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.  

The Rise and Fall of Nokia

In 1991 on July 1^st the Finnish Prime Minister, Harri Holkeri, made the world’s first Global System for Mobile (GSM) communication call, using Nokia equipment. 1992 then saw the launch of Nokia’s first digital handheld GSM phone, the Nokia 1011. Early and heavy investment into the GSM technology saw Nokia propel itself into the industry of telecommunications and gain first mover advantage.

It is therefore hard to believe that as Europe’s biggest technology company and the global market leader, by volume at least, for mobile handsets, Nokia find themselves to be in such a parlous state. Their products have been all but squeezed out at the top end of the market by Apple, HTC and Samsung. Their inability to equal and surpass their competitors through innovation has seen the once $300billion corporation plummet their market value by 77% to $25.6billion since Apple introduced the first iPhone in June 2007.

The problem lies in Nokia struggling to find their marketing niche. Apple is dominating the high-end market and the Google Anroid has taken over the mid-market. This has left Nokia battling it out with Chinese manufactures in emerging markets where consumers are looking for cheaper alternatives. 

So why and how did Nokia allow for their once thriving empire to become stagnant and outdated? Furthermore how has this impacted on shareholder maximization?

From 1992, the new CEO Jorma Ollila steered the company into a golden age. Nokia dominated mobile phones throughout the Nineties, and helped create the GSM standard for voice and data. However it was their cheap and reliable handsets that were the real hit.

Between 1996 and 2001, Nokia’s sales increased almost fivefold, to reach $29.7 billion. Basic handsets were being sold in emerging markets whilst in Europe and U.S. Nokia could focus on upgrading and constantly evolving their handsets to keep up with the ever-demanding market. Furthermore their success was pinned by its unique British operating system and its creator, businessman David Potter.

In 1997 Nokia merged with Symbian hoping to create the perfect match. Together they created a new class of device and for a while they seemed to be way ahead of all other competitors in the development of smartphones. However things started to go wrong when there was an invasion of businessmen and engineers, who took over highly sensitive design areas. Their was a feeling of corporate arrogance as they lead Nokia to a string of bad decisions. The company's visions, strategies and education were being violated by those without the track record, education or passion.

The rapid growth of Nokia resulted in the company’s capabilities becoming misaligned as communication broke down. They bought anything and became so big and so self-congratulatory they lost sight of their roots.

In 2007 Apple introduced their revolutionary iPhone. Nokia tired to compete and adapt to the changes created by Apple. In 2003 they created a ‘gaming phone’ however this failed miserably and the concept of a gaming phone was only realised with the arrival of the iPhone and iTunes Store. Ovi, Nokia’s answer to the iTunes Store, was a disastrous launch and furthermore they refused to add touchscreen to their high end products.

Rather than sticking to their philosophy of ‘simple is successful’ Nokia have tried their hardest to compete with the high technology and innovative iPhone. Their biggest decision to date has been to drop Symbian, used by 400 million phones worldwide and sign up to Windows Phone 7 software (used by 4 million people), made by Microsoft.

Both shareholder value and the finances of Nokia have taken a battering over the years. Cash reserves of $5.6bn, were down from nearly $7bn last year and the share price plummeted to an all time low of just $3.98 in June 2011, compared to 2000 when the share price was $61.

2012 will be a real test for Nokia.  The integration with Microsoft will make or break Nokia’s desire to crack the smart phone market and compete with the likes of Apple and Google. The link below gives an incite into whether Microsoft can save Nokia.

http://news.bbc.co.uk/1/hi/programmes/click_online/9626628.stm

It is clear that Microsoft is key to Nokia’s success however a lack of investor confidence is affecting Nokia’s capability to move out of the rut they have created for themselves. Therefore the creation of shareholder value needs to be emphasized and present in order for Nokia to successfully move forward.