What is Market Efficiency?
efficiency is possible when stock price and other security prices reflect all
available information about goods in the market. This information is
pre-assumed to include; the amount of capital used to produce and supply a
certain commodity in the market. Disclosing all the information about a
particular product in the stock market is not advisable since investors may
find loopholes to exploit the stock exchange market (Heakal 1st
Investor’s primary goal in business is to make a decent profit out of their
investment plan. When investors put their money on the stock market, the goal
is to create a sound return on the capital invested. Many investors do not only
aim for returns, but they also want to outperform the market and take full
control of it so that they can make much profit at the expense of other
efficiency was developed by Eugene Fama-an economist whose theory efficient
market hypothesis (EMH) stated that it is not possible for an investor to
outperform the market because all the available information about a good is
already built into all stock prices. In other words, a competitive market
automatically achieves an efficient allocation of resources by ensuring
equilibrium of demand price with that of supply price and quantity demand and
quantity supply is obtained. With this equilibrium in place, buyers and sellers
have no other option but to seek a mutually exchangeable plan at the market
price that achieves efficiency and maintain competition through elimination of
market failures (Hussain 5th December 2015).
price refers to the maximum price buyers are willing and able to pay for a
certain commodity in the market. Buyers pay a certain amount of money if they
are fully convinced the value of the good fulfills their needs. On the other
hand, supply price is the minimum amount of money sellers are willing to accept
for good. The price accepted by sellers is based on the opportunity cost of
production. Here, the value of good not produced is put into consideration in
that once the good is produced and ready for the market, the goodwill still be
relevant in the market. To illustrate how demand price and supply price
equilibrium is important, let’s access the situation of Mark who is the
supplier sells good worth 50 dollars at 70 dollars to Ken. Mark will be better
off than Ken in the exchange by 20 dollars and by this he will have improved
his situation. Mark will take advantage of the market by supplying more goods
at the expense of Ken. On the other hand, if Mark receives less money from Ken,
the production of his goods will be affected since Ken will take advantage of
buying all the market can offer because they are cheap. With the two examples,
in the first case, the supply price is less than the demand price, and the
supplier benefits by exchanging more goods while in the second case the supply
price is greater than the demand price the, the buyer will benefit by buying
more goods at a lower price.
Impact of Market Efficiency
direct impact of market efficiency is the ability to reduce chances of
predictability of stock exchange market by investors. How the stock market is
performing is not limited to financial reports alone but also the political,
social and economic activities of a certain country. This subjects investors to
have their thinking of how the stock market is going to perform. Prices respond
only to issues available in the market, and since all investors depend on the
same information, no one will have the ability to make profit more than the
other investors. Inefficient markets, the price of goods is random, and
investors are limited to plan on how to exploit the market. This unpredictable
nature of the market is referred as “random walk” of prices and is seen as a
killer of any investment strategy by investors who aim to outperform the
market. However, the unpredictable nature of the market has received critics
from investors since some investors are found to have made a profit at the expense
Three Forms of Efficient Market Hypothesis.
are three defining forms of efficient market hypothesis (Maverick 26th
weak-form, semi-strong and strong form. The weak-form of market states that the
old information about a stock market is irrelevant since the current price in
the stock markets represents everything including the old information.
Therefore an investor cannot predict on the current or upcoming stock market
price using the old stock information data.
semi-strong form of the market states that the current stock market reflects
all public information. This includes even the old stock market information.
This form assumes that the market adapts quickly to new information. Therefore
an investor cannot benefit from new information because the market has already
absorbed the information.
the part of strong efficiency market, it states that all the information, both
public and private, is priced in the stock market. Therefore no investor can
gain the advantage over the market as a whole.
of Market Efficiency for Corporate Managers
managers make several implications concerning market efficiency. For instance;
corporate managers may decide that shareholders should not know the company
budgeting process and decisions of the company. Disclosing financial
information to shareholders will be having a negative impact on the company in
the stock market. A shareholder has no place in the company, and his playing
field is in the stock exchange market. When a shareholder has access to
companies budgeting process, the company may be in the loose end. For example,
a company may be experiencing financial problems, but it is still doing well in
the stock exchange market. This will see the continuity of the company by
attracting many investors to buy companies shares. They would, in turn, use the
money made from the selling of shares to try reviving the company deteriorating
the financial situation. Unknowingly, the company is performing badly, but its
relevance in the stock markets enables it to sell shares. By this, the company
demand price will be performing well at the expense of the shareholders.
Although this does not promote equilibrium between supplier price and demand price,
the company can make a profit by not disclosing the financial problem.
Shareholders should not know the company budget decision of a company. Making them know will give them a platform to
know the weaknesses of the company an exploiting it will be possible. As
mention earlier in the introduction part, the stock market pricing provides all
the necessary information an investor would like to know. Therefore, disclosing
the budget will be seen as unfair competition by other companies. As long as
the company is still running, it’s not its duty to inform the shareholders.
However, if such company does not regain its normality, high chances of its
shares dropping in the stock market will be evident. This will happen when
investors realize that the company returns are not meeting their needs. They
might opt to sell the shares at a low price and this may lead to the collapse
of the company.
when the company is performing well, and it is not experiencing any financial
problems, shareholders will start receiving returns that meet their demands. In
such situation the equilibrium between demand price and supplier price is
present. The company will attract many investors wanting to buy its shares.
However, this will be determined by the stock exchange market in an attempt to
maintain market efficiency and fair competition to other companies.
implication by corporate managers is that they cannot fool the market and the
shareholders as this will result to being punished by the market. A company may
decide to promote its share market by advertising the wrong information. For
instance, in the past, a company was performing well in the stock exchange
market. However, with time the company starts making losses and as a result
they opt to sell many shares as possible when the company is still relevant in
the market. The company can do this by convincing stakeholders to buy their
shares using the records of how the company performed well in the stock
like investing on promising projects that guarantee returns. They will,
therefore, buy such shares. The company doing this has first engaged itself in
uncompetitive competition by revealing its past profit records, and according
to theories of market efficiency, the stock market, the pricing of company
shares are enough information to attract or not attract investors. In this
case, this company shares should be sold at a price that maintains the
equilibrium between the demand and supply price. If they stick to this
portfolio, their shares will be sold at a low price. After this, it is now left
for investors to decide for themselves whether they will buy the shares or not.
investors may decide to take a risk and buy such shares. They are taking a risk
because they are not sure if the company will be able to regain its momentum.
However, if the company continue fooling its shareholders by selling them
shares that do not bring substantial results, the stock market will realize,
and as a result, the company will make even more losses since no one will be
willing to buy their shares since all along the company was engaging itself in
decide to take the risk of buying the shares, might end up making big returns
from selling the shares after the company starts to make profits once again.
Another implication a corporate can make is
deciding not to participate actively in the stock market. The company can then
decide to use funds it would use to pile stocks for another investment plan
that would enable them to make good returns. By this managers argue that they
will be able to offer worthy competition to big companies who have the largest
share of the stock market. Being in the stock exchange market also mean the
company will employ a specialist to represent the company in the stock market.
To hire such employees is expensive and the money used to pay them could be
channeled to other investment of the company. Although a good businessman is
one who takes risks, some manager may feel the risk with the stock exchange
market is not worth taking. Buying of stock or maintaining stock securities is
not easy since the security to stocks can fall anytime depending on the stock
exchange market analysis.
Corporate managers may also decide to keep off
the stock market exchange in fear of intermediaries in the sector. Such people
make the shares to be expensive more than it’s supposed to be so that they can
end up benefiting from the market as well. Intermediaries have the expertise
needed in the stock market, and they know how to manipulate the market in an
effort of making a profit (Choi 30th September 2015).
corporate managers might decide to remain in the stock exchange market since
being in the marketplaces the company in the limelight of not only investors
who buy their shares but also customers of the services they offer. Companies
in the stock market usually draw a lot of attention to customers who want to
know how the company is performing in the stock exchange market. Also, a company
can gain experience on how the market operates and things to implement to match
the quality of other companies.
conclusion, market efficiency is essential as it sees companies engage each
other in worthy and fair competition. The stock market plays a critical by
providing guidelines on how firms should operate in the market.