks, with no rules and regulations to oversee stock broking activities. At that time it was a sideline business conducted by few professionals like accountants, auctioneers, estate agents and lawyers who meet informally and exchange price. Francis Drummond established the first professional stock broking firm in 1951. He impressed upon Sir Ernest Vasey, the finance minister of Kenya at that time, the need to set up a stock exchange in East Africa .In July 1953, Sir Ernest Vasey and Francis Drummond made the proposal to the London Stock Exchange officials who accepted and recognize the establishment of Nairobi Stock Exchange (NSE) as an overseas stock exchange.
Muragu (1990) has indicated that the Kenyan stock market, then named the Nairobi Stock Exchange, was founded in 1954 as a voluntary association of brokers registered under the Societies Act. It was through the NSE that saw the first ever privatization in the country of a 20% government stake in the Kenya Commercial Bank (KCB). Since 1994, there have been significant changes to the NSE in terms of structure, trading premises and its operations.
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Item Type: Kenyan Topic | Size: 66 pages | Chapters: 1-5
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