Chapter 02-Literature Review
In this chapter is to be discussed about the theoretical implication and empirical literature regarding the determinants of share price. A number of empirical studies have been undertaken by the previous researcher to identify the factors that affect share price. Objective of this chapter is to provide theoretical background for this study and also discussed different views of share price. Furthermore it support to identify the research gap.
Stock exchange is one of most important institution in the capital market established to buying and selling securities. Among the key drivers of the economy, capital market activities play a major and significant role. It is most important that the efficiency and effectiveness functioning of the capital market to achieve its objectives and the development of the county CITATION Dya14 l 1033 (Dyarathne, 2014). Investors must consider about two factors when they make investment decision. They are macro factors (External factors to the firm) and micro factors or firm specific factors. These factors can be a signal to stock market participants to analyze the future expected returns from investing in stocks. Out of this main information micro factors or firm specific factors or variables can significantly affect both returns as well as stock prices. Many individuals as well as institutional investors in Sri Lanka like to deal with stock exchange by investing their funds in stocks CITATION Kod16 l 1033 (Kodithuwakku, 2016). Listed companies issue shares to collect fund for their business operations. It is one of the most important sources of collecting finance for companies at a low cost than other resources CITATION Dis17 l 1033 (Dissanayaka & Biyiri, 2017).
Companies should have to register in stock exchange for trading securities. It allows only for the members to buy and sell their securities. Now a days in many individual and institutional investors involving investment on securities. Especially they tend to invest on share market. Share dealings are important for the companies to collect finance at a low cost. As well as it is important for the investors who provide funds for the companies. Main objective of the investors is to maximize their return. So investors prefer to invest their excess money on shares of profitable listed companies. Return on investment consist with two parts such as annual dividend and capital gain. Return on the investment is varied according to the changes of share prices. Investor must be a knowledgeable person to maximize their return. So that they should have information about the changes of share prices.
Investors make their investment decisions based on the share price of the particular company. It is difficult to deal with fluctuating share prices. Therefore companies who issuing shares should knowledgeable about the reasons to fluctuate the share prices. Market price of the share is an important factor which affect to the investment decisions. It helps investors to make their investment decisions on particular shares or not. Improvements of share price also contribute to maximizing shareholders wealth CITATION Gil12 l 1033 (Gill, Biger, & Mathur, 2012). Shareholders wealth maximization represent the maximizing market price per share. Maximizing market price of share not only important from the shareholders point of view but also it is important from the investor’s point of view. Basically, share prices are determined in the share market according to the demand and supply forces when buyers and sellers meet together CITATION Sub13 l 1033 (Subramanium ; Murugesu, 2013).
Lack of knowledge on investor ratios among the ordinary investors and professional investors is a barrier for making effective and economic investment decisions. However less awareness on these ratios hinders current and potential investors investing more profitable companies. Therefore information on investor ratio is more important for making their investment decisions CITATION Ban10 l 1033 (Bandara ; Athauda, 2010).
Therefore updated information about share price fluctuations and its determinants are very important for the both existing and potential investors to make their investment decisions. Furthermore it is useful to know about the determinants of share prices to the companies to maintain good share price to attract more investors.
Stock prices play an important role in the development of country and also it act as a leading economic indicators CITATION Kha121 l 1033 (Khan, 2012). All investors in the world majorly concerned about the share prices. Generally they prefer increasing share prices of their investment to make higher return. However, share prices are not always increasing in the market. It could fluctuate due to various factors and make losses for the investors CITATION Gha15 l 1033 (Gharaibeh, 2015). It is much more difficult for the companies to raise finance on the stock market with falling share prices. Therefore all the listed companies in the stock exchange pay high attention on share price fluctuations CITATION Kod161 l 1033 (Kodithuwakku S. , 2016).
Price fluctuations in the share market are the important economic phenomena that should be monitored closely among various kind of people. Increase and decrease of the prices are depend on the strength of the demand and supply forces of the market. There is no clear evidence to show that which factors are responsible for the changes of share prices CITATION FAC10 l 1033 (FACTORS AFFECTING STOCK PRICES: A CASE STUDY OF KARACHI STOCK EXCHANGE (KSE), 2010). Investment decisions made by the investors affect many factors. Share price is one of the important factor which affect to the investment decisions. It also depend upon various factors such as earning per share, dividend per share and size of the firm etc. CITATION Hem13 l 1033 (Hemadivya ; Hemadivya, 2013).
The main thing is that the movements of share price indicate what investors feel a company is worth. They make investment decisions looking at the situation of share price at that moment. Therefore share price is the important factor which help to investors make high return on their investment.
Past researchers have investigated the factors affecting to the share price fluctuations. Most of studies related with well-established stock market in developed countries. They investigated share price movements using different variables such as internal and external factors. Some researchers focused macro factors which affect to the share prices. But most of studies used micro factors to identify the relationship between share prices.
Firm specific factors
Firm specific factors are factors generated within the business organization. Because of that those are known as internal factors such as earnings per share, dividend policy, size of the company, debt policy, dividend yield, book value per share etc. Firm specific factors can control by the business organization up to some level. External factors are the factors which generated outside to the company. These factors cannot be control by the business organization such as interest rate, inflation rate, exchange rate, government policies, technological factors, other economic factors etc.
Every investors must considered both internal factors and external factors when making their investment decisions. These factors provide signal to analyzed future expected return from the investment on shares. Internal factors or the firm specific factors are the most important factors for the investors because these affect both return and share price and also finally their investment decisions. Most of investors loss their earnings because of lack of knowledge about share market and its operations. Therefore measuring impact of firm specific factors on share price has long been an interesting query for all CITATION Kod161 l 1033 (Kodithuwakku S. , 2016).
There are many research articles concerned with the factors affecting share prices. Mainly they considered about the firm specific factors. Most of studies reveal that there is a significant relationship between firm specific factors and share prices. Dividend per share, earning per share and price earnings ratio accounts for 57.8% of share price movements. Furthermore, they found that earning per share and price earnings are significantly positively correlated with share prices. It reflect internal factors highly influence to the share price movements CITATION Eno16 l 1033 (Enow ; Brijlal, 2016).
Even though external factors affect to the share price movements it would be determined primarily by the fundamentals refer to a combination of two things earning base (earnings per share, return on equity and dividend per share) and valuation base(book value per share and market value per share). Identification of internal factors affecting to the share price movements is very important for the company CITATION Dis171 l 1033 (Dissanayaka ; Biyari, 2017).
Share price fluctuations can be caused by both micro and macro factors. Micro factors or the internal factors related to company performance, capital structure, company value, the prospect of a company in the future and others. These factors can be changed, controlled and perfected by the relevant company itself. And also investors can used these factors to predict the share prices CITATION Sub17 l 1033 (Subing ; Kusumah, 2017)And also dividend per share is most significant when determining dividend distributed per share. It indicates the return per share. These two factors have significant effect on stock prices CITATION Vel17 l 1033 (Velankar, Chandani, ; A.K, 2017). Dividend is the share of profit. Companies distribute profit portion as a form of dividend for their shareholders. Investors more consider about dividend policy as a way of assessing the company. And also it is a financial indicator of the firm and the demand of the firm’s share will depend on dividend policy of the company up to some extent CITATION Mas141 l 1033 (Masuam, 2014).
Investors take into their account fundamental factors such as earning per share and dividend per share when dealing with share market. Generally EPS is considered as a most important factor to determine share price and value of the firm CITATION Fac10 l 1033 (Factors affecting stock prices: A case study of Karachi Stock Exchange (KSE), 2010). When consider regarding the impact of EPS, DPS and P/E ratio on behavior of share prices, these variables are only affected to the prices of few industries. Correlation analysis revealed that EPS is the most determinant factor of the share price than other variables. It founded that DPS has significant impact on share prices of all selected companies CITATION Bal16 l 1033 (Balakrishnan, 2016).
Most of scholars founded that internal factors or the firm specific factors have significant impact on share prices in different stock markets. ROE, BVS, DPS and PE ratio are the active determinants of the share prices and it was founded that dividend yield have negative significant impact on share prices of Bahrain stock market. The study was recommended to investors to monitor these factors before expand their investments CITATION Sha151 l 1033 (Sharif, Purohit, & Pillai, 2015)