Impact of Economic Variables on Stock Prices of Companies Listed In the Stock Market - Literature review Example

Impact of economic variables on stock prices of companies listed in the stock market Contents The stock market is vital in the growth and developmentof a country’s economy. Investors look at the performance of companies listed on the stock market to know whether or not they will invest in a country. The stock market is unpredictable and various aspects contribute to the changes that are experienced. A company may be profitable in one year but a change in dynamics may cause it to suffer losses. This will in turn push away the investors; a no one wants to be associated with a company that does not earn a profit their money. Country with a stable economic and political atmosphere attracts investors. Developing nations also serve as a great place for investors as they develop and provide services that were not available to the citizens. African countries such as Ghana, Nigeria and Kenya have attracted a lot of foreign investors who intend to work with the citizen to develop their investments (Card et al. 2004). Various economic variables can affect the performance of companies listed in the stock market, as well as the interest of investors. This study will focus on understanding the various economic variables that have an influence on the performance of companies listed in the stock market. Some of the variables that will be discussed in this paper include, the exchange rate, interest rate, economic indicators, inflation rate among others. Literature review Various studies have been conducted by different scholars in a bid to understand the effect of economic variables that influence stock prices of companies in the stock market. To help understand the concept, the authors have provided evidence as well as examples to support their claims. Discussed below are the different arguments that have been presented by scholars in their different works. Gay, Richards found out that the government has a huge influence when determining the prices of various stocks. In his review on the performance of various companies listed in the United Kingdom stock market, he declared that the government owns a good portion of the shares. This means that the government can float its shares at any given time to achieve a given financial regulatory responsibility. In such case, the prices of shares are observed to fluctuate depending on the action taken by the government, (Gay, R.2008) John Kuwornu, in his research, stated that economic indicator such as employment, sales, gross domestic product, and personal income. These indicators help to show the growth performance of a company, as well as the amount of cash flow it accumulates. Investors rely on this information to have a clear understanding on the best companies they can invest in without the risk of incurring losses. Companies that show continuous economic growth, and have impressive net earnings are favored by investors (Kuwornu, 2011). Small companies that show potential in their growth also attract a huge number of investors. The history of a company is also important to investors. They find it safer to invest in company shares that have been in existence for a while and have had outstanding performance. A company that has experienced seasons where it incurred losses is considered a risky investment unlike a company that has been profitable for a long time. Companies go through rough patches, but how they respond to that is what will make or break them. Some of them tend to go bankrupt and cease operations, while others forge ahead. The directors of the companies may take loans to restore the company. Jeff Madura clearly stated in his book that the dollar also affects the performance of companies in the stock market. Most investors choose to buy shares in companies when the dollar is weak and sell them when the dollar rate is high. This way, they make maximum profits (Madura, 2011). This can also hold when the approach of Menike, (2006) is considered. In his scholarly research, he acknowledged that the stock price of companies in the stock market is also affected by the exchange rate of the dollar. The higher the rate of the dollar, the more expensive the stock prices will be and vice versa. He adds that the stock acts as goods and services and hence their price affects the demand and supply. In this case, the market force come to play and hence the price are either pushed up or down accordingly. Exchange rate of the dollar is usually influenced by international trade and trade balance. Menike in his study that focused on the Sri Lankan Stock market determined that inflation rate is also an economic factor of stock prices. Companies in countries with a high inflation rate tend to have lower prices in the stock market, Menike, (2006). This is because the inflation rate weakens the currency, and is investors are not attracted because the market is seen as high-risk. On the other hand, countries with low inflation rate attract a lot of investors who scramble to buy shares in the existing companies. These companies are profitable and the investors are guaranteed that their money will garner profits. An increase in the inflation rate in turn leads to the rise of the discount rate that is used in valuating stocks prices (Gay, 2008). This indicates that for stock prices to be high or attract investors, the inflation rate should be controlled. Inflation also leads to the loss of value in currency, leading to poor economic development in a country (Madura, 2011). Inflation rate may also lead to the rise in the amount of revenue collected by a company but this will depend on whether the demand after rise in cost of their products will remain the same or increase. A decrease in demand will, however, have a negative influence. Maysami, in his study about macroeconomics variables relationship to market indices, noted that interest rates greatly affect the stock prices of companies in the stock market. A lower interest rate reduces the cost of borrowing capital for companies. Companies depend on financing by lending institutions to finance their capital equipments, as well as inventories. Interest rates determine the profits achieved by a company, and this in turn influences the amount investors would be willing to pay to buy shares of a company. The more profitable the company is, the more willing the investors will be to invest in it. This is because they look at the future of the company and the benefits they will reap because of the investments, such as higher dividends payment (Maysami et al. 2004). Investors are usually willing to buy shares in company even if the price is high, as continued profitability of the company is guaranteed. Similarly, Maysami et al. (2004) cites the effects of government action in regulating the interest rates charged on the credit facilities. By increasing the interest, the government lowers the amount of money in the hands of investors and hence the demand of shares goes down. On the other, reduced interests rate allows investors to obtain loans and invests in the stock market. The demand will for sure push the cost up. In the study of how economic variables affect the stock market, Siddhartha Sarkar explains that there have been international effects that contribute to rise or fall of stock prices in companies in the stock market. The performance of some companies may be influenced by other countries that are more superior, such as the United States or Germany (Sarkar, 2011). A company in a developing nation may be affiliated to the parent company in the developed countries. The performance of the company in the parent country may affect the performance of its branches. The interest rates of a country may also affect the economy of partner countries, thereby influencing the general performance of the companies in the stock market (Hussainey, 2009). The performance of the stock market in some countries has also affected the stock market of different countries, especially countries that they trade with. Hassanzadeh & Kianvand,( 2012) were also instrumental in the study of the stock market and economic variables, and they concluded that the price of gold coin is also likely to influence the stock prices. Gold is one of the most valuable minerals and also a form of exchange. An increase in the value of gold will influence the buying and selling of shares of a company listed in the stocks market. Investors and stakeholders tend to sell their shares in favor of buying gold coins when its value is high (Hassanzadeh & Kianvand, 2012). Gold is seen as a substitute for currency and investors can buy it and sell it when the value is higher. Gold is a worthwhile investment as its value will never decline. Talla (2013) in his study focused on oil and he realized that the price of oil in the international market is also a key influence in the stock market (Talla, 2013). In this case, he wrote that the major source of used in homes and industries is the oil. Similarly, the costs of goods and services are directly varied by the oil prices as they will need to be transported for improved utilities. Since it has already been shown that the net cost of goods and services determines the cost of stocks, it can also hold that the oil prices are also a factor. Oyama, (1997) identified the commodity price index (CPI) as a factor that also contributes to the performance of companies on the stock market. In his work, he argues that products such as metals and other commodities listed by companies on the stock market are likely to influence their share prices when their value increases or decreases significantly. This affects companies especially if the commodity is of high value (Oyama, 1997). Equally, Zhu, (2012) reckons that the gross national production and CPI is used to determine the effects of products in the market. Her scholarly journal has become popular for relating the rise in the prices of commodities with the cost of production and hence the cost of a company’s stock. The rise in prices will also lead to decrease in the amount of goods purchased, and this will result to the decline in the stock prices of the company shares (Zhu, 2012). Another important hypothesis on this matter was developed by (Kwapong, 2005). In an attempt to explain the effects of tax regime on stock market performance, he hypothesized that the tax system has the potential of attracting or scaring away investors. In this case, he observed that tax charges influence the stock prices by controlling the type of companies the investors are involved with. High charge in taxes should be accompanied by high returns in investments (Kwapong, 2005). This is, however, usually not the case as it leads to a decrease in the dividends given to investors. High taxation therefore indicates that investors will not benefit from their investments and will avoid investing in companies on the stock market. When low taxes are charged, the investors prefer to invest so that they can get value for their money. Countries with a low tax charge, therefore, have more investors opting to spend their money on the stock market. Similarly, Alkhudairy (2008) published his work that sought to relate the performance of a company’s stock with the general attitude of the authority towards that particular n company. In this case, his work declared that when the government or the political class favors a given company, its stock will perform very well. He added that the company will be shielded during tough times as it will be awarded tenders in expense of other companies. This in turn leads to the development of the country’s economy. In conclusion, it is evident that the economic variables have significant influence on the stock prices of companies that are listed in the stock market. The discussion above used different books and journals written and researched by different authors on the topic. From the data collected, some of the economic variables that affect the stock prices are the interest rates of a country, as well as global lending institutions, taxes charged, economic indicators such as employment, gold and oil prices, the commodity price index, and international effects. References Maysami, R, Howe L, & Hamzah, M. 2004. Relationship Between Microeconomic Variablesand Stock Market Indices: Cointergration Evidence from Stock Exchange of Singapore ‘s All-S Sector Indices. Hussainey, K. 2009. The Impact of Macroeconomic Indicators on Vietnamese Stock Prices. The Journal of Risk Finance. 10(4). P. 324. Hasanzadeh, A & Kianvand, M. 2012. The Impact of Macroeconomic Variables on Stock Prices: The case of Tehran Stock Exchange. Money and Economy. 6 (2). P. 177. Talla, J.2013. Impact of Macroeconomic Variables on the Stockholm Stock Exchange. Jonkoping International Business School. P. 16. Kuwornu, J. 2011. Macroeconomic Variables and Stock Market Returns: Full Information Maximum Livelihood Estimation. Research Journal of Finance and Accounting. 2(4). P. 55. Menike, L. 2006. The Effect of Macroeconomic Variables on Stock Prices in Emerging Sri Lankan Stock Market. Sabagaramuwa University Journal. 6 (1). P. 53. Sarkar, Siddhartha. 2011. Economics in Business Study. International Journal of Economics and Business Studies. 1 (2). P. 26. Alkhudairy, K. 2008. Stock Prices and the Predictive Power of Macroeconomic Variables: The Case of the Saudi stock Market. ProQuest LLC. Gay, R. Effect of Macroeconomic Variables on the Stock Market returns for Four Emerging Economies: A Vector Regression Model for Brazil, Russia, India, and China. 2008. Proquest. Madura, J. Financial Markets and Institutions. 2011. South Western Southern Learning. Card,D., Blundell, R., & Freeman, R. Seeking a Premier Economy. The Economic Effects of British Economic Reforms, 1980-2000. 2004. 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