Stock Market Efficiency - Fact or Fiction?

Stock markets are crucial for the economy to survive, as stocks represent ownership in a company. The recession in 2008 was arguably caused by the stock market crashing, which in itself reflected a lack of investor confidence in the future earnings of companies. This is still a present day problem with the economy flat lining; in order for things to change, investor confidence needs to be restored.  This can be viewed as a ‘win win’ situation as companies need investors in order to raise capital for future growth strategies and investors can enjoy the high returns, whilst everyone else enjoys the general benefits of a booming economy.

The assumption of a ‘win win’ situation is based on the stock market being ‘efficient’, meaning all new information revealed about the company will rationally and quickly impact and become incorporated into the share price (Arnold, 2008).  However in an ‘ideal and fair’ world if this was the case investors would not be presented with the opportunity of making a huge return on their investment that was any greater than the risk associated with it in the first place . . . . . unless by chance! Therefore is this concept of stock market efficiency ‘fact or fiction’?

A proficient stock market gives everyone equal opportunities, but unfortunately like every day life this is just not realistic. Economists like Fada (1970) defined three levels of efficiency according to the information available. They are: ‘Weak-form efficiency’, ‘Semi-strong form efficiency’ and ‘Strong-form efficiency’ (Arnold, 2008), however I am going to focus on ‘Strong-form efficiency’ in relation to the supermarket giant Tesco.

Tesco had a hugely disappointing UK Christmas trading period whereby the Company saw over £4billion wiped off its value and shares plunging 16pc (Telegraph, 2012).  But what is most significant is the Company’s chief operating officer, Mr Robbins, selling 50,000 shares a week before the supermarket group announced the biggest profit warning in 20 years. Furthermore earlier in the year two directors sold off shares, all in all resulting in over £2million shares being sold (Telegraph, 2012). Whilst in the scheme of things this may seem insignificant compared to the £4billion wipe off, this is a perfect example of ‘Strong-form efficiency’. In my opinion and assumption it is highly likely that all three employees had the relevant and ‘private’ information needed to trade their shares and take advantage prior to the normal investors receiving the new of Tesco’s poor performance.

The question therefore remains ‘should the CEO have prevented Mr Robbins from selling his shares, prior to Tesco announcing its ‘Big Price Drop’? I believe the answer to be yes. Mr Robbins should not have been permitted to sell his shares, as chief of operations selling his shares prior to a big announcement of poor profits does not encourage investor confidence within the Company. Furthermore it is questionable whether Mr Robbins was abusing his ‘insider’ information in order to benefit his own purpose.

Tesco defended Mr Robbins saying he was not in possession of any ‘price sensitive’ information, so are we to believe it was just a coincidence? But coincidence or not, with or without ‘price sensitive’ information Mr Robbins as someone highly involved in the running of Tesco UK would have had a  fairly comprehensive picture of its trading performance by January 4, when he chose to sell his shares. Robbins defended his actions saying he sold his shares for personal reasons, however as the Telegraph (2012) says ‘Robbins could, and should, have borrowed the money he needed from the bank, saving himself and Tesco a great deal of embarrassment’.

Therefore when companies such as Tesco can’t even govern their own internal controls, how can the stock market be expected to control and operate effectively and efficiently? This leads me to the conclusion that stock market efficiency is fiction.