Company Fundamentals,Macroeconomic And Non-Economic Factors As Determinants Of Equity Premium:Evidence From Pakistan

Pakistan stock exchange is one of the best emerging stock market in South Asian region.However,it has not been deeply studied and having room for empirical research.This study explores firm level equity premium and its determinants in the context of Pakistan stock exchange.We calculates market premium,the individual asset premium for306 non-financial firms listed in Pakistan’s stock exchange and sector premiums for 17non-financial sectors.We used data for the period of 15 years ranging from 01/2001 to12/2015,a total 4590 observations.During the selected sample period the average market premium of Pakistan Stock Exchange(PSX)KSE100 Index is 20 percent.However,the average equity premium of individual firms is 8 percent.The sector wise equity premium is ranging between-2 percent to 61 percent annually.The main objective of this study to investigate the factors influencing firm level equity premium.These influencing factors are classified into three different categories according to its different control level and behaviour.Firstly,we explored the impact of selected company fundamentals on firm level equity premium.Secondly,we examine the interplay between macroeconomic factors and firm level as well as industry level equity premium.Thirdly,we investigate the impact of non-economic factors on firm level equity premium.Lastly,we use the concept of optimal arbitrage pricing theory and combine different level of variables for different econometric equations to examined the sensitivity effect.This study gives certain insights to fund managers,investors and policy makers for taking necessary steps in possible accurate decision making from their own perspectives.In next two paragraphs we discuss the empirical findings of our study followed by concluding remarks and future directions.While investigating the relationship between company fundamentals and firm level equity premium it is found that company fundamentals significantly affect the firm level equity premium.The signs of company fundamentals were found according to the theoretical expectations and the previous literature.The increase in market premium,return on equity,dividend payout ratio,account receivable and firm size positively affect the firm level equity premium.However,increase in debt to equity and quick ratio negatively affect the firm level equity premium.This provides an insight to the shareholders and institutional investors for investment in an individual firms stock.Such company fundamentals help them in better allocation of funds in different portfolio stocks.Similarly,it can help corporations to adjust their financial leverage and encourageinvestors to invest in those stocks.Secondly,we follow the concept off macro-based risk factor model and consider macroeconomic variables another set of equity premium determinants.The macroeconomic variables include interest rate,money supply,industrial production,inflation and foreign direct investment are not in control of the firm’s management.The Macro-based Multi-factor Model is estimated and found that the market premium and the selected five macroeconomic factors significantly affect the firm level equity premium of non-financial firms.Increase in market premium,money supply,foreign direct investment and industrial production positively affect the firm level equity premium while increase in interest rate and inflation negatively affects the firm level equity premium.These findings are beneficial for the common shareholders,institutional investors and policy makers to find more specific insight about the relationship between macroeconomic variables and equity premium of non-financial sectors.The macro-based Multi-factor model is further estimated and examined for each non-financial sectors separately.The result of different macroeconomic variables found different for different industries.The sector which produced seasonal goods are free from any sever effect of change in macroeconomic variables,e.g.Beverages and Tobacco sectors.Thirdly,we examined the non-economic factors included terrorism,government stability and law and order on firm level equity premium.In addition to this,the change in the government regime and 2008 global financial crises dummy are also considered as influencing factors of equity premium.The estimated results reveal that terrorism has statistically significant negative impact on firm level equity premium in Pakistan.Controlled law & order variable has significant positive effect on firm level equity premium,which implies that equity premium increases with the improvement in law &order situation in the country.Government stability and democratic system in the country positively affect firm level equity.The results also reveal that 2008 global financial crisis negatively influenced the firm equity premium.Furthermore,in the last part of this study,we examine the optimal arbitrage pricing concept and use different combination of factors to examine the combine effect on firm level equity premium.The results of the variables remain consistent with the previous findings of our study except the account receivable turnover and dividend payout ratio which shows insignificant effect in this optimal arbitrage pricing model and can used for valuation of PSX securities.Non-economic factors cause the major impact on firm level equity premium followed by macroeconomic and company fundamentalsIn summary,this study makes a significant contribution to existing literature with respect to decision making at different levels.This concludes that the investors and policy makers need to review but not limited to the company fundamentals,macroeconomic variables and the non-economic factors as determinants of equity premium.This can help in better industry diversification and calculations of expected rate of returns.The firms itself can greatly be benefitted from the analysis for better financial management decisions.Further policy implications and some future directions are discussed in the conclusion section of this study.