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Stock market development: Stock market

development
a reflection of governance
regulatory framework in Nigeria
Fisayo Fagbemi, Opeoluwa Adeniyi Adeosun and Kehinde Mary Bello 71
Economics, Obafemi Awolowo University, Ile-Ife, Nigeria
Received 10 July 2021
Revised 27 November 2021
Abstract Accepted 7 December 2021
Purpose – The article examines the possible long-run and short-run impact of regulatory quality on stock
market performance in Nigeria for 1996–2019 period.
Design/methodology/approach – The study adopts autoregressive distributed lag (ARDL) bounds test and
cointegrating regression techniques.
Findings – Findings reveal that regulatory quality positively and significantly influences the performance of
stock market, which strengthens the view that market-enhancing governance can engender an improvement in
stock market performance. The study further demonstrates that quality of the regulatory environment is a
critical component of market operations, since the improvement of the operation of stock market performance
depends on appropriate policy measures, which could be the outcome of improved governance.
Practical implications – It is suggested that, while improving the institutional environment is a challenge to
regulators, there is need for strong and effective regulatory mechanism to enhance the development of stock
market in the country.
Originality/value – Based on the two competing hypotheses and limited attention, previous studies accorded
the role of regulatory quality in the performance of stock market in the context of Nigeria. This study assessed
the gap in the literature by taking the task of validating the impact of regulatory quality on stock market
development.
Keywords Stock market performance, Regulatory quality, Business environment, ARDL, Nigeria
Paper type Research paper

1. Introduction
The quality of governance presents primal concerns for the viability of a business
environment. Since ensuring proper surveillance of political activities and business
operations, institutions play a central role in terms of facilitating the effectiveness of rules
and regulations, and adherence to rule of law. According to World Bank (2020) report, for the
attainment of higher economic performance, strengthening institutions is crucial. The report
emphasizes that developing economies should strengthen their governance structures for
proper functioning of their financial markets. The state of stock market in an economy is
determined by government policies and the soundness of regulatory framework (Asongu,
2012). Viable institutions could advance the operation of rules and regulations for efficient
resource mobilization and allocation, and thus engendering a sound business environment.
However, poor regulatory framework and inadequate supervision mechanisms could lead to

© Fisayo Fagbemi, Opeoluwa Adeniyi Adeosun and Kehinde Mary Bello. Published in Journal of Capital
Markets Studies. Published by Emerald Publishing Limited. This article is published under the Creative
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Authors are very grateful for the comments of anonymous referees, which have significantly Journal of Capital Markets Studies
Vol. 6 No. 1, 2022
enhanced the quality of the paper. The authors specially thank the editorial team of the journal for the pp. 71-89
professional support offered. Emerald Publishing Limited
2514-4774
Funding: This study received no specific financial support. DOI 10.1108/JCMS-07-2021-0022
JCMS the erosion of investors’ confidence and the undermining of the development of stock market
6,1 (the engendering of immature stock markets) and the economy as a whole Milyo (2012).
Hence, effective governance systems offer tailoring support for the space of stock market
development. Nonetheless, there are two noticeable competing hypotheses in the literature
regarding the effect of institutional quality on stock market performance. For instance, one
side argues that by attaining economics of scale, good governance quality causes a reduction
in transaction and agency cost, and thus enhances increased stock returns for shareholder
72 (Hooper et al., 2009). Another side states that countries with weak governance quality have
experienced higher stock returns compared to those countries that have stronger governance
quality (Low et al., 2011).
This development and the state of institutions in most developing countries have been a
critical issue for policymakers. The concern for improved governance and to ascertain the
exact role of institutional quality in the promotion of the development of stock market have
prompted the move to strengthen the regulatory framework and explore further its impact in
developing economies. Specifically, in Nigeria, in spite of numerous reforms initiated to
address the huge institutional gaps, the quality of regulation and its estimate remain poor (see
Table 1). Most reform programmes (such as the establishment of economic and financial
crimes commission [EFCC]; central securities clearing system [CSCS]; and independent
corrupt practices and other related offences commission [ICPC]) have failed to drastically
fortify the rules of enforcement and market discipline for enhanced stock market performance
(Manasseh et al., 2014). Recognizing that there are strong reasons why government
intervention could stimulate capital market development, some authors have revealed that
enabling government policies substantially determine issuer demand for capital markets
funding (North, 1990; Law and Azman-Saini, 2008). A good example of this development is
China. Weak regulatory quality and poor adherence to the rule of law could account for the
country’s underdeveloped capital market compared to that of peer countries (Uwaleke, 2018).
For instance, the Nigerian Stock Exchange (NSE) is small (see Table 2), compared to the key
international exchanges, with a total market capitalization around $80bn (circa N23 trillion,
based on NSE data) and with just 166 listed companies. Comparing this to the Johannesburg
Stock Exchange, with equities capitalization alone circa $1tn accounting for over 280% of
South Africa’s gross domestic product (GDP) and with over 380 listed companies. This
incidence seems to be the result of not having measures that advocate for capital market
expansion and development.
Sound regulation is fundamental to improved economic governance (Kirkpatrick, 2014). In
this study, regulatory quality is termed as a set of measures designed or developed with a
view to strengthening the regulatory and institutional environment including regulatory
institutions, policies and processes (OECD, 2011). The evidence provided in the literature in
relation to the role of regulation in investment in most developing countries seemed to be
consistent with the proposition that the quality of the regulatory environment is a critical
component of effective business operations (Eifert, 2009; Haider, 2012; Kirkpatrick, 2014).
This further suggests that relatively well-managed poor economies can benefit significantly
from a broad push for streamlining regulatory processes. Relating to this hypothesis, for
donors, business operators and policymakers, there is reassurance that improving the quality
of regulatory governance can be anticipated to have a positive influence on economic
performance, and thus affects stock market performance. In spite of this, Nigerian regulatory
environment has disdained the opportunity for efficiency and effectiveness across all key
sectors of the economy which include financial sector, trading and investment, among others.
Where there is noticeable regulatory laxity, poor regulatory supervision is often instigated in
governance systems (Canare, 2017). Hence, Nigerian case has given rise to uninspiring
business performance, coupled with the increased dilemma faced by listed corporations
operating in the country, as evidenced in unceasing poor trading result in the stock market,
 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019

Nigeria
0.91
0.89
0.80
0.75
0.73
0.68
0.71
0.66
0.82
0.85
0.92
0.89
0.80
0.86
South Africa 0.68 0.49 0.50 0.41 0.36 0.41 0.38 0.42 0.29 0.28 0.21 0.23 0.13 0.16
Source(s): World Governance Indicators (Kaufmann et al., 2010)
73
Stock market
development

The estimate of

Nigeria and South

and 2019
Africa between 2006
regulatory quality in
Table 1.
JCMS Nigeria South Africa
6,1 Market capitalization of Stocks traded, Market capitalization of
listed domestic companies total value (% of listed domestic companies Stocks traded, total
Year (% of GDP) GDP) (% of GDP) value (% of GDP)

2006 13.90510641 1.523731181 261.8304694 63.95990248

2007 30.80067448 6.298353509 276.6006789 86.07587301
74 2008 14.26030142 4.960489139 168.3231334 70.66205086
2009 11.0399402 1.539237651 269.998391 73.50014291
2010 13.91083659 1.40498723 246.4389298 73.85752005
2011 9.5113578 0.943603146 189.4815959 54.23168919
2012 12.23511762 0.890947624 229.0306084 57.24081018
2013 15.65343246 1.209380139 257.0165135 63.3129313
2014 11.04070841 0.902888231 266.1494793 70.01807252
2015 10.1042417 0.825925781 231.705799 73.66916909
2016 7.362527811 0.373074471 321.0045388 135.795082
Table 2.
Nigeria’s and South 2017 9.905007867 0.587127801 352.156399 117.2114186
Africa’s stock market 2018 7.91654563 0.649537676 234.9589023 80.10352933
performance between 2019 9.801293842 0.606223199 300.5823301 81.04466989
2006 and 2019 Source(s): World Development Indicators (World Bank, 2020)

weak market capitalization, high-risk fluctuations and ill-returns (Ojeka et al., 2019). These
scenarios have consistently challenged the availability of evidence-based for the government
of its role in the designing of viable regulatory policy in the country. Since the bulk of studies
concerned with elucidating why a sound regulatory policy can have real effects for the stock
market have mostly employed regression approach to cross-country or panel data (Eita, 2015;
Winfu et al., 2016; Umar and Nayan, 2018; Imran et al., 2020), there is need to provide critical
evidence that would help the government develop regulatory measures that could work
better. The study’s aim is not concerned with particular categories of regulation (such as
competition law and employment law) but rather how to enhance the processes for improving
regulation in Nigerian context.
Moreover, as the debasement of the Nigeria’s institutional environment seems to have
exacerbated, the dwindling state of the country’s stock market which has engendered the
high incidence of market manipulations, market rigging, illicit trading and false
representations in the country (Ojeka et al., 2019), the improvement of the operation of
stock market performance depends on appropriate policy measures, which could be the
outcome of improved governance. Therefore, it is crucial to know how regulatory quality
influences the stock market development in Nigeria. This is necessary considering the fact
that most previous studies for Nigeria have given attention to other institutional factors. For
example, in the work of Manasseh et al. (2017) and Ajide (2019) for Nigeria, the former
employed democratic accountability, corruption control and bureaucratic quality as
governance measures, while in the latter only the democratic indicator was used as
governance measure. Also, with a focus on the role of corruption and institutional quality in
the performance of stock market, Ojeka et al. (2019), with 135 listed companies in Nigeria,
employ panel data. In view of this, it is clear that the role of regulatory quality as one of the
institutional indicators in the development of stock market has not been accorded much
scholarly investigation regarding Nigeria. As a result, it is pertinent to assess the effect of
regulatory quality on long-term capital market performance dynamics. Although these
indicators are mostly correlated, the problem with the institutional quality concept is that it
does tell us very little about the impact of specific components of the quality of institutions on
the performance of stock market performance. Hence, it is empirically plausible that gauging
their respective effects on stock market performance may result in different outcomes.
 Based on the two competing hypotheses and limited attention, previous studies accorded Stock market
the role of regulatory quality in the performance of stock market in the context of Nigeria, this development
study tends to assess the gap in the literature by taking the task of validating the impact of
regulatory quality. To carry out this objective, the regulatory quality measure of the World
Governance Indicators (WGIs) proposed by Kaufmann et al. (2010) is considered. With this
process, the study’s findings could offer viable remedies for the Nigeria’s stock market
challenges by making provisions for sound policy measures that might ensure the
strengthening of the regulatory framework and the advancement of the rule of law. 75
The rest of the article is prepared in the following ways: Section 2 focuses on the review of
literature. Section 3 deals with the methodology and data sources. Section 4 presents the
analysis and discussion of results, while section 5 contains the concluding remarks.

2. Literature review
2.1 Theoretical review
The bourgeoning interest among economic scholars on the role of institutions in economic
performance has been to unravel the critical causal factors of economic growth and
development trajectory across countries. This is necessitated by the need to offer convincing
argument to the seemingly unresolved issues by the proponents of neoclassical growth model
(such as Solow, 1956; Becker, 1962). Over the years, there has been increasing concern that
since output levels could be truly shaped by capital accumulation and technological
innovation across economies, why is it that measures required to accumulate and acquire the
capital and technology needed to engender a balanced growth have often been neglected by
some countries? In order to address this issue, the New Institutional Economics (NIE), mainly
based on the work of North and Thomas (1973); and North (1990), which incorporate the
essence of institutions in the narrative, stressed that institutions are the significant
determining factor of development and long-term economic outcomes. Accordingly,
institutions are defined as the humanly devised constraints that influence human
interactions and decisions (North, 1990). In this light, political and institutional factors are
viewed as important facilitators of the development of stock markets, indicating that the
financial market operations are influenced by some factors including institutional setups.
The main role of institutions in most economies is to regulate and monitor the level of
transparency in the market, governance procedures and the economic competitiveness.
Furthermore, the quality of governance does affect foreign investors’ decision and thus the
level of foreign direct investment. As a result, improved governance quality could lead to
reduced transaction costs and enhanced business environment (Williamson, 1985). It gives
rise to stable rules, which are critical factors for the advancement of viable investment and
projects (North, 1990).
Thus, the work of Levine (1997) clearly substantiates the nexus between financial markets
and institutions. Institutions are perceived as “third type” factors, suggesting that good
institutions are very critical elements which if not allowed, the development that could be
present in the financial sector might be a mirage. In theory, NIE has established that the
quality of institutions influences economic performance in the long run through the reduction
of transaction costs, risks containment and the disappearance of fluctuations that could
destabilize the functioning of the markets (Chtourou, 2004). Also, in the success of the market
reforms, sound institutions can cause drastic change, and even for long-term economic
growth, institutional environment is assumed to have represented a key factor (Yahyaoui,
2009). The author further stresses that the flow of information in the financial market would
be improved by such reforms, given that the existence of strong institutions would enhance
social standards that could lead to the entrenchment of property and contract rights.
Analogously, La Porta et al. (1997, 1998) posit that legal origin shapes the level of financial
JCMS development. Their view is based on the notion that common law-based systems better
6,1 stimulate the development of financial markets compared to civil law systems — in
protecting private property, common law has been more instrumental. The protagonists of
this assertion include Rajan and Zingales (2003); Acemoglu and Johnson (2005); Law and
Azman-Saini (2008); and Roe and Siegel (2009). For instance, according to Law and Azman-
Saini (2008) and Law and Habibullah (2009), for enhancing the development of financial
markets, sound legal and institutional systems interact with financial opening. Hence, in their
76 conclusion, fortifying the institutional framework could engender financial market
development. In addition, Rajan and Zingales (2003); and Acemoglu and Johnson (2005)
summit that governance measures such as, political instability, regulatory quality,
government effectiveness and property right among others are key determinants of
financial sector development and long-run economic growth and development.

2.2 Empirical review

In line with the view that a complex institution imbued with underlying mechanisms that
enhance the effective mobilization of long-term funds of the surplus sectors to the deficit
sectors in the economy, the state of institutions is no doubt pivotal to the improvement of
the financial sector and the level of economic performance (Nyong, 1997). This empirical
assertion seems to have given the researchers a strong footing for moving beyond the
horizon of stated knowledge regarding governance quality–finance nexus. Given the
different indicators of institutional quality, some authors focus on the relationship between
the quality of legal systems and the financial sector. For instance, Demirguc-Kunt and
Maksimovic (1998) argue that high quality legal systems facilitate the use of long-term
external financing by firms operating in countries with such sound legal systems as these
countries often score high on an efficiency index. Thus, productivity is enhanced, since
external financing is linked with a well-functioning stock market and an effective banking
sector. Also, Djankov et al. (2007) stress the significance of contract rights and good
institutions in financial market development, positing that legal origins is a key
determinant of creditors’ rights and sharing of information. Girma and Shortland (2008)
analyse the effect of the political system and legal origin in the development of the financial
sector with the use of panel data on developed and developing countries. The authors argue
that political stability and the degree of democracy are crucial factors in determining the
rate of financial development. In another study, Chinn and Ito (2006), with a focus on 108
countries, note that among emerging market countries, a lower level of corruption, a higher
level of bureaucratic quality and law and order elucidate financial opening in promoting the
market development.
Using instrumental variable approach, Asongu (2012) examines the relationship between
government quality and stock market performance in Africa, noted that institutional
dimensions such as political stability (no violence), corruption control, regulation quality
government effectiveness, voice and accountability and rule of law, substantially influence
stock market performance. The author posits that countries with strong institutions would
foster stock market development. Similarly, Yartey (2008), based on emerging economies
which include South Africa, Nigeria, Kenya, Botswana, Ghana and Zimbabwe, finds that
governance quality enhances stock market development. Using panel data of 65 developing
countries, Khafagy (2016) suggests that democracy, civil liberties and political rights
stimulate the rate of financial cooperative development. Following a focus on the nexus
between political regimes/events (autocracy vs democracy) and the development of stock
market, Chien et al. (2014), with the use of data between 1900 and 2008 for 27 separate
presidential regimes in the United States (US), submit that political events have a significant
effect on the performance of stock markets. In line with this, Nazir et al. (2014) also examine
political events in Pakistan and its impact on Karachi Stock Exchange performance. These
authors find a similar effect, but the impact is found to be more pronounced in autocratic Stock market
system in Pakistan. While focussing specifically on the effect of democracy and political risk, development
Lehkonen and Heimonen (2015) for 49 emerging markets (2000–2012) suggest that
democracy and political risk substantially impact stock market returns. Hartwall (2014);
Lipscy (2011); Ganio
glu (2016) have equally argued in support of this submission. In addition,
Selçuk (2018) examined the nexus between the quality of governance and financial
development over the period 1975–2015. With the use of democracy as governance quality, it
is found that improved democracy stimulates financial development. Some authors also 77
found that good quality of institutions enhances financial development (Asif et al., 2019;
Ondoa and Seabrook, 2020).
Regarding studies specifically on Nigeria, while some authors have posited that stock
market development is critical to Nigeria’s economy (Akinlo and Olufisayo, 2009; Fagbemi
and Ajibike, 2018), efforts to ascertain the key determinants of stock market performance
seems to be limited and few findings on this are mixed. Given this concern, Maku and Atanda
(2010); Okpara (2010) submit that macroeconomic variables such as GDP, exchange rate,
interest rate, stock market liquidity and income level play a substantial role in stock market
development. Also, Manasseh et al. (2012) assess the causal effect of stock market
development, financial sector reforms and economic growth in Nigeria between 1981q1 and
2010q4. These authors take into account the role of institutional quality in stock market
development, while a legal framework is captured for institutional quality. Their findings
also support the view that governance quality is significant in explaining stock market
development. Recently, Manasseh et al. (2017) examines institutional quality–stock market
development linkage between 1985 and 2013. In their work, institutional quality is
represented by democratic accountability, corruption control and bureaucratic quality. These
authors argue that democratic accountability and corruption control are major institutional
measures that influence substantially stock market development. Similarly, Ajide (2019)
contributes to the argument by assessing the dynamic non-linear impact of democracy on
stock market development over the period of 1984–2015 with the application of nonlinear
autoregressive distributed lag (ARDL) framework. Findings indicate that, in the short run as
well as long run, the response of stock market to democracy is negative in Nigeria. It is,
therefore, suggested that weak governance system, economic mismanagement and lack of
independence of the monetary authority are the main cause of challenges facing Nigeria’s
stock exchange market. The author affirms that the state of institutional environment
matters. Thus, the study seeks to assess the effect of the quality of governance on Nigeria’s
stock in the context of the institutional measure of regulatory quality. It could be observed
that most previous studies reviewed specifically for Nigeria seem not to have incorporated
this governance measure in their analyses. Since the level of regulatory framework and
maintenance of law and order are critical in any economy, it is essential to examine the nexus
between this measure and stock market development in Nigeria’s context. The study could
offer a better elucidation on the effect of the quality of regulations on stock market in the
country.

3. Methodology and data description

The theoretical model underpins the study is based on studies that have established the link
between stock market performance and governance quality in the literature (Williamson,
1985; North, 1990; Levine, 1997). These authors maintain that institutions are critical to the
state of financial sector development. Thus, the model for the study can be specified in a
functional form as;

SMKTt ¼ f ðREGt; Xt Þ (1)

JCMS where SMKTt is the stock market performance indicators — market capitalization ratio
6,1 (MRK) and Value trade ratio (VTR); REGt; represents regulatory quality, while Xt is a vector
of some economic indicators that could affect stock market performance; t is the time
dimension. These stock market indicators have been widely used in the literature and they
are regarded as key measures of market performance (Akinlo and Akinlo, 2009; Fagbemi and
Ajibike, 2018; Umar, 2018).
Furthermore, based on Pesaran et al. (2001), the conditional ARDL (p, q) error correction
78 model (ECM) is stated as:
X
p−1
Δmt ¼ c0 þ cit þ ∅mm mt−1 þ ∅mgg gt−1 þ π i Δzt−i þ γΔgt þ εt (2)
i−1

Δgt ¼ P1 Δgt−1 þ p2 Δgt−2 þ . . . ; ps Δgt−s þ μt (3)

where Δ is the first difference operator; π i are vector matrices; Pi is the k x k estimated
matrices given that the vector autoregressive process in Δgt maintains stability (Pesaran
and Shin, 1995); gt is the k-dimensional; εt and μt represent serially uncorrelated
disturbances. The delineation of equation (2) can be based on the way the deterministic
components are stated. In the study, the third case of unrestricted intercept and no trend are
adopted and specified as;

X
p−1
Δmt ¼ c0 þ ∅mm mt−1 þ ∅mgg gt−1 þ π i Δzt−i þ γΔgt þ εt (4)
i−1

where zt−i is a vector of m and g variables; mt is an I (1) regressand and gt is a vector matrix of
a given set of regressors. This set of regressors can either be I (0) or I (1).
In this case, ARDL is better than others’ cointegration techniques, since they can only be
used in the presence of I (1) variables. According to Odhiambo (2009), ARDL approach is more
conventional, efficient and reliable in the estimation of long-run association compared to
other techniques such as Engle and Granger (1987); Johansen (1988); Johansen and Juselius
(1990). Therefore, with emphasis on the long run nexus, the impact of governance quality on
stock market performance can be examined based on Pesaran et al. (2001). Hence, the ARDL
order p is stated as;
ΔSMKTt ¼ α0 þ α1 SMKTt−1 þ α2 REGt−1 þ α3 GDPt−1 þ α4 INFt−1
Xp Xp
þ α5 TOPENt−1 þ γ 1 ΔSMKTt−i þ γ 2 ΔREGt−i
i¼1 i¼o (5)
X
p X
p X
p
þ γ 3 ΔGDPt−i þ γ 4 ΔINFt−i þ γ 5 ΔTOPENt−i þ μt
i¼o i¼0 i¼0

where α0 is the intercept; α1; α2; α3; α4 and α5 measure the estimated parameters of the
variables, γ i represent short-run dynamics of the model; GDP is the GDP per capita; INF is
the inflation; TOPEN represents trade openness. They are used as control variables. The
inclusion of GDP and INF are informed by the work of Akinlo and Akinlo (2009); Fagbemi
and Ajibike (2018); Imran et al. (2020), while TOPEN is included to capture the effect of
external influence on the performance of stock market in the country.
To test for the existence of a cointegrating long-run association ARDL bounds testing
approach is adopted which is based on the Wald test (F-statistics) to determine the joint
significance of the lagged levels of the estimated variables.
 The null hypothesis of no long-run association among the variables is stated as: H0: Stock market
α1 ¼ α2 ¼ α3 ¼ α4 ¼ α5 ¼ 0 against the alternative hypothesis of cointegration; H1: development
α1 ≠ α2 ≠ α3 ≠ α4 ≠ α5 ≠ 0. As developed by Pesaran et al. (2001), the computed F-statistic
is then compared to the critical bounds values. If the computed F-statistic lies below the lower
critical values, the null hypothesis of no cointegration is accepted. However, if the computed
F-statistic lies above the upper critical values, the null hypothesis is rejected, while the test is
termed inconclusive if the computed F-statistic falls within the lower and upper critical
values. With the confirmation of the existence of cointegration in the model, the ECM is 79
stated, and it measures the speed of adjustment to restore to the equilibrium in the dynamic
model.
X p Xp Xp Xp
ΔSMKTt ¼ γ 0 γ 1 ΔSMKTt−i þ γ 2 ΔREGt−i þ γ 3 ΔGDPt−i þ γ 4 ΔINFt−i
i¼1 i¼o i¼o i¼0

X
p
þ γ 5 ΔTOPENt−i þ ϑi ECMt−1 þ μt
i¼0

(6)

where ϑi represents the speedy of adjustment. Theoretically, they are expected to be

significant and negative.
Since the central point of focus is the investigation of long-run relationship among the
variables, in the absence of I (0), the existence of I (1) series in the model, implies that dynamic
ordinary least squares (DOLS) and conical cointegration regression (CCR) techniques can also
be employed in the study. As these methods can only be applied when there are only I (1)
variables in the model, the work of Stock and Watson (1993) is followed. The use of DOLS and
CCR in the study would account for the robustness check of the estimates. Thus, the model is
specified as:
X
l
SMKTt ¼ γ 0 þ αzt þ γΔzt−j þ μt (7)
j−m

where l represents the lag length; α connotes the cointegrating vector; m is the lead length; z is
the matrix of the independent variables.
The study covers the period between 1996 and 2019. Since we intend to use institutional
indicators constructed by Daniel Kaufmann et al. (2010), the scope is based on the data
availability. The data description and their respective sources are stated in Table 3.

3.1 Empirical results and discussion

3.1.1 Summary statistics and correlation analysis. In the study, Tables 4 and 5 report the
descriptive statistics and correlation results, respectively. This first approach is necessary in
order to know the features of each of the variables. For example, in Table 4, the mean
(average) values of market capitalization ratio (MRK) and value traded ratio (VTR) are 12.58
and 1.23 (suggesting low market performance), respectively. Based on the large differences
between maximum and minimum values in the Table with respect to stock market indicators,
there is a high volatility in the stock market performance. Regarding the explanatory
variables, regulatory quality (REG), GDP per capita (GDP), trade openness (TOPEN) and
inflation (INF), their respective average values are
0.89 (implying weak REG), 1986.45, 37.97
and 12.32. With exemption of GDP and TOPEN, other variables have significant (at 5%)
probability values. While MRK is skewed towards 1.17, VTR level of skewness is 2.73, and
REG is
1.18. Also, in Table 5, the correlation results indicate that while INF has a negative
JCMS Variable Description/definition Source
6,1
Dependent variable
Market capitalization It represents the value of listed shares (% of GDP). World development
ratio (MRK) MRK measures the market size indicators (World Bank,
2020)
Value traded ratio It is the total value of shares traded (% of GDP). VTR World development
80 (VTR) measures the liquidity level indicators (World Bank,
2020)
Independent variable
Regulatory quality It captures perceptions of the ability of the World governance indicators
(REG) government to formulate and implement sound (Kaufmann et al., 2010)
policies and regulations that permit and promote
private sector development. Values range from
approximately
2.5 (weak) to 2.5 (strong)
governance performance
GDP per capita (GDP) It is gross domestic product divided by midyear World development
Population indicators (World Bank,
2020)
Inflation (INF) It represents the annual % change in the cost to the World development
average consumer of getting a basket of goods and indicators (World Bank,
services that can be fixed or changed at defined 2020)
intervals, such as annually
Table 3. Trade openness The sum of exports and imports of goods and World development
Variable description (TOPENs) services measured as a share of GDP indicators (World
and sources Bank,2020)

MRK VTR REG GDP TOPEN INF

Mean 12.57654 1.231341
0.887648 1986.447 37.97372 12.32313

Median 11.33691 0.896918
0.855753 2032.685 39.30777 11.83790
Maximum 30.80067 6.298354
0.659629 2563.900 53.27796 29.26829
Minimum 2.488777 0.189650
1.351967 1350.984 20.72252 5.388008
Std. Dev 6.469514 1.421943 0.175580 445.3813 9.079199 5.090075
Skewness 1.169370 2.729497
1.183137
0.233205
0.122337 1.504929
Kurtosis 4.277305 9.511999 3.915476 1.511365 2.251316 6.160010
Jarque-Bera 7.101210 72.20675 6.437351 2.433571 0.620394 19.04490
Probability 0.028707 0.000000 0.040008 0.296181 0.733302 0.000073
Sum 301.8370 29.55218
21.30354 47674.74 911.3692 295.7551
Sum Sq. Dev 962.6562 46.50423 0.709049 4562383 1895.933 595.9039
Observations 24 24 24 24 24 24
Table 4. Note(s): MRK 5 market capitalization ratio; VTR 5 value traded ratio; REG 5 regulatory quality;
Summary statistics GDP 5 GDP per capita; TOPEN 5 trade openness; INF 5 inflation

relationship with VTR and REG, and TOPEN is negatively related with REG, other variables
are found to be positively related with one another.
3.1.2 Unit root test. With a view to know the order of integration of both the dependent and
independent variables, following Augmented Dickey–Fuller (ADF) and Philips–Perron (PP),
the unit root test is conducted. In Table 6, the results reveal that the whole variables are
integrated at order one (I (1)) at 5% level of significance. In light of this order of integration,
ARDL bounds test is appropriate for the study, and to ascertain long-run relations among the
series (Pesaran et al., 2001). Furthermore, since the variables are I (1), both DOLS and CCR can
as well be applied (Stock and Watson, 1993). In the study, DOLS and CRR are employed to Stock market
further validate the robustness of the estimates obtained under the ARDL approach. development
3.1.3 Cointegration and stability test. In Table 7, F-bounds test for cointegration indicates
that the variables have a cointegration relationship, that is, there exists a cointegrating
association between the stock market indicators and the explanatory variables in the model.
As the study comprises two models, in each of the models, calculated F-statistic is found to be
above their upper bound value at 5% level of significance. Hence, in favour of the alternative
hypothesis, the null hypothesis of no long-run association is rejected. On the test of stability, 81
the cumulative sum of recursive residuals (CUSUM) and cumulative sum of squares of
recursive residuals (CUSUMSQ) reported in Figure 1 confirm the stable nature of the model

Variable MRK VTR REG GDP TOPEN INF

MRK 1
VTR 0.60 1
REG 0.44 0.39 1
GDP 0.48 0.64 0.45 1
TOPEN 0.51 0.37
0.37 0.53 1
INF 0.65
0.29
0.64 0.67 0.68 1
Note(s): MRK 5 market capitalization ratio; VTR 5 value traded ratio; REG 5 regulatory quality; Table 5.
GDP 5 GDP per capita; TOPEN 5 trade openness; INF 5 inflation Correlation matrix

Augmented Dickey–Fuller (ADF) Phillips–Perron (PP)

Variable Level First difference Status Level First difference Status

MRK
2.49 (0.13)
2.98** (0.03) I (1)
2.60 (0.11)
3.19** (0.03) I (1)
VTR
2.42 (0.15)
6.73*** (0.00) I (1)
2.44 (0.14)
6.73*** (0.00) I (1)
REG
2.34 (0.17)
5.34*** (0.00) I (1)
2.35 (0.17)
5.34*** (0.00) I (1)
GDP
1.41 (0.25)
2.97** (0.04) I (1)
1.23 (0.24)
2.99** (0.04) I (1)
TOPEN
2.14 (0.23)
5.36*** (0.00) I (1)
2.09 (0.24)
6.24*** (0.00) I (1)
INF
1.71 (0.13)
4.71*** (0.00) I (1)
1.68 (0.12)
4.67*** (0.00) I (1)
Note(s): ***represents 1%, **represents 5% level of significance. Values in bracket are probability values,
while the ones with no bracket are t-statistical values. The critical values of both Augmented Dickey–Fuller
(ADF) and Phillips–Perron (PP) technique are (
3.679322), (
2.967767), and (
2.622989) at 1%, 5% and 10%,
respectively. MRK 5 market capitalization ratio; VTR 5 Value Traded Ratio; REG 5 Regulatory quality; Table 6.
GDP 5 GDP per capita; TOPEN 5 trade openness; INF 5 inflation Unit root test

Test statistic Value K

F-statistic (Model 1) 6.66*** 4

(1, 2, 0, 2, 2)
F-statistic (Model 2) 5.06** 4
(2, 0, 2, 1, 2)
Significance I (0) lower bound I (1) upper bound
1% 3.74 5.06
5% 2.86 4.01
10% 2.45 3.52 Table 7.
Note(s): *** and ** indicate level of significance at 1 and 5%, respectively, while K is the number of F-bounds test for
independent variables cointegration
 6,1

82
JCMS

Figure 1.
Stability test
Model 1
15
1.4

1.2
10
1.0
5
0.8

0.6
0
0.4

–5 0.2

0.0
–10
–0.2

–15 –0.4
2000 2002 2004 2006 2008 2010 2012 2014 2016 96 98 00 02 04 06 08 10 12 14 16

CUSUM 5% Significance CUSUM of Squares 5% Significance

Model 2
15 1.6

10
1.2

5
0.8

0.4
–5

0.0
–10

–15 – 0.4
2000 2002 2004 2006 2008 2010 2012 2014 2016 2000 2002 2004 2006 2008 2010 2012 2014 2016

CUSUM 5% Significance CUSUM of Squares 5% Significance

specifications. This is ascertained following the falling of the plotted charts within the critical Stock market
bounds at 5% significant level. In addition, the outcomes of both CUSUM and CUSUMSQ development
indicate that testing for structural break points, unlike Chow test, is no longer necessary,
since even with unknown and unspecified structural break points, their applicable, reliable
and appropriate (Brown et al., 1975). Based on the analysis, model 1 represents the inclusion of
MRK as the dependent variable, while model 2 accounts for the use of VTR as the dependent
variable. This is done with a view to eliminating any possible statistical multicollinearity in
the study’s model. In all, diagnostic tests conducted validate the robustness of the estimation 83
results in the models.
3.1.4 ARDL long run and short-run estimates. The estimates obtained in this section are
used to elucidate the way in which REG results in stock market impact, since it is possible to
link market outcomes to the nature of regulation in the economy. Thus, in Table 8, the
estimation results show that REG has a positive and significant effect on both MRK and VTR
in the study period (both short- and long-run), indicating that the quality of regulation is an
essential ingredient of stock market performance. This can be further explained that the
improvement of the regulatory framework is highly associated with better market
performance — it has strong explanatory power for the level of stock market performance
in Nigeria. As posited by Eita (2015), Winfu et al. (2016), Imran et al. (2020), that countries with
sound regulatory frameworks would experience good stock market returns, these findings
strengthen this proposition for the country. In the long run, poor regulatory framework and
inadequate supervision mechanisms could lead to the erosion of investors’ confidence and the
undermining of the development of stock market. Hence, the soundness of regulatory systems
could offer tailoring support for the space of stock market development. This buttresses the
argument that the role of regulation in investment in most developing countries seem to be
consistent with the proposition that the quality of the regulatory environment is a critical
component of business operations (Eifert, 2009; Haider, 2012; Kirkpatrick, 2014).
Regarding the control variables, INF has a significant negative effect on the stock markets
indicators across models. This implies that as INF increases, shareholders will demand for

Long-run estimate Model 1 (MRK as the dependent variable) Model 2 (VTR as the dependent variable)

REG 0.22** [3.01] 0.71** [2.63]

GDP 0.64** [2.85] 0.83* [2.15]
TOPEN
0.60 [
0.77]
0.38 [-0.12]
INF
0.40* [
2.11]
1.85* [
1.55]
C 0.63 [0.08]
0.24** [3.11]
Short-run estimate
ΔREG 1.68* [2.02] 0.21* [1.68]
ΔGDP 0.12** [2.83] 1.03*** [4.43]
ΔTOPEN 0.76 [1.60] 0.29 [0.37]
ΔINF
0.59* [
1.98]
0.76* [
2.28]
ECM
1.05*** [
4.95]
0.37** [2.87]
Diagnostic test
Durbin–Watson 2.11 2.18
Serial correlation test 0.38 0.15
Ramsey reset test 0.26 0.16
Normality test 0.88 0.74
Note(s): ***, ** and * indicate 1%, 5% and 10% level of significance, respectively, while figures in Table 8.
parentheses are t-values. MRK 5 market capitalization ratio; VTR 5 value traded ratio; REG 5 regulatory ARDL long-run and
quality; GDP 5 GDP per capita; TOPEN 5 trade openness; INF 5 inflation short-run estimates
JCMS higher premium, while higher trading rates can result in higher stock returns and vice versa
6,1 — this supports the work of Imran et al. (2020). On the effect of GDP, estimates are significant
and positive, suggesting that any variation in the level of economic growth will have a
noticeable impact on stock market returns. By and large, this marries up with the assertion of
Maku and Atanda (2010), Okpara (2010) that GDP plays a substantial role in stock market
development. However, TOPEN is found to have an insignificant impact on the stock market
measures included across models. The overdependence of the country on imports in relation
84 to exports could be responsible for these estimated outcomes, as the level of international
trade might not contribute meaningfully to market performance. In all, ECM conforms with
theoretical expectation, indicating that the speed of adjustment restored to the equilibrium.
3.1.5 Cointegrating regression. In this section, while trace statistic and max-eigen test (see
Table 9) is conducted, lag order selection criteria (see Table 10) is also determined for the
cointegrating regression in Table 11 — to improve the efficiency of the results, these techniques
are introduced. The lag selection order is based on Schwarz information criterion which seems
to be more suitable. The results obtained in this section are somewhat similar to the findings of
the previous section, as both DOLS and CCR estimates reveal that REG has a substantial effect
on stock market performance which further affirms the centrality of regulatory framework to
market operations. As Eita (2015) showed for South Africa and Zambia, these estimation

Null hypothesis Alternative hypothesis Eigenvalue Statistic Critical value Prob

r50 r51 0.818296 96.69685 69.81889 0.0001***

r≤1 r52 0.761528 59.17852 47.85613 0.0031***
Table 9. r≤2 r53 0.586291 37.64146 39.79707 0.0439**
The trace statistic and Note(s): *** represents 1% and **indicates 5% significant level. Endogenous series: MRK, TRD, while
max-eigen test exogenous series: REG, GDP, TOPEN, and INF.

Lag LogL LR FPE AIC SC HQ

0
13.93533 NA 3.85e-06 1.721394 1.969358 1.779807

1 56.41151 102.3227 6.69e-08
2.401046
0.913261*
2.050568
2 94.08172 37.67022* 3.23e-08*
3.552884*
0.825278
2.910342*
Table 10. Note(s): * indicates lag order selected by the criterion at 5% level. LR: sequential modified LR test statistic;
Lag order selection FPE: Final prediction error; AIC: Akaike information criterion; SC: Schwarz information criterion;
criteria HQ: Hannan–Quinn information criterion

Canonical cointegrating regression

Dynamic least squares (DOLS) (CCR)
Variable Model 1 Model 2 Model 1 Model 2

REG 1.15** [3.02] 0.10** [3.05] 1.19* [1.58] 0.01** [2.91]

GDP 0.17* [1.66] 0.66** [4.38] 0.15** [2.89] 0.27* [1.64]
TOPEN
1.71 [
1.33] 1.83* [2.17] 0.19 [0.37] 0.32* [1.57]
INF
0.85* [1.71]
0.28** [
4.15] 0.17** [3.11] 0.14* [1.85]
Table 11. C 0.56 [0.45] 1.21** [3.49] 0.91* [1.63] 0.22 [1.35]
Cointegrating Note(s): ** represents 5%, while *indicates 10% significant level. REG 5 regulatory quality; GDP 5 GDP per
regression capita; TOPEN 5 trade openness; INF 5 inflation
outcomes support that REG positively influences stock market performance in Nigeria. These Stock market
results can be compared favourably with the previous studies’ findings (such as OECD (2011); development
Kirkpatrick (2014); Haider (2012); Canare (2017); Ojeka et al. (2019)) — regulatory laxity and
poor regulatory supervision could hamper stock market performance. Nonetheless, the study
contradicts the findings of Low et al. (2011) who stress that institutional quality adversely affect
the performance of stock market, although the difference might be as a result of varying
measuring components or differences in variable inclusion.
In sum, it is interesting to note that regulatory quality as one of the components of 85
institutional quality is a significant determinant of the performance of stock market in Nigeria
based on the findings. The implication is that the inability of the government to strengthen the
regulatory frameworks may engender poor market performance in the country. Regulatory
systems supportive of the efficiency and effectiveness of market operations tend to result in
improved performance (Kirkpatrick, 2014; Canare, 2017). However, a poor regulatory
environment often spurns the need for efficiency and effectiveness. Therefore, if the quality of
regulation is sufficiently high, stock market performance will drastically improve, then it is
more reasonable to ascertain solely the impact of regulatory governance on the stock market
operations in Nigeria’s context, and sub-Saharan Africa as a whole.

4. Conclusion
Given that it has been empirically established that components of institutional quality
could have an influence on the performance of stock market in any economy, evidence on
the role of regulatory quality is in scarce report, especially in Nigeria’s context. Hence, this
study aimed at addressing the lacuna by examining the possible long-run and short-run
impact of regulatory quality on stock market performance in Nigeria. Based on ARDL
bounds test and cointegrating regression, this objective is explored for 1996–2019 period.
We use MRK and VTR for the analysis, which represent stock market performance
indicators. For the impact of regulatory policy on the market performance, the estimates of
regulatory quality is employed as a measure. In all, two different models are estimated, and
findings generated consistently followed the estimated outcomes of each models in the
study period.
The study’s findings reveal that regulatory quality positively and significantly
influences the performance of stock market, which strengthens the view that better
regulatory policy can engender an improvement in stock market returns (Kirkpatrick,
2014). It is plausible to argue that strong and effective regulation encourages better market
performance, as the financial sector seems to be more prone to regulation. However, in the
long run, poor regulatory framework and inadequate supervision mechanisms could lead
to the erosion of investors’ confidence and the undermining of the development of stock
market. Thus, the soundness of regulatory systems could offer tailoring support for the
space of stock market development. The study demonstrates that quality of the regulatory
environment is a critical component of business (market) operation. In addition, it is
affirmed that both GDP and INF play a substantial role in stock market development in the
country.
In view of these findings, by implication, the study suggests that while improving the
institutional environment, for stakeholders, Nigeria seems to need more effective and strong
regulatory mechanisms critical to enhancing the practices and development of stock market.
This tends to be supportive of the level of efficiency and effectiveness of market operations
for improved performance. It is therefore a challenge to regulators to learn from prevailing
institutional arrangements elsewhere (such as developed countries) even if they cannot be
replicated fully but to use them as a basis for developing locally viable policy measures. Since
the impact of regulations may be context specific, the government should be alert to the
JCMS consequences of adopting imported blueprints and instead take into cognizance the need to
6,1 design, modify and adapt the most effective regulatory processes that best fit domestic
conditions.
The study has only focused on Nigeria. Thus, a study of this nature could be good for the
entire sub-Saharan Africa countries or be conducted for each sub-region in Africa. Since
findings from the study are mainly based on Nigeria’s context, in term of policy implication, it
may not be applicable elsewhere. Hence, further research studies in this area should focus on
86 cross-country study or employ panel data approach, especially regarding African countries.
This will help policymakers know the overall role of governance regulatory quality in the
performance of stock markets across countries in the continent.

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Corresponding author
Fisayo Fagbemi can be contacted at: [email protected]

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