There are different industry structures in this universe. Each industry construction is alone and involves alone determinations doing by the directors. One of the beginnings of house ‘s hard currency flow is the house ‘s determination in the merchandise market. For different industry construction the production forms, type of merchandises, consumer demand etc are different, so as the hard currency flow from the merchandise markets are different. For these hard currency flow each industry is involved in alone operating determinations by the directors. The determinations are for the hereafter and hereafter is ever unsure. These determinations are for future hard currency flows and therefore are beginnings of hazards.
An industry composed of stable few participants posses a low hazard because of some factors among which high barriers to entry is the outstanding 1. Industry which are more concentrated possess greater disincentive to forestall the new houses to come in into the industry. These houses have economic systems of graduated table and they produce larger volumes of end product and they are the lone providers of merchandises in such type of markets. These houses require monolithic capital investings and really specialised inputs which houses of the concentrated industries ca n’t afford. These few houses of the concentrated industries may possess the sole rights or patents rights and therefore this sole capableness is really hard for new houses to accomplish. Firms in these industries normally have big base of loyal clients. These houses may have or hold control on the full supply of natural stuffs. The authorities may give sole rights to one or few houses to bring forth and sell. The pricing scheme followed by these houses is they provide low benefits to client and charge high monetary value because they are the lone provider of the merchandise. They usually follow the schemes 6, 7, and 8 on the strategic clock developed by… … .
Contrary to the concentrated markets the houses in the competitory industries are involved in intense competition non merely on the footing of monetary value but on many factors like invention client value etc.One scheme that is followed by the directors of these houses is to take down the monetary value of their merchandises. By this they non merely discourage the new market entry but besides enforce a loss on the possible entrants. With this scheme the houses may hold losingss in the short tally but in the long tally when their, they may accomplish economic systems of mass graduated table production. Due to increased competition among the houses in the competitory industries these houses strive for invention and invention is a beginning of hazard. All these factors consequences in extremely volatile hereafter hard currency flows and increased hazard is associated with them
I will concentrate my survey on the hazard forms of the competitory and concentrated industries, the possible linkage between the industry construction and the stock returns. Literature associating to the measuring of industry concentration will besides be provided.
The nexus between market construction and Stock returns.
A nexus originates from structure/conduct/performance paradigm originated from the work of Bain ( 1954 ) .Bain linked in his work production behaviour of an industry to a steadfast pricing behaviour. This behaviour than find the house ‘s profitableness and public presentation. For illustration consider the computing machine bit industry. French friess are rather complicated merchandises.A computing machine french friess fabricating house have high fixed costs because french friess are customized and each one needs monolithic and expensive workss. This high fixed cost Acts of the Apostless as a natural barrier to entry for the new houses who want to come in into the industry. ( construction ) .With this barrier to entry the figure of houses in the industry will be few and each one is capable to bear down a high monetary value for their merchandises good above their fringy cost and they have no fright of a new entry ( behavior ) .Because of this construction and carry on the houses in such industries will gain high net incomes ( public presentation ) .
The S/C/P paradigm farther suggests that houses in such high barriers to entry industries have higher expected returns whenever the figure of houses in the industry alterations ( some are dropped because they ca n’t vie with such higher barriers and other cant enter ) or the pricing schemes they follow alterations the hazard forms of the houses in such industries. Barriers to entry besides give us a hint of the optimum response of houses to aggregate demand dazes. Industries constituted by houses holding high capital investings that give them maximal disincentive to avoid the new entrants can react to a positive demand daze either by increasing their monetary values of merchandises or by increasing their end products without any danger of a competitory entry. This behaviour will increase their profitableness. High profitableness gives the houses some deeper pockets which insulate these houses ‘ cyclical downswings and industry issue. These houses because of their construction, behavior, and public presentation show a low hazard form and therefore low expected returns from investor point of position.
The structure/conduct/performance paradigm is challenged by the efficient construction hypothesis ( ESH ) presented by Damstez ( 1973,1974 ) .The chief proposition of the hypothesis is that achieving market power is non random event and this is the consequence of high houses efficiency degrees. Because of high efficiency degrees houses grows into larger houses and that industry become more concentrated. Therefore efficient construction hypothesis predicts that houses holding high efficiency earn lower returns because they have lower hurt hazard or danger of issue.
The S/C/P and the ESH both suggest that houses in extremely concentrated industries have high efficiency degree and lower hurt hazard because of higher barriers to entry and hence they earn lower returns. This support the possibility that houses in extremely concentrated industries are less open to the hurt hazard because they have grown larger because of their higher efficiency and can exert their market power and posses high barriers to entry.
Kewei and David ( 2006 ) argue that barriers to entry in the merchandise guard some incumbent houses from aggregative demand dazes and expose others. Thus a hurt hazard is perceived which varies as the industry construction alterations. Industries holding higher barriers to entry are associated with lower stock returns. This hurt or industry entry is a beginning of hazard and shows industry construction can impact the stock returns. Thus directors runing determinations are dependent upon the industry construction of the house. These determinations are for future unsure hard currency flows and therefore a beginning of hazard They affect the house ‘s profitableness and hence its stock returns.
Keei and David ( 2006 ) through empirical observation showed that that houses in the industry that are constituted by few large houses with higher barriers to entry gain lower returns than competitory industries even if they control for size, book to market, impulse and some other factors ( rising prices, GDP ) on which returns can be predicted. They even found that one-year returns of less concentrated industries are 4 % higher than similar houses in extremely concentrated industries. Their determination showed that houses in extremely concentrated industries have experienced positive unnatural profitableness and the unnatural profitableness for less concentrated industries was negative.
They farther linked this concentration premium with concern rhythm and to future economic conditions. They through empirical observation showed that concentration premium grows as economic system curtails and low biddy the near-term GDP rate lessenings. This shows hen the future economic activity looks blurred investors expect higher rate of return for their investing in more competitory industries because of higher hazard.
Schumpeter ( 1912 ) in his Theory of Economic Development introduced the construct of ‘Creative Destruction ‘ He used the term originative devastation as a procedure affecting a alteration in the present position quo of the bing houses due to invention. Any advanced entry by a house in an industry creates a force that will guarantee the long term growing of the industry. But this advanced alteration may damage the value of bing houses of the industry. The bing houses were basking some grade of invention. This new advanced entry will divide this grade of invention and will alter the bing position quo of the large participants and therefore presenting a beginning of hazard as the figure of advanced entries into industry additions.
Companies that were one time industry criterions and were the cardinal dominant participants for illustration XEROX in photocopier or Polaroid in the picture taking are now challenged by the new entries. Their present position and place have changed in the new epoch. Their laterality has vanished because the new entrants have cut their costs trough improved merchandise designing every bit good as cost efficiency in the fabrication. Soon one illustration is that of Wal Mart that have achieved laterality trough improved inventory direction, advanced distribution, and improved personals direction techniques. Others illustrations of originative devastation include superannuation of typewriters with photocopier. Mail services were replaced by the electronic mails. Some newspapers like the Christian Science Monitor have repleced the traditional newpaers with the on-line newpapers therefore turn outing a new advanced entry and menace to the traditional newspapers.
Schupeter ( 1942 ) in his book argued that invention brings figure of problems and hazards for irms.When a house decides to travel for information neede for invention it is really difficult to acquire right and precise information.This information lies in the custodies of people or beginnings who are outside the organization.Thus an objetive uncertainity is created every bit for as this inforation is concerned.This nonsubjective uncertainity is compounded ith house ‘s employyes behahrioal response to the alterations or invention to be brought.This alteration or invention is a new unknown province and there is a common fright among the employees to come in into this unknown state.The employees may working on taken for given things and are loath to accept the alteration because of their estiblished staerotypes.Further more there may be people in the organisation who are antagonist to alter because of their fond regard ( emotional socialetc ) with the older ways of making things or products.They combat any kind of invention on legal, societal, poltical or mores basis.Thus invention by a frim is non merely a hazard to other houses but besides to tauten itself.This besides give grounds of beharioural phenomena on the portion of directors. involved with invention.
Peter W.robert ( 1999 ) argues that if a house earns higher net incomes so it must reply the inquiry from where does these higher net incomes are coming? And what are the implicit in factors of the relentless tendency of these high net incomes. When distinction takes topographic point or when a new advanced merchandise is introduced in the market at first it faces less competition and hence it earns higher net incomes. These higher net incomes attract other viing houses and they try to copy the merchandise as clip base on ballss by. Due to this increased competition in the industry net incomes are lowered, hazard is increased and therefore therefore expected return from the investor ‘s point of position additions.
( Knott & A ; Posen 2003 ) through empirical observation proved that invention in an industry is positively correlated with figure of houses in an industry. Their consequence showed that if an industry is homogeneous, there are no extra net incomes beyond a 3rd entry. But with entry of each extra house, there is an addition of R & A ; D strength of the existing houses. Adding to its on R & A ; D costs. This suggests that when the figure of houses in an industry increases invention additions and hence hazard additions. It is an of import grounds that increased competition is a beginning of hazard and hence investors expect a high rate of return on their investing in less concentrated industries.
How to mensurate the industry concentration
It will be really hard to mensurate the industry concentration or sum of competition among houses straight. However there is an indirect step of industry concentration called the Herfindhal index named after two economic expert Orris C. Herfindahl and Albert O. Hirschman and is used to mensurate the comparative size of houses in an industry and the competition among the firs in an industry.HHI is defined as amount of squares of per centums of gross revenues or market sahres of houses within an industry.It is usually used for 50 houses in an industry nevertheless if there are less than 50 houses in an industry we can aslo used it as an index of industry concentration.
The expression for Hefifinadahl Hirschman Index is given as follows
The values of Hhi will make up one’s mind about the concentartion or competition among the houses in an industry.If HHI value is high it means the industry is concentrated and is composed of few large players.If the value of HHI is lower it depicts industry characterised by more houses and high copetition.further these HHI values are compared ith a threshold value.If the value is closer or above that threshold the industry is extremely concentrated.On the other manus if HHI values are really low as compared to the Threshold value the industry is involved in high copetion and is less concentrated. Different states uses different threshold like in the U.S this bound is 0.18 and in EU it is 0.025.So a value closer to 0.18 or 0.025 will picture a Highly concentrated industry. In Pakistan I do n’t cognize the threshold values but I have made this simple for me by comparing industries on the footing of single HHI values.
Suppose we have an industry M holding 19 houses. Among these 9 houses have 90 % market portion each house holding 10 % portion each while staying 10 % is shared every bit by 10 houses. The HHI value for this industry badly be.
Comparing the HHI values of industry M and industry N it become obvious that Industry N is extremely concentrated as compared to industry M. The higher HHI value of industry N shows it has some large participants like the 5 houses holding 90 % of the entire market portion of Industry N.
The population includes all the industrial sectors of KSE_100 Index
The sampling will be done indiscriminately which will be no likely convenient sampling and I will choose the undermentioned industrial sector which will be a placeholder for all the industrial sector of KSE_100 Index.
- Cement industry
- Cars portion and accoutrements industry
- Fertilizer industry
- Cable and electrical goods industry
- Pharmaceuticals industry
- Oil and gas geographic expedition industry
All the houses in a peculiar industry will be selected for analysis. Well these industries will be than categorized on the footing of the Herfindahl index. They will be so divided on the footing of the industry construction they belong.
Data aggregation and the Data analysis
First the industries will be sorted into their several industry construction for this we will necessitate the gross revenues values of the houses. The other relevant informations will be the stock market returns. I will roll up informations from 2003 to 2007.
- The KSE web site
- The concern respects
- Annual and Quarterly studies of the houses
- Offices of the houses
Analysis will be both clip series and transverse sectional. First of all I will analyze the return behaviour for single houses from 2003 to 2007 harmonizing to the concentration values obtained from Herfindhal Hirschman Index. Then I will happen the aggregative return behaviour of the whole industry. Then we will compare the mean return of different industries cross sectional.
First I have to look into the statistical significance of return behaviour of industries harmonizing to their HHI values. for this I have to utilize the Z_test for two samples means. I will split the industries into two groups on the footing of their HHI values. One group with high HHI values and other with low HHI values. For these two samples I will cipher the Z statistic.
Statistical theoretical account
I will utilize the Fama Macbeth arrested development theoretical account for analysing the consequence of my variables on the industry returns. It is similar to capital plus pricing theoretical account. It is a multivariate theoretical account to gauge the factors or parametric quantities for industry returns. The signifier of theoretical account for the factors I have considered is given as follows.
Industry norm returns=a+ & A ; szlig ; 1 ( HHI ) + & A ; szlig ; 2 ( log of mean size ) + & A ; szlig ; 3 ( B/M ) + & A ; szlig ; 4 ( industry norm beta )
This is the multivariate theoretical account I will utilize in my survey to analyse the relationship of the independent variables with the dependent variables.
Well as this is a hypothesis survey so the research worker intervention will be minimum.
Unit of measurement of Analysis
Unit of measurement of analysis in my instance is industry as I will carry on a comparative survey of different industries of Pakistan.