The Relationship Between Economic Growth and Market Capitalization of Companies Listed at the Nairobi Securities Exchange

Abstract

Evidence on the relation between economic growth and stock market capitalization are still ambiguous, as early studies support the existence of a positive association, while more recent contributions suggest a nonlinear U-shaped correspondence. Some opine that there is a positive relationship amongst financial depth and economic growth, while some have provided empirical evidence of nonlinear, an inverse U-shaped relationship. It is not excluded that the relationship is even more complex and the impact varies depending of level of a country economic and institutional development or level of integration, quality of the financial system, its structure, and other factors. The objective of this research is to to determine the relationship between economic growth and market capitalization of companies listed at the Nairobi Securities Exchange. It also aimed at reviewing the increasing body of theoretical and empirical studies that have endeavoured to examine the range of magnitude and relations between economic growth and stock market capitalization. Secondary sources of data were employed. Time series data was utilized, data was collected for the macro-economic phenomena over a varying time periods. The research employed inferential statistics, which included correlation analysis and Bayesian regression analysis so as to establish the effect of the economic growth on stock market capitalization. The study findings exhibited that both Gross Capital Formation and Government Final Consumption Expenditure had significant positive associations with stock market capitalization. Additional study findings were that economic growth has no significant effect on stock market capitalization and thus, it cannot be utilized to significantly predict the stock market capitalization. Further findings were that the economic growth components that entail; GDP growth, Households Consumption Expenditure, Gross Capital Formation, and Government Final Consumption Expenditure had neither individual significant association nor relationship with stock market capitalization. Policy recommendations were made to the capital markets’ regulators, the National Treasury and Capital Markets Authority to delink economic growth from development of the capital markets. The policy makers should direct their energy in crafting other policies and legislations to bolster the financial deepening of the capital markets and not bank on economic growth. Further recommendations were made to the capital markets practitioners such as firm management, consultants, investment banks, equity analysts, and individual investors not to rely on the information on the economy in order to determine the value of companies. Firm management should focus on the company fundamentals to increase the companies’ intrinsic value. Investment banks, equity analysts, and individual investors should not anticipate a bull run during periods of booming economic growth. In contrast, they should endeavour to establish the companies’ intrinsic values and future prospects in determining the counters to buy and hold or to sell.