seb on journal issue 3

SEBON Journal

Securities Board of Nepal Thapathali, Kathmandu

Volume III July 2007

SEBON Journal, Vol.III, July 2007 2

Building a Dynamic Capital Market

- Deepak Raj Kafle

Nepalese financial system is characterized by small but a growing capital market. During the past 14 years of its operation, securities market has witnessed three market phases of ups and downs. The latest upswing started from the fiscal year 2002/03 and is continuing. During this phase, Nepse index, the market indicator climbed from 205 to 621 (July 10, 2007). The market capitalization of the listed stocks climbed from Rs. 35.24 billion to Rs. 169.05 billion during the same period. During the past five years, capital mobilized through public issue and rights offerings has been in the tune of Rs. 8.4 billion from 109 issues. In the fiscal year 2006/2007 alone, capital worth of Rs. 2.8 billion has been mobilized from 34 issues. In spite of expansion in size, the securities market is yet to make quality transformation gaining depth and maturity. The market lacks sectoral diversification of performing listed companies, access to secondary trading services is limited , transparency and efficiency of the issuer and market is not sufficient, capacity of the regulator, exchange and the players is limited, the market is featured by active individual investors and the institutional investors are conspicuously absent. The market infrastructures supporting the trading, clearing and settlement are not sufficient. Thus the effort to build a dynamic market is going to be an ardent task requiring a lot of commitment and efforts of the government, regulator, market place, maker players and the investors. The vision for a new Nepal has to have an important place for a dynamic capital market. It should be a market where issuers have choice to tap the funds at lower cost while people have choice to invest in the securities with different risk and return. In essence, securities market is a mechanism that delivers public access to ownership and share benefit from the investment. The fund requirement to finance the establishment and expansion of corporate sector can conveniently

Chairman, Securities Board of Nepal


come from capital market as these entities venture to tap the opportunities in the economy. The vision of a vibrant capital market assumes that a country has respectable level of and visible progress in country’s governance. Some aspects of governance like rule of law, effective tax administration, and political stability to ensure consistency and continuity of economic policies, directly impact the confidence of domestic and foreign investors in the market. The governance parameter, particularly the market related ones, should be improved so as to make a meaningful breakthrough in the capital market sector. It is well understood that large number of intermediaries, institutions and professionals are the players and advisors active in capital market. Regulations and laws governing the capital market are diverse, numerous and complex too. At this point of time, Nepalese capital market is focusing on reforming the laws, regulations and policies, building institutional capacity, above all visualizing a dynamic capital market in order to tap the inherent potential and managing the cross border issue and trading of securities. This article intends to highlight important reform initiatives and some critical aspects of capital market development in Nepal. Legal and regulatory aspects

Government is responsible to frame securities laws and devolve power to make regulations. The government also has its role in formulating capital market development plan and addressing economic, fiscal and public borrowing policies bearing close linkages to the capital market growth. Government plan should support appropriate structure, incentives and infrastructure for the capital market. Nepalese capital market has basically been an outcome of government planned efforts. It has still been a major stakeholder in the ownership and management of the stock exchange. The Securities Board of Nepal (SEBON), the capital market regulator has majority government nominee (four out of seven) including a full time chairman and an expert member. The whole set of regulations are to be


approved by the government which also has the responsibility to provide program based budgetary support to the regulator. It is now time ripe for transforming the capital market in a way that is more responsive to the need of the market and competition. This means that the capital market should be more market driven shifting from the current government driven model. As such government can focus more on creating a proactive regulatory regime and allow the market to have sufficient flexibility. It is expected that the reform initiatives will be more convenient when the government is still in the driving seat in the market operation too. Experiences of strong capital market regulator in other countries including those in the South Asian region shows more full time members enable more responsible regulation and enhanced professionalism. This is also how banking regulator in Nepal is executing its regulatory functions. For effective execution of its regulatory functions SEBON need to have three full time professional members in place of a one full time member in the role of chairman as it currently stands. SEBON’s responsibility to formulate policies, supervise market and enforce the cases of non-compliances can be addressed more professionally and in a balanced way. Another issue is that a regulatory system should have appropriate mechanism to address the conflict of interest. It is in this context, major conflict situations should be addressed by law whereas minor conflicts by ethics of the profession and disclosure of the conflicting action. The securities act has allowed even the executive of a listed company to be a member of the regulatory board. This could be counter productive while developing policies and conducting investigation against the cases of noncompliance. For the given legal framework and market needs, it is hard for the regulator to maintain its independency and autonomy. The concern here is in formulating regulation and meeting the financial needs for its operation. The government is still in the steering seat of regulation making. The approach and process of regulation approval by the government has not yet been clear and time bound.


Based on the past experiences, some approach can be suggested to expedite the process more rationally. The government should facilitate regulation making by interfering only in those regulatory areas which are in conflict with the economic and fiscal policies of other sectors. However, it always reserves the right to issue directives to the regulator and thereby entrusting the regulator for formulating regulatory standards and policies in an independent manner. The capital market development finds place in national plans but its implementation has suffered in absence of sufficient resource commitment and close monitoring. The market infrastructures that may require more investment in the beginning will pay back in terms of credible and efficient market in the future. Furthermore, a better coordination between the regulatory agencies would be helpful to nurture the growth of nascent capital market. Linkage with banking regulation

The banking regulation is closely linked to the capital market regulation. Nepal Rastra Bank (NRB), the banking regulator, has been an important player in promoting the growth of capital market institutions at the early stage of market development. It has representation in the SEBON to ensure coordination of the regulatory policies. But the bank’s involvement extends to the management and ownership of stock exchange and few listed companies. Recently, it has started withdrawing from ownership and management in order to alleviate potential conflict of interest and ensure regulatory effectiveness. As an authority of monetary policy, financial market stability is one of the prime goals of the central bank. It is also relevant to note that the efficiency of equity, bonds and government securities markets also affects the successful transmission of monitory policy. Secondary market for the government securities has been arranged through stock exchange under the rules and regulations under the National Debt Act and Securities Act.


These initiations are important to give market pricing mechanism including market based reference benchmark for setting interest rates. Market Regulation

Business persons involved in securities businesses are regulated under market regulation. They may be the players of secondary market taking a role of brokers, dealers or market makers. There are two dozen brokers and other functions are practically absent. It is in this context, SEBON has developed broker dealer regulation prescribing ‘fit and proper’ criteria for broker dealer licensing and business operation. It is expected to define regulatory jurisdiction of the SEBON as the government regulator and the stock exchange as the front line regulator with defined responsibility over listing of companies, disciplining members in the exchange and facilitating trading. However, the Securities Act oversteps by awarding stock exchange the power to recommend the members for licensing. This has made SEBON to wait for the stock exchange’s recommendation for granting license to the new entrants. It is normally a practice that regulator should focus on ‘fit and proper criteria’ for the entry and meeting the standards for operating the securities business. From regulators perspective, all those meeting the criteria and standards should be allowed to enter and remain in the business and not usually restrict business persons to enter the market competition. Market efficiency

The stock exchange is a place for providing efficient trading platform for the listed companies through its members. The present legal framework has defined the responsibility of the exchange in admitting securities for trading, providing membership to the brokers and the dealers and providing trading, clearing and settlement of securities. These functions are implemented through the membership, listing and trading, clearing and settlement byelaws. The requirement of these byelaws has been structured by SEBON under the stock exchange regulation and stock exchange has draft byelaws suggested by the international experts. These bylaws are meant to make the market run on more acceptable standard practices and make the market more flexible and efficient. It is in this context that government has a program to privatize the stock exchange


and allow it to operate under a truly corporate structure. The market looks forward to implementing these initiatives supported by more use of IT in trading, clearing and settlement. The secondary trading of stocks thus far is provided mainly for those shares going public through Initial Public Offerings (IPO). In this type of going public of the corporate bodies i.e., the issuers have a self regulated responsibility toward making disclosures as specified under the laws and regulation. The due diligence responsibility for the IPO process and the disclosure lies with the issue managers licensed by SEBON. SEBON takes the responsibility for ensuring adequacy of disclosure through its comments while relying on the issuers for the contents and issue managers for due diligence responsibility. The mechanism of offer for sale as a mode of going public is not a common practice. SEBON has been formulating appropriate policy through the upcoming regulation to enable the existing holder of securities to offer their holdings to the public, prescribe the disclosure requirements and responsibility for the disclosures. The window of going public through offering requires stock exchange to be a central place for the dissemination of corporate and market information. Corporate Financing

The stock market is bullish and getting to new peaks. This would have been good news if the sustainability of the market was not a serious question. For the given performance of the listed companies, the growth trend and future prospects, the market is higher than an analyst would justify. This may be attributable to a number of reasons including higher liquidity and absence of other investment opportunities, absence of institutional investor to make the market more stable and rational, and more investment awareness of investors on the risk return and investment profile. But the basic reason lies in the limited supply of scrip in the market. To increase market depth, it is necessary to increase the supply of securities. In order to enhance the supply of securities, a new securities registration and disclosures regulation is in the making that would bring major regulatory


changes. This regulation sets the disclosure standards for going public through IPO or secondary offerings through stock exchange. This disclosure based regulation is believed to encourage closely held companies to come to the capital market and entrepreneurs to sell their holdings in favor of the general public. Besides, this regulation enables the issue of variety of instruments. However, this could be meaningful once of the accounting standards and auditing practices assure full financial disclosure. Conclusion

The government sector involvement in the market operation should gradually be shifted to benefit from private sector efficiency and competition, and its focus should be towards strengthening the market regulator and in building market infrastructures. This would demand government to screen the different regulations based on their consistency with the overall economic and fiscal policies and not normally get involved in the details of regulation. This will help to rationalize the market which currently is requiring balancing the interest of the government sector stock exchange and SEBON as government regulator. Government has recently announced opening of stock exchange for foreign investment. In the meantime, the mechanism for collective investment vehicles with proper enabling Trust Act would be a right step to increase the market depth and manage outward flow of investment. Now, the urgency is in establishing appropriate policies through regulation, and setting standards and procedural guidelines. In this process, some regulations viz. regulation enabling SEBON to exercise its regulatory powers, regulation requiring license for stock exchange and setting operational standards and regulation for licensing of broker-dealers and setting their regulatory standards have already been developed by SEBON and awaiting government’s approval. Besides, merchant banking regulation covering issue management, underwriting and securities transfer registrar, and SEBON's employee regulation have been drafted by the management are in the discussion stage at the board. Other draft regulations finalized by the management are securities registration and disclosure regulation and mutual fund regulation. The regulations, which are currently under the approval stage of the


government are very urgent to address the emerging issues in the market before the deadline of securities registration, and licensing of stocks exchange and business persons as set by the Securities Act. The stock exchange needs to adopt the listing, membership and the trading bylaws to give appropriate standards within its jurisdictions. As the draft bylaws have already been suggested by the international experts, it should be adopted at the earliest. Furthermore, the stock exchange is in last phase of introducing trading automation under the Corporate and Financial Governance project. It will add up efficiency and transparency of the market and pave the way for further extension to online trading.

NRB Monetary Policy and Stock Market Impacts

- Professor Dr. Manohar K. Shrestha Monetary Policy of the Central Bank has a profound influence on the performance of the securities market. The conduct of Monetary Policy comes under Target and Goal Setting of Central Bank (Mishkin, 1992) that covers various objectives such as price stability, interest rate stability, high employment, financial market stability and stock market is an integral part of it, stability in foreign exchange and ultimately economic stability and growth. At present, monetary policy cannot be separated from stock market although the effects of monetary policy are guided by the broader consideration of macro-economic variables (Sprecher, 1994) in two ways: i) Relationship between economic development and contribution of stock market to its sound and steady growth and ii) Cyclical pattern generated from the changes in monetary policy and underlying upward and downward paths creating movements in stock prices. Apart from these basic influences, monetary policy plays a decisive controlling function to avoid artificial rigging in stock prices to save investors from the hands of gambling-tendency speculators. The intervention of Central Bank (Prime, 1992) in stock market has been taken positively to minimize the vast growing number of manipulators in the stock market activities as well as to accomplish the goals of enhancing economic stability, employment, income generation, capital formation, productivity of industrial enterprises and vast economic growth to raise living standards of the people. The monetary policy structure acts as a powerful tool (Widicus and Stitzel, 1996) to foster and encourage the activities of the positive-driven strategy. Monetary policy creates overall linkage to guide the stock market to take right kind of direction and change proving vital to endure fair trading practice and compliance of the guidelines and regulatory provisions to protect the common interest of the investors.

Professor, Central Department of Management, Tribhuvan University, Kirtipur,

Kathmandu


As is the case in highly industrialized and advanced countries where central bank acts as supreme legitimate authority (Hadjimichalakis, 1995) in the determination and implementation of monetary policy aggregates, NRB in our country is fully empowered to create money and regulate its value through the use of various monetary tools. Tenth Five year Plan Document, 2002-2007 (NPC,2002) clearly states that the prime objective of Monetary Policy is to maintain macro-economic stability by ensuring adequate liquidity in the economy and sufficient credit flow to the private sector to attain sustainable development and high growth rate in the economy supported by price stability and favorable balance of payments. In addition, macro-economic targets are set out to maintain average annual inflation rate to 5%, increase the growth of broad money supply to 14.5% and narrow money supply at annual rate of 11.5%, increase credit from banking sector to government at 6.3% and 20% to private sector and balance of surplus targeted to Rs. 3.7 billion. It is in this contextual perspective that the recent announcement and the declaration of Nepal Rastra Bank's Monetary Policy has drawn the attention of the government, commercial banks, development banks, non-bank financial institutions, professionals, intellectuals, investors and other interested parties. All of them are trying to observe and analyze how such a policy is going to affect the economy and stock market because directly or indirectly they are the stakeholders. The necessity for NRB to have slightly cautious and tighter Monetary Policy was designed with its justification (Economic Report, 2004/5). This is against the background of observing slow economic growth, continued and growing trend of inflation, slight improvement in balance of payments, rapidly growing high level of non-performing assets and considering many other factors influencing the economy. Making price stability as a solo objective, NRB has basic strategy to properly implement the Financial Sector reform Package by lowering the cash reserve ratio. The excess liquidity of commercial banks was taken as operating target by putting bank rate at constant level of 5% and using this as an instrument to pursue growth of broad Money (M2) at 12.5% so that price stability could be maintained at 5.5% level and achieve Rs.5.5 billion balance of payment surplus.


These are positive indicative signals under NRB's Monetary Policy Framework in operation for ensuring better Liquidity Monitoring and Forecasting Framework. Moreover, it is clearly spelled out in Economic Survey Report of 2005/6 that the Monetary Policy and Strategy of NRB as a Central Bank of the country is to consistently maintain the macro-economic stability by using various monetary instruments to mop up the liquidity position, control on inflationary pressures and not to exert unnecessary pressure on the prevailing exchange rate on the economy. In the stock market operation too, Capital Adequacy Framework as designed by NRB is a welcome proposition for all commercial banks, development banks, finance companies and other non-banking financial institutions. This has been one of leading economic variables for the purpose of investors' analysis and judgment for making investment decisions in selected blue chips. NRB's Monetary Policy and Directives after enactment of Banks and Financial Institutions Act, has also been strong as it makes mandatory for all commercial banks to meet paid-up capital requirement of Rs. 100 million by the year 2066. Keeping this in mind, all commercial banks have planned capital adequacy in response to NRB directives and compliance of BASEL Accord to follow international banking standards. NRB's stand on the implementation of it directives was very strong as even the repetitive efforts and hard lobbying by the Nepal Bankers Association proved futile and useless. Since the banks had to manage paid up capital of Rs. 100 million within the stipulated period, it resulted into a full fledge bullish trend in the stock market raising the NEPSE Index to multiple points as high as 386 points as well as enhancing the volume of trading mostly in commercial bank stocks. But, stock market development could not keep pace with real sector development in terms of operation of trading and industrial activities. Instead, Nepalese economy recorded poorest real sector performance (NEPSE Annual Trading Report, 2005/6) due to frequent transport blockade, poor security situations and other unexpected events resulting from pressure group disturbances and total breakdown of civil society's discipline. At the same time, Securities Board of Nepal emphasized on the continuity of Corporate and


Financial Governance Project for modernizing Stock Exchange (Annual Report, SEBON, 2004/5), enhancing securities regulation and disclosure with added focus on developing Central Depository System, soliciting interest from vendors for automation of stock exchange and strengthening of institutional capacity of NEPSE, SEBON and CRO to stabilize the capital market. Despite all these development initiatives, NRB's Monetary Policy had an impact on the performance of stock market as investors were lured into buying shares of commercial banks at higher market price with the expectation that banks would issued bones shares to increase its capital base to Rs. 100 million. As a result, there had been tremendous demand for shares of commercial banks in every day transaction raising stock market index to unexpected highs. Investors used their own and borrowed capital for purchasing shares of these banks and market price jumped in multiples showing higher top price swings. The credit facilities from banks and financial institution accepting banks' shares as collateral became encouraging factor to increase volume of share transactions. During such a bullish period, it is estimated that loan from various commercial banks, financial institutions and other non-bank financial institutions crossed more than Rs. 5 billion putting shares as collateral. The NEPSE Index reached to the almost peak of 430 points compared to previous year figure of 287 points. During the same period, market capitalization touched as high as Rs. 97 billion although it was just Rs. 61.4 billion in 2004/5. But beyond the investors imagination NRB made a change in its previous monetary policy. The new monetary policy announced gave flexibility in the Capital Adequacy Base Requirement of commercial banks. Under this policy capital adequacy requirement was redefined in terms of capital adjustment provision rather than the paid up capital. This change was as stated in BASEL II capital. Such a policy announcement confused the investors and immediately brought a greater setback in the stock market transaction within two-three days. There is complete stock market closure in technical sense and thin trading followed for some consecutive days. How the stock market is affected seriously can be explained with drastic drop figure of NEPSE Index as follows:


Drop in NEPSE INDEX Following NRB Announcement

Before Announcement After Announcement Change (+/-)

386.59 378.59 -7.74 366.73 -12.03 358.69 -8.04 355.60 -3.09

Total Drop -30.90 The huge slip in NEPSE INDEX by 30.90 points is the highest fall that has ever happened in the 12 years history of Stock market in Nepal. The market capitalization that has peaked to the amount of Rs. 96.94 billion immediately melted down and bringing it to the tune Rs. 89.02 million. The loss in market capitalization is Rs.7.92 billion which is a huge loss resulting from NRB's announcement of new monetary policy. How to correct the matter timely became a felt necessity for a responsible authority in the interest of the investing public so as not to affect the investors' fortune and also not to disturb the smoothly running capital market operations. To the unfavorable effects of NRB Monetary Policy statements on market price of shares, a large gathering of the investors in NEPSE immediately reacted to such a move on already declared policy statement of capital base requirement imposed on commercial bank. Investors called the media to draw their attention on the impact of new monetary policy on the stock market. The angry investors expressed their grievances that there is no reason why such a change is felt despite renewed emphasis and continuity of the enforcement of maintaining Rs. 100 million paid up capital to all commercial banks within stipulated time period. Ultimately NRB wisely and positively responded to this grave concern of investors relating to capital adjustment provision and NRB Board Meeting came to a decision to follow with release of information that paid up capital to be maintained would be Rs.80 million instead of Rs.100 million and banks were allowed to distribute dividend and bonus share to the investors. Such a decision


in motivated to avoid all pitfalls and provide remedies for avoiding disturbances and turbulence created in the capital market. At the same time, for the first time in the stock market history, NEPSE introduced circuit breaker by not allowing stock price to rise and fall more than 10 percent in every subsequent transaction to discourage price speculation within a day. During the same period, SEBO discouraged mutual trading on share transaction as this could unnecessarily rig up the market price artificially to give false impression of price rise to investors. These measures however appreciable cannot be permanent solution unless regulating authorities follow professional commitment to maintain consistent policy. Even then investors' doubt still exists as to why the earlier stand of stringent capital base requirement of Rs.100 million paid up capital was relaxed to Rs.80 million. In fact, NRB followed a logical policy rational to make some change in monetary policy to decrease paid up capital base to 80 percent to follow Win-Win Situation to balance the interests of investors on hand and commercial banks on the other hand in response to the BASEL Accord. But, the revival of the market after the announcement of new capital base requirement has already shown positive signs of improvements and impacts on the stock market since NEPSE INDEX recorded as follows:

Rise in NEPSE INDEX Following NRB Announcement

Before Announcement After Announcement Change (+/-)

355.60 357.27 +2.67 383.14 +25.87 385.22 +2.08

Total Drop -30.52 This clearly shows that NEPSE INDEX revived to the previous level although there is slight difference and market capitalization still takes time to maintain previous record level.


The lesson learned from New Monetary Policy Announcement is that it should be a long-term policy and should not interfere in the price sensitive capital market phenomena determined from the free play of the market forces. References:

Bober, Stanley, The Economics of Stock Market Cycles and Growth, Wiley and Sons, New York, 1998.

Chiristy, George A and Clendin, John C., Introduction to Investment, McGraw-Hill Book Company, Bombay, 1982.

Haberler, Gottfried, Prosperity and Depression, George Allen and Unwin Limited, London, 1955. Hadjimichalakis Michael G. and Hadjimichalakis Karma G., Contemporay Money, Banking and

Financial Markets, Irwin, Chicago, 1995. Loeb, Gerald M., The Battle for Investment Survival, Simon and Schuster, New York, 1998. Ministry of Finance, Government of Nepal, Economic Survey, Fiscal Year 2004/2005, Ministry of

Finance, Singhadurbar, Kathmandu, 2005. Mansukhani, S.K., Golden Investment Strategy: What Every Investor Should Know, Lavani

Publishing Company, Bombay, 1968. Mishkin, Frederic S., The Economics of Money, Banking and financial Markets, Harper Collins

Publishers, New York, 1992. National Planning Commission, Government of Nepal, Tenth Plan, 2002-2007, National Planning

Commission, Singadurbar, Kathmandu, March 2002. Nepal Rastra Bank, Economic Report 2004/2005, Central Office, Research Department, Baluwatar,

Kathmandu, 2005. Nepal Stock Exchange, Annual Trading Report, Fiscal Year 2005-06, Research, Listing and

Planning Division, Nepal Stock Exchange Limited, Singhadurbar Plaza, Kathmandu, September, 2006.

Poudel, Dandapani, Monetary Policy and Transmission Mechanism in Nepal, NRB Samachar, NRB, Baluwatar, 2061.

Securities Board of Nepal, Annual Report, Fiscal Year 2004/2005, SEBON, Thapathali, Kathmandu, 2005.

Shrestha, Shivraj, The Efficacy of Liquidity Monitoring and Forecasting, NRB Samachar, NRB, Baluwatar, 2062.

Sprecher, C. Ronald, Introduction in Investment Management, Houghton Miffin Company, Boston, 1975.

Thapa, Nara Bahadur, Financial Sector Stability and Monetary Policy, NRB Samachar, NRB, Baluwatar, Kathmandu, 2062.

Widicus, William W. and Stitzel, Thomas E., Personal Investing, Homewood, Illinois, 1985.

Price Volatility and Measurement of Risk

- L. D. Mahat People hold shares with an intention to earn money. Finance theory states that in every return, there is some risk associated with it. While an investment in shares has the prospect of earning good return, it also has the risk of losing large amounts of equity. A traditional investor in stocks can only protect his or her holdings by divesting the investments. The stock market can be a risky place for investors if they do not know how to protect themselves from potential losses. Change is the essence of life and risk is the integral aspect of living. This holds equally well for the capital market. In the capital market, risk may be defined as the chance that the expected return either may not materialize or may be less than expected. Return earned from investment in shares of a company usually has two components: the periodic cash flow such as receiving dividend; and the appreciation in the price of shares, called the capital gain. Price volatility is generally used to describe price fluctuations of a commodity. Volatility is measured by day-to-day percentage difference in the price of commodity. Applying the similar concept in capital market, the price volatility of a share may be defined as the amount of variation in its price. The most volatile shares are those with the largest variation in the value of their share price. Due to this fact investment in such shares are considered the most risky. Volatile share market is a market subject to price fluctuations, which increases the risk of price changes of shares. Compared to the dividend, market price is the more crucial factor, which contributes to the success of investment. Therefore, volatility in the price of shares is a more critical risk associated with the capital market. The degree of variation in the prices of shares, not the level of prices, defines a volatile share market. Greater volatility of shares in the capital market for several reasons matters the investors. It sheds light on what is happening in an economy-

Chartered Accountant, CSE and Company, Baluwatar, Kathmandu


and in the minds of investors. It makes investing in shares a riskier business, and it has big knock-on effects on the prices of other securities, such as bonds. Volatile market is not always risky for the investors. In the financial market, return can be maximized only at the cost of incurring higher degree of risk. A fall in the market price of shares results in decreased profit or increased loss to the investors. However, appreciation in share price would put the investor in a favourable position. It is, therefore, understood that many investors respond positively to market volatility since increased volatility provides opportunity to move into the market. Short-term fluctuation in the price of shares also affects the investors who intend to invest in the shares and earn returns in the short span of time in a similar manner. The prospective investors need to find out the degree of price fluctuations in order to know the degree of risk involved in the investment. The degree of fluctuations in the price of shares can be found by computing price volatility index of shares. Volatility measures the dispersion about a central tendency. There are a number of ways to measure the price volatility of shares. One of the widely accepted methods is the Price Volatility Index (PVI). PVI is computed by dividing the range of price fluctuations of a share by the average price of the same share. A range is the difference between the highest and lowest price of shares during a particular period and the average price of share is the average of these highest and lowest prices. For example, if a company's shares are traded in the market at the highest price of Rs. 1,500 and at lowest price of Rs. 700 in a particular year, the PVI of the shares of the company becomes 0.73, i.e., {(1500-700)/(1500+700)/2}. PVI can be computed on an annual basis in order to find out long-term price fluctuations. But, in order to find out long-term price fluctuations PVI can be computed on a weekly, monthly or quarterly basis.


Nepalese capital market has always been dominated by the banking and finance sector. The market is almost non-existent in other sectors with the exception of few companies. Therefore, PVI of selected listed banks has been computed and presented in the following table in order to analyze price fluctuations of their shares. Table 1: PVI of selected banks

Name of Bank 1998/99 1999/00 2000/01 2001/02 2002/03 Average Nabil Bank (NABIL) 0.61 0.72 0.55 1.05 0.22 0.63

Nepal Investment Bank (NIB) 0.56 0.53 0.87 0.67 0.33 0.59

Nepal Std. Chartered Bank (NSCB) 0.53 0.54 0.50 0.71 0.24 0.51

Himalayan Bank (HBL) 0.53 0.56 0.69 0.86 0.24 0.57

Nepal SBI Bank (NSBI) 0.43 0.43 0.80 1.37 0.47 0.70

NB Bank (NBBL) 0.92 0.61 1.13 1.12 0.44 0.85

Everest Bank (EBL) 0.82 0.84 0.94 0.78 0.34 0.74

Bank of Kathmandu (BOK) 0.92 1.17 0.83 1.16 0.42 0.90

Higher the PVI riskier will be the security. Generally, a PVI value greater than 1 is considered as aggressive security. On the other hand, a PVI value less than 1 is considered as defensive security. Over a period of 5 years, NSCB has an average PVI far lower than 1, hence the shares of this bank has the lowest risk. The other less risky securities are of HBL and NIB. BOK's shares are the most risky based on PVI calculation. Fluctuations in the price of shares of a company could arise due to price sensitive information received by the market such as earnings announcement, announcement of bonus and announcement of right shares. NSCB has no bonus announcements since 1999/00. This may be one of the reasons for low PVI of this bank. On the other hand, HBL has been maintaining lower PVI next to NSCB, in spite of bonus announcements in all the years. NABIL had higher PVI in 2001/02, although it had no bonus and right announcements in that year. BOK had a PVI value 1.17 in 1999/00, although it had no bonus and right announcements. NSBI and BOK had exceptionally higher PVI in 2001/02 as a result of right announcements at the ratio of 2:1 and 1:1 respectively in that year.


While ancient societies used to face the risk just by believing in fate, modern societies endeavor to manage the risk with the help of various risk management tools and exploit the opportunity of enhancing returns. Management of risk calls for understanding, measuring and analyzing it. PVI is one of the useful tools for the investors to manage risk.

Nepalese Securities Market: Regulation and Development

- Kiran Thapa

1. Introduction

Looking back into the history of Nepalese securities market, we can find that the market started in the mid 1930s with the issuance of shares by some companies. However, the formal institutionalization began only after the establishment of Securities Exchange Centre in 1976. The then Securities Exchange Centre was responsible for undertaking the job of brokering, underwriting, managing public issue, market making for government bonds and other securities markets services. Introduction of the Companies Act in 1964, issuance of Government Bond in 1964 and introduction of Securities Act in 1983 were the important past initiatives for developing securities markets in Nepal. The development process accelerated with the liberalization policy of the Government during 1990s. During this period major initiatives were taken for the development of the securities market, the most important one being establishment of Securities Board of Nepal (SEBON) in 1993 as an apex regulator of securities markets. With the establishment of SEBON the then, Securities Exchange Centre was converted into Nepal Stock Exchange Ltd. (NEPSE), which started secondary trading of securities with the introduction of stockbrokers. As of the March 2007 there are 23 stockbrokers, 3 securities dealers and 9 issue managers providing securities market intermediation services and 131 listed companies. The major regulatory framework for the securities markets is provided by Securities Act, 2006, which has given authority to the SEBON for the regulation of securities market. As per the Act, the major objectives of SEBON are to regulate issue and trading of securities and market intermediaries, promote the market and protect investor's rights. Besides, the duties and responsibilities of Securities Board are to register securities and approve prospectus of public companies, provide license to operate stock exchanges, provide license to operate securities businesses, permit operation of collective investment schemes and

Mr. Thapa is Lecturer of Finance in Shanker Dev Campus.


investment funds, draft regulations, issue directives and guidelines, and approve bylaws of stock exchanges, supervise and monitor stock exchanges and securities business activities, take enforcement measures to ensure market integrity, frame policies and programmes relating to securities markets and advise the Government in this regard. Thus, the responsibility of developing and regulating the securities markets in the country rests solely on the SEBON. 2. Status of the Market

The performance of the market during the period of 1993/94 to 2005/06, as shown by the various indicators, reflects a progressive trend. Table 1 shows that the annual public issue amount in the fiscal year 2005/06 is about 10 times more than that of the fiscal year 1993/94. Similarly, the market capitalization value, annual turnover and NEPSE Index have also increased significantly during the period. However, average turnover to market capitalization ratio being only 4.16 indicates that the liquidity level of the market is very low. The contribution of market capitalization to Gross Domestic Product during the period is on an average 8.76 percent, which indicates that the securities market does not have significant contribution to the economy. Table 1: Trend of Securities Market

Year Amount of issue

(Rs in million)

Market capitalization

(Rs in million) Turnover (Rs in million)

Turnover to Market

Capitalization Ratio

Market Capitalization

to GDP Index

1993/1994 244.4 13872.0 441.6 3.18 7.24 226.03 1994/1995 174.0 12963.0 1054.3 8.13 6.17 195.48 1995/1996 293.7 12295.0 215.6 1.75 5.14 185.61 1996/1997 332.2 12698.0 416.2 3.28 4.71 176.31 1997/1998 462.4 14269.0 202.6 1.42 4.93 163.35 1998/1999 258.0 23508.0 1500.0 6.38 7.12 216.92 1999/2000 326.9 43123.0 1157.0 2.68 11.77 360.70 2000/2001 410.5 46349.4 2344.2 5.06 11.78 348.43 2001/2002 1441.3 34703.9 1540.6 4.44 8.58 227.54 2002/2003 556.3 35240.4 575.8 1.63 8.22 204.86


Year Amount of issue

(Rs in million)

Market capitalization

(Rs in million) Turnover (Rs in million)

Turnover to Market

Capitalization Ratio

Market Capitalization

to GDP Index

2003/2004 1027.5 41424.3 2144.3 5.18 8.77 222.04 2004/2005 1626.8 61365.9 4507.7 7.35 12.06 286.67 2005/2006 2443.3 96813.7 3451.4 3.56 17.35 386.83 Average 738.25 34509.66 1503.95 4.16 8.76 246.21

Source: Annual Reports of SEBON

Out of the total securities issue of Rs. 9597.25 million, 55.86 percent is from commercial bank, 2.71 percent from development bank, 15.11 percent from finance companies, 3.18 percent from insurance company, 8.30 percent from hotel, 9.40 percent from manufacturing company, 0.03 percent from trading companies and 5.41 percent from others. (SEBON, Annual Report, 2005/06). This data shows that about 74 percent of the total issue is from banks and financial institutions. The issue from real sector on one hand is very nominal while on the other hand their issues are not often subscribed because of their deteriorating performance. This indicates that the basis of Nepalese securities market is very weak as the performance of the dominant sector may anytime get deteriorated because of lack of long term investment opportunities for the financial institutions. The securities instruments issued in the market are dominated by risky instruments i.e., equity, which has covered about 78 percent of the total amount of the securities and the rest being debenture and preference shares (SEBON, Annual Report, 2005/06). There are two mutual funds operating in the market, however, their regulation is questionable due to the lack of proper and adequate legal framework. All these indicate the limited diversity of securities instruments in the market leaving no choice for the investors to invest as per their risk return preference.


3. Issues

The above facts indicate that the securities market in Nepal is still at a nascent stage and has failed to show impact on the overall national economy. Small market size has made it vulnerable to manipulation and price rigging, low turnover ratio indicates that the market is highly illiquid. Dominance of equity instruments has restricted the participation of risk averter types of investors in the market. There are also the various lapses in legal as well as institutional framework of the market. The major issues of the market are briefly dealt below. 3.1 Structural deficiency in formulation of regulation

As per the provision of Securities Act, SEBON prepares regulations and issued with the approval of the Ministry of Finance (MOF), which is also the reporting authority of the SEBON. At present, there is only one stock exchange which is in the ownership of government. By the authority of government, the responsibility for the management of stock exchange goes to MOF being the reporting ministry of SEBON, the MOF official chairing the NEPSE board would have conflict of interest while approving the rules and regulations related to NEPSE functioning. 3.2 SEBON’s structure is not broad based and the conflict of interest is not

properly balanced As per the provision of Securities Act, the governing board of SEBON comprises of seven members representing various government and private sector agencies, which also includes a full-time Chairman appointed by the Government. Other members of the Board are joint secretary from Ministry of Finance, joint secretary from Ministry of Law, Justice and Parliamentary Affairs, a representative from Nepal Rastra Bank (the central bank), a representative from Institute of Chartered Accountants of Nepal, a representative from Federation of Nepalese Chambers of Commerce and Industries, and a member appointed by the Government of Nepal amongst market experts (SEBON, Annual Report, 2005/06). However, if we look at the governing structure of securities regulator of other countries, in most of the cases we can find at least two full time members from the legal and accounting field. This is important in view of the


securities regulators responsibilities requiring frequent inputs from these fields. The other deficiency in structure is that there is no restriction for the board members to be involved in the listed companies as board member or chief executives or to play other key roles. SEBON being a quasi-judiciary agency, can penalize the listed companies in case of violation of laws, and if the member is from that particular company being penalized, may defend against the action of SEBON resulting to a situation of conflict of interest, which may hamper be effective regulatory function of SEBON 3.3 Inadequacy in securities market legal framework

As visualized by the Act, many rules and regulations have to be developed for the implementation of the Act. It is often heard in the media that the licensing of stockbrokers has been hindered due to lack of stockbroker regulation. Besides, there is also a lack of basic legal infrastructure for the operation of mutual funds in the market. The trust act is also very important for the operation of central depository system of securities and development of bond market. Recently, it was highlighted in the newspapers that a company could not issue rights shares on time with the provision of rights renouncement as enabled by the new provision made in the Companies Act, 2006 and Securities Act, 2006, because SEBON could not give proper modality for rights renouncement as per the provision of the acts. This also shows the deficiency in the legal framework. 3.4 Slow process of enactment of laws

It is noted that the enactment of securities laws has taken near about a decade. The securities act was prepared considering the suggestions of the capital market study report of ADB conducted in 1995 and submitted by SEBON to the parliament in 1999 (SEBON, Annual Report, 2000/2001). This act was passed in 2005 in the form of ordinance (SEBON, Annual Report, 2005/06). Later in 2006, this ordinance has been approved by the parliament and issued as Securities Act, 2006. Not only the act, also the enactment of regulations is also taking unusually long time. SEBON submitted some regulations related to stock exchange and broker dealer to MOF after the issuance of Ordinance (SEBON, Annual Report, 2005/06), however, they were not approved by the MOF. Later, when the


Ordinance was passed in the form of Act, these regulations were again submitted to MOF (Gorkhapatra, June 8, 2007). All these indicate the slow rule making process, which in view of the dynamic nature of capital market is very embarrassing. Such type of delay may be attributed to the fact that either the lawmakers do not understand the technical nature of market and/or the regulator does not have sufficient capability to convince the lawmakers as well as the government about the importance of particular law to be issued. 3.5 Lack of Institutional Infrastructures

The Central Depository System of Securities (CDS), which is very important from the aspect of market efficiency, has not been established. Absence of CDS is one of the reasons why the process of clearing and settlement and ownership transfer has not been efficient and transparent. Similarly, the markets also lacks in the services of institutions like Credit Rating Agencies, which in view of the development of bond market is very important. Lack of alternative trading mechanism such as OTC markets and third and fourth markets is the other prominent issue of the market. The securities, which do not meet the listing criteria of stock exchange or are de-listed from the stock exchange, have no avenue for trading due to lack of such trading arrangements. 3.6 Efficiency of Stock Exchange

It is usually heard in the market and read in the newspaper that the services provided by the stock exchange are very inefficient. Companies are often complaining about the delay in listing. It has even been published in the newspapers in the past that the debentures listing of Himalayan Bank Limited had taken months because NEPSE could not develop appropriate criteria for listing and trading of such instruments. A study of SEBON on performance of issue manager for the period between the fiscal year 1993/94 to 2002/03, published in SEBON Journal Volume II reveals that out of 74 issues, only 12 were listed timely. The trading of stocks in the floor of NEPSE is still carried out through open-out-cry system, which has been obsolete from most exchanges in the world. Due to


lack of automated trading system of securities, the trading has not able to gain confidence in terms of efficiency and transparency. The trading facility is limited only in Kathmandu valley and there is no any provision for providing this facility to the people in other parts of the country. This has also hindered in increasing public participation in the securities markets. 3.7 Efficiency of stock broking services

Currently, there are 23 stockbrokers in the stock market, out of which about 10 are actively involved in the trading. Lack of easy entry and exit mechanism for stockbrokers in the market has limited their number and put constraint in providing fair and competent services. They are not concerned with expanding their services out of the valley and mostly are found to be taken this business as a secondary business. Questions on their professionalism are often raised and the media time to time has also highlighted their involvement in manipulative trading. They are often blamed for not being well equipped to provide investment counselling services to the investors. They are also lagging behind in keeping updated records of trading. In the fiscal year 2005/06, SEBON and NEPSE, on their joint on-site inspection of stockbrokers, found many brokers not keeping updated records of securities transactions and transaction orders for which they were suspended from trading securities (SEBON, Annual Report, 2005/06). 3.8 Absence of institutional investors

The market is dominated by individual investors and most of them are not making informed investment decisions rather driven by market rumours. Because of lack of institutional investors in the market, there is no pressure for the issuers to make timely and regular disclosure. The price formation process of the market is also not fair as the market is lacking the role of such investors in stabilizing the price of securities in case of unusual ups and downs. The role of institutional investor in the market is known to add up new instrument through collective investment schemes, play role in stabilization of the securities prices, make rational analysis of information and pressurise the issuer for the regular flow of credible information.


3.9 Information disclosure

Information is an important element of securities market. Investors can make rational investment decision if there is sufficient information. The institutions disseminating information are issuing companies and stock exchange. Issuing companies have to prepare prospectus at the time of public issue. After listing they have to disclose periodic and other material information (Securities Act, 2006). However, specific format of the prospectus has not been prescribed yet to confirm the requirement of the Securities Act, 2006 and Companies Act, 2006. In lack of specific standards the listed companies under the same group do not have uniformity in corporate disclosure. The credibility of the information has always been questionable in case of many companies as evident from the issues raised by the newspapers from time to time on the professionalism of accountants and auditors. Also there is no any mechanism within the securities regulator for the review of corporate information to test the reliability. Stock exchange has to receive and disclose the price sensitive information, periodic information and other information of the listed companies and also provide the trading information. Timely disclosure of market information such as ask and bid prices, trading amount and price, traded companies, actual demand and supply of securities, types of transaction etc. helps investors to make rational decision and to determine the time to enter the market and exit from it. However, only the information on price and quantity of traded securities is available in the market. 3.10 Securities instruments

The diversity in securities market instruments attracts the investors of various risk preferences providing the choices in the investment alternatives. But in case of Nepalese securities market, it is mostly dominated by risky instrument (equity share), which constitutes more than 80 percent of the total paid up value of the securities listed in the stock exchange and the rest consisting of preference shares, debentures/bonds and mutual funds. Recently government securities was listed in the stock exchange, however, these securities are mostly held by institutions and free float securities are not in the hands of individuals resulting in


limited or no trades. Lack of benchmark interest rate provided by government securities market and the trustee mechanism, the corporate bonds issue practice has still not been popular. So, the market has not become attractive to risk averter and risk neutral investors. 4. Conclusion

The above analysis reveals the weak performance of the market and slow pace of development. Several efforts were made to reform the market and improve market performance. However, these efforts have not become fruitful because of structural deficiencies in market mechanism. Lack of appropriate and standard legal framework has been the major reason for not improving efficiency of regulation. Various kinds of frauds and malpractices from the service providers have been noted. Investors are being the victims of market hypes, as their awareness level could not be raised adequately. SEBON as being the regulator of securities market must be responsible for proper functioning of market. With the enactment of new Securities Act, SEBON should gear up for the overall development of the market. For this SEBON should give maximum emphasis to bring into implementation of the various regulations as provisioned by the Act. A prerequisite for this would be the capacity building of the regulator with adequate authority and operational autonomy, proper resources and experts, and technological enhancement. SEBON should focus to play its role in infrastructure development, improvement of professionalism of the market participants, enhance disclosure standards, supervise market and take enforcement actions to ensure fairness and transparency in the market.

The Performance of Nepalese IPOs

- Gyan Bahadur Dahal

Abstract This paper assesses the performance of Nepalese IPOs and relates them to potential

factors. The study finds that the Nepalese IPOs are heavily oversubscribed and provide the investors with the market adjusted excess rate of return leading to the conclusion that

Nepalese IPOs are underpriced too. The study finds that the NEPSE Index and the subscription as times of issue have significant predicting strength on the performance of IPOs. The study results show that phenomenon of oversubscription can be explained by

the firm size and the debt equity ratios. I. Introduction

The performance of initial public offerings (IPOs) is one of those empirical questions that continuously draw the attention of many researchers in finance. Several researches have been carried out to examine the performance of IPOs in the developed countries like United States, France, Germany, United Kingdom, Japan, Israel etc. and in the developing countries like India, Malaysia, China, etc. where IPO market mechanisms may not be identical. Several empirical studies put forward that IPOs are sold at a significant discount, a phenomenon known as underpricing, from the prices that prevail in the aftermarket that results into significantly better performance of IPOs than that of equity market in general. The deeper the underpricing, the higher will be the initial returns resulting into the better performance of IPOs for the investors. On the other hand, the deeper the underpricing, the lesser will be the net proceeds for the issuing companies resulting into the loss of wealth of the company as it represents the part of the cost of going public for the companies. Various explanations have been laid down to explain why IPOs outperform the market initially due to the underpricing of IPOs under varying IPO market mechanisms. There are both supporting and opposing evidence for these explanations in the finance literature. This study aims to examine the mechanism

Mr. Dahal is lecturer of finance in College of Applied Business, Kathmandu


of Nepalese IPOs market which stands out as an emerging market and their performance. The rest of the article is organized as follows: Section II provides the literature review of the studies carried on different IPO market mechanisms. Section III introduces Nepalese IPOs market mechanism. Section IV gives details of the research data and methodology. Section V presents the empirical findings of the study a period of 13 years from fiscal year 1993/94 to 2005/06. Finally, conclusion is given in section VI. II Literature Review

Empirical studies provide evidence for and against different hypotheses on the issues of market adjusted excess return of IPOs in varying IPO market mechanisms. A study conducted by Security Board Nepal (2006) sheds light into the fact that the Nepalese primary market is dominated by risky instrument i.e. equity shares and the major portion of the total public issue approval being from bank and finance sectors. However, Adhikari (2006) sheds light into the fact that investors hesitate to subscribe in public issues of manufacturing and processing, trading and hotel sectors and due to this the companies from these sectors face difficulties in raising funds from the market. The study finds that the financial forecasting in most of the issues is overstated. Pradhan (1993) finds that the stocks with largest market value to book value of equity have higher price earning ratio in Nepalese stock market. Pradhan and Balampaki (2004) find that in Nepal the capital gain yield is positively related with the size of a firm measured in terms of market capitalization. Timilsina (2004) concludes that the companies making IPOs overstate their forecasted accounting figures. Habib and Ljungqvist (2001) find that the US IPOs are underpriced by 13% on average; Chinese IPOs are underpriced by 42% whereas the Malaysian IPOs are underpriced by 6%. They argue that some IPOs are more underpriced than others because their owners have less reason to care about under pricing and that the


extent to which owners care about under pricing depends on how much they sell at the IPO. It is because the promoters who sell very few shares to the public suffer less from under pricing than those who sell large portion of the shares They predict that issuers can reduce the under pricing by spending more in the IPOs promotion. They consider both the under pricing and IPO promotion costs are the part of the costs of going public. They illustrate the US and Canadian IPO mechanisms where issuers can choose between a best-efforts offering which is cheap in terms of cash expenses but typically leads to high under pricing and a firm commitment book-building which is expensive in terms of fees but leads to lower under pricing. Benveniste and Busaba (1997) observe that American book building mechanism is becoming the method of choice in the context of fixed price method being historically dominant approach in the UK and its former colonies (e.g. India and Singapore) and in most of Europe. They also observe that fixed price mechanism creates cascading demand thereby guaranteeing the issuer some proceeds. However, book building mechanism generates the higher expected proceeds to the issuers and provides option to sell additional shares at fair price but exposes to the greater uncertainty too. Sherman (2005) too finds that the U.S. book-building method has become increasingly popular for IPO worldwide over the last decade. Derrien and Womack (2003) find that the auction mechanism is associated with less under pricing and lower variance of under pricing than other mechanisms namely book building, and fixed price mechanism with reference to the data from the French IPOs market where all three of the aforementioned mechanisms were prevalent at the same period (1992—1998) in France. They also observe that even though the auction procedure dominates the book building procedure in mitigating underpricing in varied market conditions, book building procedure is dominant in the United States and very significantly increasing in the rest of the world. They explain that even though the mitigation of under pricing is a worthy objective to issuers, it clearly is not their only objective. Besides, they argue that controlling underpricing is clearly not the most important issue to underwriters


who suffer an agency conflict of interest, pitting their issuing clients against their investor clients. Derrien and Kecskés (2007) observe there is a ‘two stage mechanism’ prevalent in the UK in which under pricing has been found to be reduced by 10 percent to 30 percent in comparison to the traditional under pricing in which IPOs are made at first and then the shares are listed in the secondary market. First time public financing through equity is proceeded in two stages i.e., a firm lists and lets a public market develop in the firm’s existing shares in the first stage, and sells new shares to the public in the second stage. Kandel, Sarig and Wohl (1999) find small but significant average abnormal return of 4.5% from the auctioned data of IPOs in Israel where the stock price is not fixed prior to the IPOs and where allocations are not determined by the issuers or the underwriters unlike in the US IPOs under book building mechanism. This implies that a small but significant underpricing is documented even in countries where IPOs are conducted as auctions. Kutsuna and Smith (2004) conclude that in regimes where firms can select between book building and auctioning, issuers overwhelmingly select book building from the IPOs data in Japan where both book building and auction mechanisms are prevalent. Aussenegg, Pichler, and Stomper find that when-issued trading reveals information that is relevant for setting the IPO offer price with reference to the IPOs data in Germany where there is a very active when issued market for IPO shares that operates concurrently with book building. The when-issued market also known as the ‘grey market’ is a forward market for IPO shares and remains over-the-counter trading. Krishnamurti and Kumar (2002) show evidence regarding the widespread underpricing of Indian IPOs, an emerging market, which has shifted to free pricing mechanism from fixed pricing mechanism. Jaitly and Sharm (2004) show that the IPOs return is, on average, 72 percent after deregulation has been


adopted. They simulate and conclude that the initial return would have been 160% with government restriction in the Indian IPOs market. Gouldey (2006) finds that an IPO that is oversubscribed in the pre-market sale almost certainly will experience a short-term price increase in the secondary market. This shows positive relationship between IPOs performance and oversubscription. III Nepalese IPO Market

The performance of Nepalese IPO market has made it an attractive market for the investors. Shrestha (1992) observes that whenever the public limited companies issue new shares, the stock market gets busy with crowds of share applicants. It is evident by the heavy oversubscription and very good initial market returns in the Nepal Stock Exchange Ltd.(NEPSE), the only organized stock exchange for the listing and trading of outstanding shares1. The Nepalese IPO market gives issuers and their underwriters a choice of either to issue the ordinary share at par or at premium incase the annual general meeting (AGM) of the company decides to do so. However, only those companies having higher net worth than the total liabilities profit record and distribution of dividends for the last three subsequent years can issue shares at premium. 2 Companies can issue their shares at discount only when a special resolution is passed by the general meeting to do as per the provision under the circumstances specified in the Company Act 20633.The face value of a share shall be Rs. 50 or any amount above it that is divisible by Rs10 for any public companies4. The application money should not exceed 50 percent of the face value of share for the companies other than the banks and finance companies as well as those companies whose audited financial statements of three subsequent years have been published. The allotment of shares has to be done within three months from the last day of the subscription of shares.

1 ‘Ordinary Shares’, shares, equity share and the common stocks are use interchangeably in this paper. 2 See Section 29 of Company Act 2063. 3 See Section 64 of Company Act 2063. 4 ‘Company’ is used to refer to the public company.


The issuing company appoints the issue manager as the mandatory provision by law in order to apply to the Securities Board of Nepal (SEBON) for the approval of public issue. The issue manager submits the due diligence certificate regarding the proposed issue along with the prospectus and necessary documents. IPOs may be underwritten by the issue manager or any other financial institutions. However, underwriting of IPOs is compulsory only for manufacturing companies. Once the application for the public issue is approved by the SEBON, the IPOs have to be made within two months. Otherwise the company has to obtain approval again from SEBON for public issue. IPOs are offered at a fixed price as approved by the SEBON for public subscriptions should be open for at least for five working days. The share allotment, refund, and distribution of share certificate have to be completed from 45 days to 90 days as per the share allotment guidelines of SEBON. The companies apply to NEPSE for the listing. Generally, listing has to be done within 45 days from the date of the allotment. Although there is no legal barrier for the companies to opt for the over-the-counter (OTC) market, the OTC market is still non-existent in Nepal. IV Research Data and Methodology

To analyze the aspects of issues and subscriptions of IPOs, all of 107 IPOs from the fiscal year 1993/1994 to the fiscal year 2005/2006 have been taken into account. Descriptive statistics of issues and subscription have been brought into light. The means of issues and subscriptions have been compared by way of paired t-test in order to determine whether the oversubscription is significantly higher than the issues made over the study period. In order to accomplish the aim of the studying IPOs performance, a sample of 21 IPOs time series data has randomly been selected out of total of 107 IPOs. Audited accounting data related to the prospectuses have been collected manually


from the prospectus of sampled companies from the records. Data of NEPSE has been collected from its website and the annual reports. A regression analysis has been carried out in order to test the predictive power of firm size, age of firm, portion of public issue, debt-equity ratio, price earning ratio, Return of Nepal Stock Index, market share of issue manager, and subscription as times of issues. To investigate the factors affecting IPOs returns, the following Ordinary Least Squares (OLS) model is formulated: RET = f (FS, AGE, PI, D/E, P/E, RIDX, MSI, STI) (Model 1) Similarly, to investigate the determinants of subscriptions times of issues, the Ordinary Least Squares (OLS) method is employed under following model: STI = f (FS, AGE, PI, D/E, P/E, RIDX, MSI) (Model 2) Where,

RET: Return of the IPO FS: Firm size at the time of IPO AGE: Age of firm in years at the time of IPO PI: Portion of public issue D/E: Debt-equity ratio in the year prior to the IPO P/E: Ratio of the IPO offering price to pre-IPO earnings per share RIDX: Return of Nepal Stock Index MSI: Market share of issue manager STI: Subscription times of issue

Definition of Variables

Return of IPO (RET): Return of IPO is defined as the annualized return of the initial return which is the percentage change of the stock price from its offering price on the day of public issue to the first trading day closing price in the secondary market. RET has been taken as the independent variable. The initial return has been annualized by dividing the initial return with the holding period days and multiplying it with 365 days. The comparison of the return of IPOs with


the return of stock market can be taken as the indicator of the performance of IPOs. The higher the RET exceeds over the return of Return of Nepal Stock Index, the better will be the performance of IPOs and vice versa. Both of the aforementioned returns are annualized for the comparison purpose. Firm size (FS): Total assets of a firm can be taken as the measure of firm size. Firm size is calculated as the natural logarithm of the total assets (LnTA) of the firm prior to the IPO. The effect of size of total assets on the performance of IPOs depends on degree of efficient utilization of the total assets of the company. AGE: The age of the firm is calculated by dividing the number of days from the date of the commencement of business to date of issue assuming 365 days in a year. The age variable is used as the natural logarithm of age (Ln age). The study aims to find out whether the age of a firm has significant effect on the return of IPOs or not. Public Issue (PI): PI is the ratio of the total shares offered to the public. Generally, the firms that issue less of the equity to the public are perceived to be in a better position. The firms that have better prospects prefer to issue debt capital rather than equity capital. P/E (P/E ratio): Ratio of the IPO offering price to pre-IPO earnings per share is calculated to determine the P/E ratio at the time of the IPO. Only the paid up value at the time of IPOs has been taken as the offering price to determine the P/E ratio. P/E ratios indicate the value of Rs. 1 earnings at the time of issue. In the context of fixed price regime in Nepal, the lower the P/E ratio, and the higher will be the performance of IPOs as the secondary market is expected to fairly value the shares. No P/E ratio has been calculated when the company has negative earnings prior to the IPOs. Return of Nepal Stock Index (RIDX): RIDX is defined as the annualized return of the NEPSE return which is the percentage change of the Nepal Stock Index from the day of public issue to the first trading day of stock in the secondary market. The NEPSE return has been annualized by dividing the NEPSE return with the holding period days and multiplying it with 365 days. Annualized return


of Nepal Stock Index has been taken as the market return in order to measure the performance of the IPOs. Market share of issue manager (MSI): Market share of issue manager is the ratio of issues made by a particular issue manager out of total issues in the period of study. Market share of issue manager is a measure of the popularity of a particular issue manager. The study aims to find out whether the performance of IPOs has any significant relationship with the MSI. At first a model is developed based on the regression analysis for all the independent variables. Then a model is proposed including the predictive variables that have predictive power at 10 percent level of significance. Subscription times of issue (STI): STI is determined by dividing the amount of IPOs subscribed by the amount of IPOs issued. It indicates the demand condition for an IPO. Therefore, it can be taken as the investors’ perception over the performance of an IPO. The higher the STI, the higher is the investors’ perception over the performance of the IPO. This study aims to find out whether STI has any significant relationship with the RET. Model 2 tries to find out the significance of predicting power of firms size, age, portion of public issue, debt equity ratio, price earning ratio, and market share of issue manager. If the investors perceive that amount of total assets is indicator of better company, they will demand more of the IPOs and vice versa. Model 2 tries to find out whether FS has any significant relationship with STI. Similarly, this study aims to find out whether the investors prefer the firms with a long history or otherwise. Similarly, the portion of public issue is expected to have inverse relationship with the STI as the larger issue does not give good signal to the investors. Similarly, D/E is expected to have inverse relationship with the STI as D/E indicates the level of risk. The STI is expected to have positive relationship with RIDX as investors expect to have better performance of IPOs when the market is bullish. MSI is expected to have positive relationship with STI as companies are expected to choose the issue managers which have had larger


market share in terms of amount issued. On the other hand, the investors also would choose the issue manager whose IPOs management has led to better performance. The study aims to study whether MSI has any significant predicting strength for STI. V Data Analysis and Findings

Data analysis and findings have been carried out into two headings viz. general and regression analysis. General Analysis of Nepalese IPOs

As of fiscal year 2005/2006, a total of Rs 3760.53 million has been issued to the public with a mean and standard deviation of Rs 35.15 million, and Rs 50.65 million per issue. The corresponding descriptive statistics of subscriptions are given in table 1. In aggregate the issues have been oversubscribed by 593 percent. The amounts of issue and corresponding subscription have moderate positive correlation of 0.53 and it is significant at 5 percent level of significance. Paired sample t-test shows that the mean subscription of Rs. 243.61 million is significantly higher than the mean issue of Rs 35.15 million. We can infer the heavy oversubscription of IPOs from this test. Table 1: Descriptive Statistics of IPOs

(Rs. in million)

Issue Subscription

Mean 35.15 243.61 Median 16.50 77.32 Mode 8.00 N/A Standard Deviation 50.65 451.69 Minimum 2.00 1.03 Maximum 237.41 2798.00 Sum 3760.53 26066.36

Figures 1 and 2 shows the annual trend of Nepalese IPOs were bumpy both in terms of number and issued amount. This shows that the development of IPO


market in Nepal has not been smooth. However, the figure 2 shows the amount of IPOs is in increasing trend. It is because the correlation between the number of issues and the amount issued is not significant at 5 percent level of significance though they have moderate positive correlation of 0.52 as shown in table 3.

IPOs

02468

10121416

FY93/94

FY94/95

FY95/96

FY96/97

FY97/98

FY98/99

FY99/00

FY00/01

FY01/02

FY02/03

FY03/04

FY04/05

FY05/06

Fiscal Year

Num

ber

of IP

Os

Figure 1: Trend of the Number of IPOs

IPOs Issues and Subscription

01000200030004000500060007000

FY93/94

FY94/95

FY95/96

FY96/97

FY97/98

FY98/99

FY99/00

FY00/01

FY01/02

FY02/03

FY03/04

FY04/05

FY05/06

Fiscal Year

Amou

nt in

Mill

ion

Rs

Figure 2: Trend of the Issues and Subscriptions of IPOs


Table 2 shows the descriptive statistics of annual IPOs in terms of both number and issued amount during the study period of 13 years. It further shows that the annual issues in terms of number as well as amounts are not smooth over the study period. Table 2: Descriptive statistics of annual IPOs

Number Issued Amount (Rs. in million)

Mean 8.23 289.27 Median 8.00 227.90 Mode 10.00 #N/A Standard Deviation 4.09 175.29 Sum 107.00 3760.53 Minimum 2.00 57.00 Maximum 14.00 657.50

Table 3 shows that the number of IPOs and the amount of IPOs has positive correlation and the correlation is significant at 10 percent level of significance. Table 3: Correlation between number and issued amount of annual IPOs

Pearson Correlation .520 Sig. (2-tailed) .069 N 13

Table 4 shows that the higher the amount of issue, the higher will be the amount of subscription. The positive correlation of 0.53 is significant at 5 percent level of significance. Table 4: Correlations between the issue and subscription of IPOs

Pearson Correlation .530* Sig. (2-tailed) .000 N 107

* Correlation is significant at the 0.01 level (2-tailed).


Paired sampled t-test has been carried out in order to find out whether the average of subscriptions is significantly higher than that of the issues. Table 5: Paired Samples Test

Paired Differences T df Sig. (2-tailed) Mean Std. Deviation

Pair 1 IPOs Issues - IPOs Subscription

-208.46 426.98 -5.05 106 0.000

Table 5 shows that the average amount subscribed is significantly higher than the average amount of issues at 5 percent level of significance. Return analysis of IPOs

The annualized mean return of IPOs is 63.43% which is much higher than the annualized mean return of NEPSE which is only 10.18%. This shows that the Nepalese IPOs are under priced in comparison to the overall market returns. This is in confirmation with the findings of many empirical studies in other developed and emerging capital markets. The standard deviation of annualized returns of IPOs and NEPSE are 88.4 percent and 25.7 percent. It shows that the returns of IPOs in Nepalese market are more risky than the overall stock market returns. The statistics are given in table 6. Table 6: Paired samples statistics of annualized returns of IPOs and NEPSE

Mean N Std. Deviation Std. Error Mean

Pair 1 Annualized IPOs .6343 21 .88406 .19292

Annualized NEPSE .1018 21 .25706 .05610

The correlation between annualized returns of IPOs and NEPSE is positive at lower end. It is also not significant at 5 percent or 10 percent level of significance. This shows that the IPOs returns move to the similar direction of market returns but the conclusion is not definitive. Table 7 summarizes the explanation.


Table 7: Paired samples correlations

N Correlation Sig. Pair 1 Annualized IPOs &

Annualized NEPSE 21 .309 .173

The mean return of annualized IPOs is higher by 53.25% than that of NEPSE. The paired sample t-test shows that the mean return of annualized IPOs is significantly that of NEPSE at 5 percent level of significance. The results are given in detail in table 8. Table 8: Paired Samples Test

Paired Differences t df Sig. (2-tailed)

Mean Std. Deviation

Std. Error Mean

95% Confidence Interval of the Difference

Lower Upper

Pair 1

Annualized IPOs – Annualized NEPSE

.53248 .84093 .18351 .14969 .91526 2.902 20 .009

The regression analysis

The results of regression analysis identify the factors affecting IPOs returns on all variables explained in the methodology, which is given below: RET = - 2.40 + 0.091 FS + 0.020 AGE + 2.00 PI - 0.0053 D/E - 0.00009 P/E +

1.36 RIDX + 0.50 MSI + 0.0340 STI. (Equation 1) The significance of coefficients of independent variable is found to be very low in the above model. Besides, the problem of multicollinearity has been found among the independent variables. Therefore, all the variables except subscription as times of issue (STI) and Annualized NEPSE Return (RIDX) are excluded for regression analysis as other independent variables are found to have insignificant


prediction strength to the annualized return of IPOs (RET). The finding that P/E ratio does not have any significant relationship with IPOs in Nepalese market is in line with the finding of Kim and Ritter (1999). Therefore, the regression analysis has been rerun with the annualized NEPSE return and the subscription as the times of issues as the independent variables. The result of rerun regression is found as below: RET = f (RIDX, STI,) has been obtained as RET = 0.028 + 2.00 RIDX + 0.0461

ST (Equation 2) Table 9: Model Summary

Model R R Square Adjusted R Square Std. Error of the Estimate 1 .558(a) .311 .234 .77355

A Predictors: (Constant), Annualized NEPSE Return (RET), Subscription times Issues (STI)

The study shows that 31.1% of the variation in the IPOs returns can be explained by the NEPSE returns and subscription as the times of issues. Table 10: ANOVA (b)

Model Sum of Squares df Mean

Square F Sig.

1 Regression 4.860 2 2.430 4.061 .035(a) Residual 10.771 18 .598 Total 15.631 20

A Predictors: (Constant), Annualized NEPSE Return (RIDX), Subscription times Issues (STI) B Dependent Variable: Annualized IPO Return (RET)

Table 10 shows that the regression model shows the significant relationship at 5 percent level of significance between the dependent variable viz. IPO return and the independent variables viz. NEPSE returns and subscriptions as times of issues. The positive coefficients of both STI and RIDX show that they have significant positive relationship with the RET.


Table 11: Coefficients (a)

Model Unstandardized Coefficients

Standardized Coefficients t Sig.

Collinearity Statistics

B Std. Error Beta

Tolerance VIF 1 (Constant) .028 .278 .101 .921

Subscription times Issues(STI)

.046 .019 .539 2.372 .029 .743 1.347

Annualized NEPSE (RIDX)

2.003 .781 .582 2.565 .019 .743 1.347

A Dependent Variable: Annualized IPO (RET) Table 11 shows that both of the independent variables i.e. STI and RIX are very good predictors as their relationship is significant at 5 percent level of significance. It also shows that there is still nominal problem of multicollinearity and therefore has insignificant effect on the model. NEPSE return has a little bit more strength to affect the IPOs return than the subscription times of issues as RIDX has slightly higher standardized beta coefficient than the STI. Regression analysis has been performed in order to identify the significant factors affecting the subscription times of issues. The results of regression analysis excluding the insignificant factors are given below: STI = - 87.9 + 5.14 FS - 0.244 D/E (Equation 3) The analysis shows that the firm size has positive relation and the debt equity ratio has negative relation with the level of subscription. The details of the results are given following table. Table 12: Model Summary

Model R R Square Adjusted R Square Std. Error of the Estimate 1 .526(a) .277 .187 9.49538

A Predictors: (Constant), Debt equity ratio(D/E), Total Assets(FS)


Table 12 shows that D/E and FS explain 52 percent of the variation in the subscription times of issues with 90 percent level of confidence. (See table 13) Table 13: ANOVA (b)

Model Sum of Squares df Mean Square F Sig. 1 Regression 552.684 2 276.342 3.065 .075(a)

Residual 1442.595 16 90.162 Total 1995.279 18

A Predictors: (Constant), Debt equity ratio(D/E), Total Assets(FS) B Dependent Variable: Subscription times Issues (STI)

Table 14: Coefficients (a)

Model

Unstandardized Coefficients

Standardized Coefficients

t Sig.

Collinearity Statistics

B Std. Error

Beta

Tolerance VIF

1 (Constant) -87.881 39.920 -2.201 .043 Total Assets(FS)

5.143 2.095 .764 2.454 .026 .467 2.143

Debt equity ratio (D/E)

-.244 .121 -.627 -2.014 .061 .467 2.143

A Dependent Variable: Subscription times Issues (STI) Table 14 shows that both predicting variables’ beta coefficients are significant at 95 percent level of confidence. There is some degree of multicollinearity as Variance Inflation Factor (VIF) is 2.143 for both variables. However, the VIF is much lower than the typical cutoff point of 5 which means there is less adverse effect of multicollinearity in the model. The higher standardized beta coefficient of FS shows that FS has greater effect than the D/E. VI Conclusion

Nepalese IPOs have been found to be heavily oversubscribed. It shows that the investors have a very high degree of attraction to the IPOs. The study shows that growth of Nepalese IPOs in terms of issues and subscription has been bumpy


during the study period. The study shows that the IPOs investors make 53.25% market adjusted returns leading to the conclusion that Nepalese IPOs are highly underpriced. In one hand, the investors do make money from Nepalese IPOs. On the other hands, the higher the underpricing, the higher will be the wealth loss of promoters. This might have prevented the potential issuers from going public. Such companies which refrain from going public might not have made appropriate level of investment. As a result, the society and nation at large might have lost the potential gains from the increased investment and productivity of those companies. IPOs returns have been affected mainly by the subscription times of issue and general returns of stock market. The positive relationship of oversubscription with the return of Nepalese IPOs is in line with the findings of Gouldey (2006). The study also reveals that the firm size expressed as the size of total assets affects the subscription times of issues positively and the debt equity ratio affects the same negatively. The study has shed light on some of the important aspects of the IPOs performance and opened several doors for the further researches in Nepalese IPOs. References:

Adhikari, Nabaraj 2006, Securities markets development in Nepal, SEBO Journal, 1,40-5. Benveniste, Lawrence M and Walid Y Busaba, 1997, Bookbuilding vs, fixed proce: An analysis of competing strategies for marketing IPOs, Journal of Financial and Quantitative Analysis, 32, 383-403. Derrien, Francois and Ambrus Kecskes, 2007, The initial public offerings of listed firms, The Journal of Finance, 62, 447-480. Derrien, Francois and Kent L, Womack, 2003, Auctions vs, bookbuilding and the control of underpricing in hot IPO markets, The Review of Financial Studies, 16, 31-61. Timilsina, Dhruba 2004, Financial projection and actual results of the issuer companies, SEBO Journal, 1, 80-87. Durukan, M, Banu, 2002, The relationship between IPO returns and factors influencing IPO performance: Case of Istanbul Stock Exchange, Managerial Finance, 28, 18-38. Gouldey, Bruce K. 2006, Uncertain demand, heterogeneous expectations, and unintentional IPO underpricing, The Financial Review, 41, 33-54. Habib, Michel A. and Alexander P. Ljungqvist, 2001, Underpricing and entrepreneurial wealth losses in IPOs: Theory and evidence, The Review of Financial Studies, 14, 433-458.


Jagannathan, Ravi and Ann E. Sherman, 2005, Reforming the bookbuilding process for IPOs, Journal of Applied Corporate Finance, 17, 66-73. Jaitly, Shailesh and Ruchira Sharma, 2004, Pricing of IPOs and their after issue performance in the indian equity market, Managerial Finance, 30, 29-45. Kandel, Shmuel, Oded Sarig, and Avi Wohl, 1999, The demand for stocks: An analysis of IPO auctions, The Review of Financial Studies, 12, 227-247. Kim, Moonchul and Jay R. Ritter, 1999, Valuing IPOs, Journal of Financial Economics, 53, 409-437. Krishnamurti, Chandrasekhar, 2002, The initial listing performance of Indian IPOs, Managerial Finace, 28, 39-51. Kutsuna, Kenji and Ric hard Smith, 2004, Why does book building drive out auction methods of IPO issuance? Evidence from Japan, The Review of Financial Studies, 17, 1129-1166. Ljungqvist, Alexander P. William J. and Wilhelm Jr, 2002, IPO allocations: Discriminatiory or discretionary? Journal of Financial Economics, 65, 167-201. Pradhan, Radhe S. and Surya B. Balampaki 2004, ‘Fundamentals of stock returns in Nepal, SEBO Journal, 1, 8-24. Pradhan, Radhe S, 1993, Stock market behaviour in a small capital market: A case of Nepal,,The Nepalese Management Review, 20-32 Purnanandam, Amiyatosh K, and Bhaskaran Swaminathan, 2004, Are IPOs really underpriced? The Review of Financial Studies, 17, 811-848. Sherman, Ann E, 2005, Global trends in IPO methods: Book building versus auctions with endogenous entry, Journal of Financial Economics, 78, 615-649. Shrestha, Manohar K. 1992, Shareholders’ democracy and annual general meeting feedback, Portfolio Analysis Nepal. Securities Board, Nepal, 2004, Annual reports, 2003/04 Thapathali, Kathmandu. Securities Board, Nepal, 2001, A study on Forecast and Actual Profits, Bagbazar, Kathmandu. Securities Board, Nepal, 2000, Review of Primary Markets, Bagbazar, Kathmandu. Securities Board Nepal 2000, Securities Registration and Issue Approval Guidelines, Bagbazar, Kathmandu. Securities Board Nepal1997, Issue Management Guidelines, , Bagbazar, Kathmandu, Welch, IVO, 1992, Sequential sales, learning, and cascades, The Journal of Finance, 47, 695-732

Dividend Policy in Nepalese Enterprises: Case Studies

-Nabaraj Adhikari 1. Introduction

The word ‘dividend’ literally means that which may or is to be divided. In relation to an enterprise it refers to the return that a shareholder gets from the enterprise, out of its profits, on her/his shareholding. It is that part of the profits of the enterprise which is distributed amongst shareholders. Since business enterprises are formed to earn profits, every such enterprise has an implied power to declare and pay dividends, and this power is not required to express by the memorandum or article of association. However, the mode of distribution is regulated by the Companies Act. Dividend is a reward to the shareholders of enterprises for their investment and risk bearing. It is paid in cash out of profits after the depreciation and tax requirements have been met. In addition to cash dividend, an enterprise may also issue stock dividends (bonus shares) to its existing shareholders by means of capitalisation of its free reserves. The amount of dividend paid to the shareholders depends upon the type of dividend policy pursued by an enterprise. Dividend policy refers to some kind of consistent approach to the decision involving distribution versus retention of the profits rather than making the decision on a purely ad-hoc basis from year to year (Hunt, Williams and Donaldson (1971)). More recently, Brealey and Myers (2003) defined dividend policy as the trade-off between retaining earnings on the one hand and paying out cash and issuing new shares on the other. It is concerned with the question of ‘when’ and ‘how much’ dividend should be paid. Dividend policy decision is one of the three basic decisions of an enterprise; the other two being investment and financing. All the three decisions are interrelated and should be taken jointly so that an optimal combination of these decisions can be arrived at for maximisation of owner’s wealth, the main objective of corporate finance.

Officer, Securities Board of Nepal


Retained profit is shareholders’ money, which is parked in general reserves but in its treatment is on a par with equity capital. If retained profits are not gainfully invested and unable to earn in excess of the cost of capital (which is higher for equity), the enterprise ends up destroying value. Therefore, if an enterprise is making good profits but has no use of it, in order to maintain its return on equity it must return most of it to shareholders. An appropriate dividend policy varies from enterprise to enterprise as it is determined by the multiplicity of factors. In view of the variety of considerations affecting dividend policy, it is very difficult to have one dividend policy which can be considered completely satisfactory in all respects. Often it is a compromise of conflicting objectives. The corporate management has to assess the relative importance of factors and choose a line of action which is of maximum advantage, considering the circumstances of the business and the objective of its shareholders. Dividend decisions belong to critical area of corporate finance which brings into open the conflicts of interest between management and the shareholders and also between each group of shareholders with another. As dividend policy of every enterprise is generally different from that of the other, it would be prudent to make case studies of some selected enterprises. This study is an attempt to gain an insight into the whole set of circumstances and factors that govern the dividend decision of Nepalese enterprises at the micro level. In this study, dividend policies and practices of Nepalese enterprises in each of the seven sectors (as categorised by Nepal Stock Exchange Ltd.) have been analysed for the year 1995 to 2004. For the purpose of case studies, selection of seven enterprises, one in each of seven corporate sectors has been made. This is done on the basis of their dividend policy pattern. First of all, one enterprise with the most stable dividend record and another with the most irregular dividend record are chosen and then, enterprises in between these two extremes are selected. The growth of the value has been calculated based on the concept of exponential rate of increase. Exponential corresponds to the assumption that value increases from a constant rate of growth. In this situation,


the size of value will increase without limit, if the growth rate is positive and decrease if it is negative. The formula is;

rtn eVV 0 Or, rtn e

VV

0

Or, rtLogeVV

Log n 0

Or, t

VV

LogrLoge

n

0 Or, t

VV

antiLogr

n

0

Where, V0 = initial value; (r) = annual rate of change; Vn = value at the end of the period; and t = number of years

2. Case studies

2.1. Standard Chartered Bank Nepal Limited

2.1.1. Background information

Standard Chartered Bank Nepal Limited (previously, Nepal Grindlays Bank Limited), one of the leading banks in the country, was established in 1985 as a foreign joint-venture bank. Its foreign joint venture partner is the Standard Chartered Bank Limited with 50 percent equity investment, the rest of being Nepalese promoters. The bank is managed under Technical Services Agreement between Standard Chartered Bank Limited and Nepalese Promoters. The bank has wisely used newer technologies for providing services to the customers. Table1: Deposits, investments, profits and assets

(Rs.in Mn.)

S.N. Particulars 1995 2004 Annual rate of growth (%)

1. 2. 3. 4. 5. 6.

Deposits Investments Net profits after tax Reserves Net asset block Total assets

5519.4 1537.5 151.1 501.7 100.2 6570.7

21161.4 11360.3 537.8 1121.1 136.2

23642.1

13.4 20.0 12.7 8.0 3.1 12.8

Source: Annual reports of Standard Chartered Bank Nepal Limited


The Bank is fairly large-sized having total paid-up capital of Rs.374.6 million as at the end of year 2004. The Bank showed all-round improvement in its results over the study period. Its deposits, investments, net profit after tax, reserves, net asset block, and total assets, etc. recorded manifold increases during the 10-year period of the study. This is evident from the Table 1. 2.1.2. Dividend policy

Review of the Bank’s annual reports revealed that it considered the dividend policy to be important finance function. The Bank had target dividend payout ratio of 100 percent on paid up value, which it maintained in four years, and in two years it had exceeded the target level of dividend. It also viewed this policy as a long-term finance function. Its policy is to pay more or less a stable rate of dividend (on paid up value) to the shareholders. This is also borne out by the fact that the Bank maintained the rate of dividend at 100 percent in years 1996, 2000, 2001, and 2002, and at 110 percent in year 2003 and 2004 with the exception of years 1995, 1997, 1998 and 1999 when the rate was 30 percent, 90 percent, 70 percent and 80 percent respectively. The Bank also had paid 50 percent stock dividends to its shareholders in the years 1996, 1997, and 1998 and 10 percent in the year 2003. The Bank considered earnings and adequate capital base while paying cash dividends and considered shareholders’ demand, need of capital resource, goal of future expansion and directive of Central Bank for increasing share capital, while paying stock dividends. The policy of maintaining the rate of dividend was followed not only in respect of the existing equity capital but was applicable to the increased equity capital base as well. The paid up equity capital was increased as a result of four successive payments of stock dividends.

2.1.3. Dividend behaviour

As presented by Table 2, the total amount of dividend paid by the Bank to its shareholders increased from Rs.30 million in the year 1995 to Rs.412.1 million in the year 2004. This increase was caused by the increase in the equity capital as a result of issue of stock dividends. However, in the year 1997, due to cut in the dividend rate, the amount of dividend declined, while in the years 2000, 2001 and 2002, the amount of dividend remained constant due the maintenance of constant


dividend rate. Despite the cut in dividend rate in 1998 and 1999, the amount of dividend increased due to the stock dividends paid in the previous years. Table 2: Investments, profits and dividends

(Rs. in million)

Years Investments Net profits Dividends Payout ratio* (%)

1995 1996 1997 1998 1999 2000 2001 2002 2003 2004

1537.5 1831.0 2288.9 1031.5 2681.1 3349.9 9559.2 9275.9 10357.7 11360.3

151.1 239.2 248.1 292.4 359.4 392.6 430.8 479.2 506.9 537.8

30.0 150.0 135.0 157.9 271.6 339.5 339.5 339.5 373.5 412.1

20 63 54 54 76 86 79 71 74 77

*Ratio of equity dividends to net profits Source: Annual reports of the bank The payout ratio recorded wide fluctuations during the study period. It ranged from 20 to 86 percent. The decline in the payout ratio was recorded in years of high earnings, against which only a stable rate of dividend was appropriated. Table3: Dividend rates

Years Dividend as % of paid up value

Dividend as % of net worth*

Dividend as % of average market

price**

Stock dividend as % of paid up

capital 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004

30 100 90 70 80 100 100 100 110 110

10 37.7 16.7 18

28.3 33.4 30.5 27.5 27.3 27.5

2 11 9.7 7.6 7.3 5.7 4.2 6.4 6.9 6.5

0 50 50 50 0 0 0 0 10 0

*Paid up capital plus reserves ** Average of high, low and closing market price Source: Securities Board of Nepal


The rate of dividend has been increased to 100 percent in the year 1996 from 30 percent in the pervious year, which has been maintained in the years 2000, 2001, and 2002, and increased to 110 percent in the years 2003 and 2004, while in the years 1997, 1998 and 1999 the rate has been decreased to 90 percent, 70 percent and 80 percent respectively. The rate of dividend on net worth varied between 10 percent and 37.7 percent, while the dividend yield fluctuated between 2 percent and 9.7 percent during the study period. The Bank paid stock dividend at the rate of 50 percent in the years 1996, 1997 and 1998, 10 percent in the year 2003. 2.1.4. Determinants of dividend policy

Changes in profit level and financing policy are the major determinants of the dividend policy of the Bank. The Bank increased the amount of dividend in response to the increase in its net profits. It is evident from Table 2 that there is an increasing trend of net profit of the Bank in 1996 and onwards. Accordingly, the amount of dividend has been increased in those years compared to previous years. Table 3 revealed that the Bank has declared 50 percent stock dividend in the years 1996, 1997 and 1998 and 10 percent in 2003. The purpose of issuing stock dividend as stated in its annual reports are to raise the capital to fulfil the requirement of central bank, goal of future expansion and fulfilment of shareholders' demand. In those years except in 2003, the amount of dividend has been decreased to some extent compared to that of other years. As a growing Bank, its requirements for funds to finance various expansion plans were also in increasing trend, which is evident from Table 4 that the total paid up share capital of the Bank increased from Rs.100 million to Rs.374.6 million in during the study period. The impact of such requirements on dividend policy would depend upon the financing policy of the Bank. The Bank obtained funds from the sources like issue of shares, issue of stock dividends, loans from the banks and foreign financial institutions and retained earnings. Short-term loan of the bank has increased from Rs.16.1 million to Rs.78.3 million; retained earnings increased from Rs.183.5 million to Rs.217.6 million and the Bank had not used any long-term loans during the study period. In view of relying more on equity funds and having substantial earnings, the investment requirements did not have any adverse impact on the dividend policy.


Table 4: Share capital and loans (Rs.in million)

Years Total Paid-up Capital

Long-term loans

Short-term loans

Retained earnings

1995 1996 1997 1998 1999 2000 2001 2002 2003 2004

100 150 150

225.6 339.5 339.5 339.5 339.5 339.5 374.6

0 0 0 0 0 0 0 0 0 0

16.1 861.9 997.6 344.5 190.1

2430.2 1666.7 684.7 79.2 78.3

183.5 174.9 235.8 236.8 123.7 94.5 99.6 130.9 216.0 217.6

Source: Annual reports of Standard Chartered Bank Nepal Limited

2.1.5. Findings

The dividend policy of the Bank had the following characteristics.

a) Dividend policy is being taken as primary policy variable. b) Dividend policy is being treated as a long-term finance function. c) Attempt has been made for regular dividend payment with stable rate in

most of the years. d) Target payout ratio is set and attempt has been made to meet the target. e) Rate of dividend is increased or decreased with the changes in profits. f) Requirement to increase share capital, goal of future expansion, and

shareholders’ demand influenced dividend policy 2.2. People’s Finance Limited


People’s Finance Limited was established in year1993. The company had a total paid-up capital of Rs.31.3 million in 2004. It is evident from Table 5 that the company had shown all-round improvement in its results over a period of time.


Its deposits, investments, net profit after tax, reserves, net block assets and total assets etc. recorded manifold increases during the study period. Table 5: Deposits, investments, profits and assets

(Rs.in million)

S.N. Particulars 1995 2004 Annual rate of growth *

(%) 1. 2. 3. 4. 5. 6.

Deposits Investments Net profits after tax Reserves Net asset block Total assets

116.4 4.0 1.0 1.0 1.6

138.2

187.3 18.1 4.7 8.5 2.6

279.4

4.7 15.1 15.5 21.4 4.8 7.0

Source: Annual reports of People’s Finance Limited 2.2.2. Dividend policy

The company paid cash dividend only in four years over the study period. In the years 1996, 1997, 2000 and 2004, it paid 30 percent, 30.8 percent, 18 percent and 10 percent dividends respectively. It did not pay any stock dividend over the study period. The company considered earnings and directives of central bank for capital adequacy requirement while paying dividends, which is evident from the Chairman’s speeches.


Table 6 reveals that the total amount of dividend paid by the company remained more or less constant as the amount of dividend in the years 1996, 1997, 2000 and 2004 being Rs.3 million, Rs.4 million, Rs.3 million, and Rs.3.1 million respectively. It was seen that the company paid dividend based on increase in net profits. The net profit of the company was Rs.3.1 million in 1996 increased from Rs.1.0 million in the previous year and again increased to Rs.5.2 million in 1997. Same trend was in 2000 and in 2004. There was no dividend paid by the company in 1998 as the company suffered loss in that year and in the following year, though there was profit made by the company, there was no dividend paid, which may be due to cumulative loss in that year. Similarly, no dividends were


paid in those years in which there were no significant profits. The range of dividend payout ratio was 21.9 percent to 96.8 percent over the study period. Table 6: Investments, profits and dividends

(Rs.in million)

Years Investments Net profits Dividends Payout ratio * (%)

1995 1996 1997 1998 1999 2000 2001 2002 2003 2004

4.0 6.0 6.0 11.0 13.2 12.8 15.7 20.1 16.1 11.1

1.0 3.1 5.2

-15.8 8.7 13.7

0 1.7 0.8 4.7

0 3.0 4.0 0 0

3.0 0 0 0

3.1

0 96.8 76.9

0 0

21.9 0 0 0

65.9

*Ratio of equity dividends to net profits Source: Annual reports of People’s Finance Limited

The rate of return in the form of dividend to the shareholders on paid up value was zero in 1995, which increased to 30 percent in 1996 and 30.8 percent in 1997. Then, the rate of dividend on paid up value decreased to 17.6 percent in 2000 and 9.9 percent in 2004. The rate of dividend on net worth ranged from 7.8 percent to 26.9 percent and that on average market price ranged from 6.3 percent to 22.6 percent.

Table 7: Dividend rates

Years Dividend as %

of paid up value


Dividend as % of average

market price**

Stock dividend as % of paid

up capital 1995 1996 1997 1998 1999 2000 2001

0 30.0 30.8

0 0

17.6 0

0 26.9 20.6

0 0

11.6 0

0 14.6 22.6

0 0

6.3 0

0 0 0 0 0 0 0


Years Dividend as %

of paid up value



market price**

Stock dividend as % of paid

up capital 2002 2003 2004

0 0

9.9

0 0

7.8

0 0

9.5

0 0 0


Thus, it is seen that the company proposed dividend when it was in profit and did not propose dividend when it was in loss. Besides, the dividend is also influenced by the directives of Central Bank for loan loss provision. These facts indicate that the company considered the dividend policy as an important decision variable in financial policy making. 2.2.4. Determinants of dividend policy

The analysis of Chairman’s speeches of the company highlighted various factors influencing its dividend policy. One of the factors is the increase in net profits. It is evident from Table 6 that the company has increased or decreased the amount of dividend in response to the increase or decrease in net profits. The other factor determining the dividend policy of the company was its financing policy. The company under the study period appeared to use external sources of fund to finance expansion requirements. The use of external sources of funds is borne out by the fact that the company increased share capital from Rs.10 million to Rs.31.3 million during the period. The company had not used any loans (short term or long term). As there was very low level of retained earnings, it can be inferred that the company had also not used its internal sources of funds.


Table 8: Share capital and loans (Rs.in million)

Years Total Paid-up Capital

Long-term loans

Short-term loans

Retained earnings

1995 1996 1997 1998 1999 2000 2001 2002 2003 2004

10.0 10.0 13.0 17.0 17.0 17.0 20.0 20.0 20.0 31.3

0 0 0 0 0 0 0 0 0 0

0 0 0 0 0 0 0 0 0 0

0.7 0.1 0.1

-15.7 -7.0 0.1 0.1 -1.1 0.3 0.9

Source: Annual reports of People’s Finance Limited

2.2.5. Findings

The dividend policy of the company had the following characteristics.

a) Dividend policy is being taken as primary policy variable. b) Dividend payment is irregular and the rate is also not stable. c) Rate of dividend is increased or decreased with the changes in profits. d) Dividend policy is influenced by loan loss provision requirement.

2.3. Nepal Insurance Company Limited


Nepal Insurance Company Limited was established in 1947. The company, as a subsidiary company of Nepal Bank Ltd. with 51 percent share ownership, is the oldest insurance company with successful track record. The investments increased to Rs.208.5 million in 2003 from Rs.99 million in 1995 with an annual growth rate of 8.3 percent. Total assets increased to Rs.454.2 million in 2003 from Rs.135.3 million in 1995 with an annual growth rate of 13.4 percent. Net block assets and reserves increased with annual growth rate of 7 percent and 7.6 percent respectively from 1995 to 2003. The company's


investments, reserves, net assets block and total assets recorded manifold increases during the year 1995 to 2003. Its net profits after tax, however, increased with an annual growth rate of 1.0 percent and reached to Rs.28.8 million in 2003, which as compared to its business expansion is very low.

Table 9: Investments, profits and assets

(Rs. in million)

S.N. Particulars 1995 2003 Annual rate of growth *

(%) 1. 2. 3. 4. 5.

Investments Net profits after tax Reserves Net asset block Total assets

99 26.3 39.7 5.7

135.3

208.5 28.8 79

10.7 454.2

8.3 1

7.6 7

13.4

Source: Annual reports of Nepal Insurance Company Limited

2.3.2. Dividend policy

The annual reports of the company revealed that it considered the dividend policy to be active and primary finance function. It paid cash dividend in all the years during the study period, which ranged from 10 to 50 percent of paid up value. It also paid stock dividend in four years and the rate ranged from 20 percent to 25 percent of paid up value. From 1995 to 1997, the company paid dividend at increasing rate of 20 percent to 35 percent. In 1998 and 1999 the rate of dividend was 25 percent. In 2000, it paid 50 percent dividend, which is the highest one compared to other years during the study period. In 2001, the dividend paid was 20 percent and in the years 2002 and 2003, the rate of dividend was 10 percent. 2.3.3. Dividend behaviour

As revealed by Table 10, the amount of dividend paid by the company increased from Rs.7.3 million to Rs.18.4 million from 1995 to 1997, which is decreased to Rs.13.2 million in 1998. Again, it increased to Rs.31.6 million in 2000 and decreased to Rs.12.6 million in 2001. In 2002 and 2003, it further decreased to eight million. Dividend payout ratio ranged from 23.2 percent to 81.2 percent during the study period.


Table 10: Investments, profits and dividends (Rs. in million)

Years Investments Net profits Dividends Payout ratio * (%)

1995 1996 1997 1998 1999 2000 2001 2002 2003

99 109

143.6 146.3 168.7 132.9 143.9 164.5 208.5

26.3 34.5 35.6 25.6 25.4 38.9 37.8 34.4 28.8

7.3 13.1 18.4 13.2 15.8 31.6 12.6

8 8

27.7 38

51.7 51.6 62.2 81.2 33.3 23.2 27.8

*Ratio of equity dividends to net profits Source: Annual reports of Nepal Insurance Company Limited The company also paid stock dividend in four different years. In 1995, 1996, and 1997, it paid dividend in the increasing rate of 20 percent, 30 percent and 35 percent respectively. In 1998 the rate of dividend was 25 percent which was increased to 50 percent in 1999, while it was decreased to 25 percent in 2000, 20 percent in 2001 and 10 percent in 2002 and 2003. Table 11: Dividend rates

Years Dividend as %

of paid up value



market price**


capital 1995 1996 1997 1998 1999 2000 2001 2002 2003

20 30 35 25 25 50 20 10 10

8.7 14.7 15.1 10.6 10.6 19.7 9.8 5.1 5.1

0.8 2.6 4.2 3.3 3.6 5.1 1.8 1.5 1.7

20 20 0

20 0 0

25 0 0



The rate of dividend on net worth ranged from 5.1 percent to 19.7 percent while the dividend yield fluctuated in between 0.8 percent and 5.1. The company paid stock dividend at the constant rate of 20 percent in the years 1995, 1996 and 1998 and 25 percent in 2001.

2.3.4. Determinants of dividend policy

From the above analysis, it is clear that one of the major determinants of dividend policy of the company is its net profits. In 1995 to 1997 there was increasing trend of net profits and accordingly the rate of dividend declared was also in the same trend. In 1998, as the net profit decreased, the rate of dividend was also decreased. In 2000, the amount of net profits increased at highest level to Rs.38.9 million; accordingly, there was increased rate of dividend to the highest level of 50 percent. In 2001 to 2003, the amount of net profits decreased gradually, in response to that rate of dividend was also decreased to 10 percent. Table 12: Share Capital, loans and retained earnings

(Rs. in million)

Years Total paid-up

capital Long-term

loans Short-term

loans Retained earnings

1995 1996 1997 1998 1999 2000 2001 2002 2003

36.5 43.8 52.6 52.6 63.2 63.2 63.2 79 79

0 0 0 0 0 0 0 0 0

0 0 0 0 0 0 0 0 0

0.09 0.04 1.4 0.07 2.0 1.2 1.2 1.4 11.3

Source: Annual reports of Nepal Insurance Company Limited Company's financing policy was the other determinant of dividend policy. Table 9 revealed that the total assets of the company increased from Rs.135.3 million to Rs.454.2 million and net assets block increased from Rs.5.7 million to Rs.10.7 million during the study period. To finance this expansion requirement, the company relied on the share capital, which can be inferred from the fact that the share capital of the company was also increased from Rs.36.5 million to Rs.79


million during the period. It also financed its capital requirements from the retained earning as evident from the fact that the amount of which had been increased from 0.04 million to 11.3 million over the period. The company had not used any loans, which is evident from the Table 12.

2.3.5. Findings

The preceding analysis reveals the following characteristics of dividend policy.

a) Dividend policy is taken as primary policy variable. b) There is regularity in dividend payment. c) There is fluctuating rates of dividend. d) There is direct impact of net profit to the rate of dividend.

2.4. Soaltee Hotel Limited


Soaltee Hotel Limited was established in 1968 as a private limited company. Later on, in 1975 it was converted into public limited company and International Finance Corporation, Washington D.C. and Oberoi Hotel, India also involved as its shareholders. The Hotel is one of the leading hotels in the country. The paid up capital of the Hotel as at the end of 2004 was Rs.87 million. Table13: Sales, investments, profits and assets

(Rs. in million)

S.N Particulars 1995 2004 Annual Rate of

Growth*(%) 1 2 3 4 5 6

Net sales Investments Net profits after tax Reserves Net assets block Total assets

392.3 15.3 22.9 290.5 338.3 639.6

370.5 20.5 -44.4 186.7 508.8 414.1

-0.6 2.9 -

-4.4 4.1 -4.3

Source: Annual reports of Soaltee Hotel Limited As can be seen from Table 13, from 1995 to 2004, investments and net assets block of the Hotel have increased with an annual growth rate of 2.9 percent and


4.1 percent respectively. Its sales, reserves, and total assets were decreased in 2004 with an annual decrease rate of -0.6 percent, -4.4 percent and -4.3 percent respectively from 1995. Its net profits after tax decreased drastically to Rs.44.4 million in 2004 from Rs.22.9 million in 1995. 2.4.2. Dividend policy

The trend of dividend payment by the Hotel showed that it paid dividend regularly to the shareholders from 1995 to 2001, and stock dividend in 2001. It paid 30 percent dividend in 1995, 40 percent in 1996, 35 percent in 1997, 40 percent in 1998, 50 percent in 1999, 40 percent in 2000 and 10 percent in 2001. Along with cash dividend, the Hotel also paid 33 percent stock dividend in 2001. The trend of dividend payment and Chairman’s speeches revealed that the Hotel has a policy to pay more or less a stable rate of dividend. 2.4.3. Dividend behaviour

Table 14 reveals that dividend paid by the Hotel to its shareholders during 1995 to 2004, ranged from zero to Rs.32.6 million. The amount of dividend paid was 19.9 million in 1995, Rs.26.1 million in 1996, Rs.22.8 million in 1997, Rs.26.1 million in 1998, Rs.32.6 million in 1999, Rs.26.1 million in 2001 and Rs.6.5 million in 2001. From 2001 onwards the Hotel had paid no dividends. In each year during 1995 to 2001, the Hotel is in profit and thereafter it is in loss. It can be seen that whenever the Hotel has highest profit, the amount of dividend paid was also highest and when there was no profit, there was no dividend paid. This behaviour of dividend reflected the fact that the Hotel made dividend payments based on the level of profits. This also indicated that the Hotel considered the dividend policy as an important variable in financial policymaking. The ratio of the amount of dividend on net profits ranged from zero to 86.9 percent during the study period. The net sales of the Hotel was Rs.392.3 million in year1995 which was increased as high as to Rs.527.8 million in year 1999 and decreased as low as to Rs.296.3 million in year 2002. From the year 1995 to 1999, sales increased smoothly, and after this year the downfall of the sales started.


Table 14: Sales, investments, profits and dividends (Rs. in million)

Years Net sales Investments Net profits Dividends Payout ratio* (%)

1995 1996 1997 1998 1999 2000 2001 2002 2003 2004

392.3 476.4 497.3 523.9 527.8 499.7 454.9 296.3 300.3 370.5

15.3 14.2 15.2 31.8 29.8 31.8 29.8 29.8 27.6 20.5

22.9 47.3 42.5 51.7 57.5 46

21.6 -59.6 -37.8 -44.4

19.9 26.1 22.8 26.1 32.6 26.1 6.5 0 0 0

86.9 55.2 53.6 50.5 56.7 56.7 30.1

0 0 0

*Ratio of equity dividends to net profits Source: Annual reports of Soaltee Hotel Limited The investments of the Hotel was Rs.15.3 million in year 1995, the sales more or less remained constant up to year 1997, increased to Rs.31.8 million in year 1998, this sales amount more or less remained constant up to year 2002, and then after it started to fall down. Table 15: Dividend rates

Years Dividend as %

of paid up value



market price**


capital 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004

30 40 35 40 50 40 10 0 0 0

7.2 7.7 6.2 6.7 8

6.1 1.5 0 0 0

2.8 4

5.4 5.5 5.9 3

0.6 0 0 0

0 0 0 0 0 0

33.3 0 0 0



The rate of dividend on net worth ranged from zero percent to 8 percent during the study period, on which average market price ranged from zero to 5.9 percent.


One of the major factors affecting dividend policy of the Hotel is changes in profit level. The record of profits and dividend data of the Hotel indicated that the rate of dividend fluctuated in conformity with the changes in its net profits. The other important factor affecting the dividend policy is its financing policy. The financing policy of the Hotel under the study period appeared to use external as well as internal sources of funds to finance expansion requirements. This is borne out by the fact that the Hotel used both long term and short-term loans in all the years under study. Table 16: Share capital, loans and retained earnings

(Rs. in million)

Years Total paid-up capital

Long-term loans

Short-term loans

Retained earnings

1995 1996 1997 1998 1999 2000 2001 2002 2003 2004

65.2 65.2 65.2 65.2 65.2 65.2 25.2 87 87 87

146 104 100 74.2 38.7 15.7 5.2 40

125.2 140

57.9 81.3 83.6 54.9 42.4 8.8 8.8 8.8 6.8 0.4

7.6 21.2 19.7 25.6 24.9 19.9 15.1

0 0 0

Source: Annual reports of Soaltee Hotel Limited The policy of using internal sources of financing is evidenced by the trend of increasing level of retained earnings from 1995 to 2001. The Hotel, however, did not depress the dividend payment because of retained earnings. Thus investment requirements did not have any bearing on its dividend policy in view of the financing policy of the Hotel to use the funds provided by external sources (equity) and also internal sources of finance.


2.4. 5. Findings

The dividend policy of the Hotel has following feature from the above analysis.

a) Active and primary decision variable in the financial policymaking. b) Irregularity in dividend payment due to losses in some years. c) More or less stable rates of dividend on paid up value of share. d) The major factors determining the dividend policy were net profits and

financing policy of using equity.

2.5. Salt Trading Company Limited


Salt Trading Company Limited was established in 1963. The company is one of the leading trading companies in the country. The paid up capital of the company was Rs.24.8 million as at the end of 2004. The Company showed all-round improvement in its results except investments over study period year 1995 to year 2004. Its sales, net profits after tax, reserves, net assets block and total assets etc. recorded manifold increases during the study period. This is evident from the Table 17. Table17: Sales, investments, profits and assets

(Rs. in million)

S.N Particulars 1995 2004 Annual rate growth*(%)

1 2 3 4 5 6

Net sales Investments Net profits after tax Reserves Net assets block Total assets

1557.4 231.7

6 42.9 35.6 744.8

3898.9 151.8

73 584.2 466

1793

9.2 -4.2 25

26.1 25.7 8.8

Source: Annual reports of Salt Trading Company Limited

The net sales increased to Rs.3898.9 million in 2004 from that of Rs.1557.4 million in 1995 with an annual growth rate of 9.2 percent. The net profits increased to Rs.73 million, reserves to Rs.584.2 million, and net block assets to


Rs.466 million in 2004 from Rs.6 million, Rs.42.9 million, and 35.6 million respectively in 1995 with an annual growth of 25 percent, 26.1 percent and 25.7 percent respectively. The total assets increased to Rs.1793 million in 2004 from Rs.744.8 million in 1995. The company’s investments were decreased to Rs.151.8 million in 2004 from Rs.231.7 million in 1995 with a decrease rate of 4.2 percent. 2.5.2. Dividend policy

The trend of dividend payment by the company during the study period shows that it paid dividend regularly except in 2000. The rate of dividend payment on paid up value ranged from 20 percent to 30 percent. As presented in Table 19, the company maintained the rate of dividend at 20 percent from 1995 to 2004 except in 2000, when it paid no dividend. In 2001 and 2002 it paid 25 percent and 30 percent dividend. The trend of dividend payment and chairman speeches revealed that the company considered the dividend policy as a primary variable in its financial policymaking and viewed as a long-term finance policy. 2.5.3. Dividend behaviour

The total amount of dividend paid by the company in 1995 was Rs.3.3 million increased to Rs.4.9 million in 1996, and remained constant till 1999. The net profit was Rs.6.1 million in 1995 increased to Rs.7.5 million in 1996 and more or less remained constant till 1998 and decreased to Rs.5.3 million in 1999. In 2000, it suffered loss of Rs.15.3 million and in this year it paid no dividend. Again, the company started paying increasing rate of dividends when it started making increasing profits 2001 onwards. This trend of dividend payment indicated that the company paid dividend based on the level of profits.


Table 18: Sales, investments, profits and dividends (Rs. in million)

Years Net sales Net profits Dividends Payout ratio * (%)

1995 1996 1997 1998 1999 2000 2001 2002 2003 2004

1557.4 1965.6 1968.9 1738.5 1842.4 1580.5 1743.1 1875.9 2461

3898.9

6.1 7.5 7.6 7.8 5.3

-15.2 10.5 26.7 50.2 73

3.3 4.9 4.9 4.9 4.9 0

6.2 7.4 5 5

54.1 65.3 64.5 62.8 92.4

0 59

27.7 10 6.8

*Ratio of equity dividends to net profits Source: Annual reports of the Company The dividend payout ranged from zero to 92.4 percent. The return to shareholders on their net worth ranged from zero to 8 percent and the yield rate ranged from zero to 9.2 percent.

Table 19: Dividend rates

Years Dividend as %

of paid up value Dividend as % of net worth*


market price**


capital 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004

20 20 20 20 20 0

25 30 20 20

5.5 8

7.7 7.6 7.6 0

6.7 1.5 0.9 0.8

1 2.8 4.2 5.9 4.9 0

7.6 9.2 6.6 6.5

0 0 0 0 0 0 0 0 0 0




The above analysis revealed that the company paid dividend when there was profit and did not pay dividend when there was no profit. This fact indicates that level of profit was one of the major factors determining the dividend policy. The other factor determining the dividend policy was the financing policy of the company. The company contemplated greater use of external sources of funds to finance expansion requirements. The net assets block of the company increased from Rs.35.6 million in1995 to Rs.466 million in 2004 and the total assets moved up from Rs.744.8 million to Rs.1793 million during this period (Table 17). To finance this large-scale expansion, the company relied, to a greater extent, on external sources as evident from its long-term loans being increased from Rs.355.9 million in 1995 to Rs.1359.6 million in 2003, which was slightly decreased to Rs.1184.1 million in 2004. The company, however, did not use any short-term loans during the study period. The retained earnings of the company being less than Rs.1 million, it was not significant to finance the expansion requirements of the company. However, the amount of retained earnings in 2003 and 2004 were high as there were higher profits and the company took policy of paying stable rate of dividend. Table 20: Share capital, loans and retained earnings

(Rs. in million)

Years Total Paid-up

Capital Long-term

loans Short-term


1995 1996 1997 1998 1999 2000 2001 2002 2003 2004

24.8 24.8 24.8 24.8 24.8 24.8 24.8 24.8 24.8 24.8

355.9 522.9 532.6 623.1 691.8 691

874.8 902.8 1359.6 1184.1

0 0 0 0 0 0 0 0 0 0

0.9 0.6 0.5 0.7 0.4 0

0.7 1.5 5.5 12

Source: Annual reports of Salt Trading Company Limited


2.5. 5. Findings

The above analysis revealed the following features of dividend policy of the company.

a) Active and primary policy variable in the financial policymaking. b) Regularity in dividend payment. c) Stable rate of dividend on paid up value of share. d) Rate of dividend based on the profit level

2.6. Unilever Limited


Unilever Limited (previously Nepal Lever Limited) was established in 1994 as a joint-venture company with Hindustan Lever Limited, which has 80 percent ownership stake. It is one of the leading manufacturing & processing company in the country. The paid up capital of the company was Rs.92.1 million as at the end of 2004. Table 21: Sales, profits and assets

(Rs. in million)

S.N Particulars Year 1995 Year 2004 Annual rate growth*(%)

1 2 3 4 5

Net sales Net profits after tax Reserves Net assets block Total assets

67.7 -3.8 -3.8

234.6 294.5

1524.9 140.8 303.9 135.7 859.9

31.1 - -

-5.5 10.7

Source: Annual reports of Unilever Limited As evident from Table 21, the total assets of the company increased to Rs.859.9 million in 2004 from Rs.294.5 million in 1995. Its net sales increased to Rs.1524.9 million in 2004 from Rs.67.7 million in 1995 with an annual growth rate of 31.1 percent, while its net profits increased to Rs.140.8 million in 2004 from -Rs.3.8 million in 1995 and reserves increased to Rs.303.9 million in 2004 from -Rs.3.8 million.



Review of annual reports of the company revealed that it considered the dividend policy to be active and primary finance function. In 1995, 1996 and 1997, it did not pay any dividend, the reason for which being lack of surplus for appropriation due to losses in 1995 and 1996. It paid dividend in uninterrupted pattern from 1998 to 2004, which ranged from 20 percent to 100 percent. In 1998, 1999, 2000, 2001, 2002, 2003 and 2004, it paid dividend at the rate of 20 percent, 40 percent, 50 percent, 55 percent, 40 percent, 90 percent and 100 percent respectively.


Table 22 reveals that the amount of dividend increased to Rs.18.4 million in 1998, increased to Rs.36.8 million in 1999 and Rs.46 million in 2000. The reason behind the increase in dividend payment was increase in net profits to Rs.99.7 million in 1998, Rs.119 million in 1999 and Rs.120.6 million in 2000. However, despite the decreased net profits to Rs.68 million in 2001, the amount of dividend increased to Rs.50.6 million. Table 22: Sales, profits and dividends

(Rs. in million)

Years Net sales Net profits Dividends Payout ratio * (%)

1995 1996 1997 1998 1999 2000 2001 2002 2003 2004

67.7 351.8 789.7

1193.6 1503.7 1728.6 1541 1236

1244.7 1524.9

-3.8 -4 24

99.7 119

120.6 68

42.6 93.2 140.8

0 0 0

18.4 36.8 46

50.6 36.8 82.9 92.1

0 0 0

18.4 30.9 38.1 74.4 86.4 88.9 65.4

*Ratio of equity dividends to net profits Source: Annual reports of Unilever Limited


In 2002, net profits decreased to Rs.42.6 million, and the amount of dividend also decreased to Rs.36.8 million, while in 2003 and 2004, the amount of dividend to Rs.82.9 million and Rs.92.1 million as the net profits increased to Rs.93.2 million and Rs.140.8 million respectively. The range of dividend payout on net profits was zero to 88.9 percent during 1995 to 2004. The financial profile of the company thus depicted that dividend policy had been an active decision variable as it paid dividend regularly in spite of the fair degree of variability in its earnings. The rate of return in the form of cash dividend on paid up value was 20 percent in 1998, which was increased to 40 percent in 1999, 50 percent in 2000, and 55 percent in 2001. This rate of return was zero in the first three years. The company paid 20 percent dividend on paid up value in 1998, and increased to 100 percent in 2004. Table 23: Dividend rates

Years Dividend as % of paid up value



market price**


capital 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004

0 0 0

20 40 50 55 40 90 100

0 0 0

10.9 14.7 14.1 14.8 10.6 23.1 23.2

0 0 0

4.5 3.4 2.4 2.4 2.4 8

7.5

0 0 0 0 0 0 0 0 0 0

*Paid up capital plus reserves ** Average of high, low and closing market price Source: Securities Board of Nepal During the study period, the rate of dividend on net worth ranged from zero percent to 23.2 percent while dividend yield ranged between zero percent to 8 percent. The Unilever did not pay any stock dividend during the study period.



Based on the company's trend of financing, dividend behaviour and chairman’s speeches, the level of profit and financing policy were identified as the major factors influencing dividend policy. It is evident from Table 22 that the company paid dividend in conformity with the changes in its net profits. Table 24: Share capital, loans and retained earnings

(Rs. in million) Years Total Paid-up

Capital Long-term

loans Short-term


1995 1996 1997 1998 1999 2000 2001 2002 2003 2004

92.07 92.07 92.07 92.07 92.07 92.07 92.07 92.07 92.07 92.07

180 157.5 112.5 67.5

0 0 0 0 0 0

22.1 71

74.9 0 0 0 0 0 0 0

-3.8 -25.1 -5.2 76.1 158.3 232.9 250.3 256

266.3 303.9

Source: Annual reports of Unilever Limited

The financing policy of the company was to rely on internal sources of fund to finance its expansion requirements. However, it was forced to use external sources as well in the initial few years due to losses. Thereafter the company had zero debt level because of receipt of dues, improved collection from domestic businesses and strong business performance. The total assets of the company increased to Rs.859.9 million in 2004 from Rs.294.5 million in 1995. To finance its increasing total assets and business expansion the company extensively retained its earnings. The retained earnings increased to Rs.303.9 million in 2004 from Rs.76.1 million in 1998; however, it did not depress the dividend payment. 2.6. 5. Findings

The above analysis revealed that the dividend policy of the company had following characteristics;


(a) Active decision variable in the financial policymaking. (b) Treated as a long-term finance function. (c) Regularity in payment with increasing rate. (d) Net profit was the major determinant (e) Expansion requirements did not have any bearing on its dividend payment.

2.7. National Productivity & Economic Development Centre Limited


National Productivity & Economic Development Centre Limited was established in 1988 for providing consulting services in designing industrial projects, enhancing productivity and other industrial and economic matters. As evident from Table 25, its total paid up capital as at the end of 2003 was Rs.7.9 million. Its paid up capital remained constant in all the years during the study period of 1996 to 2003. The revenue increased to Rs.30.7 million in 2003 from Rs.17.2 million in 1996 with an annual growth rate of 7.2 percent. During the period, its investments, net profits after tax, reserves, net assets block and total assets increased to Rs.94.8 million, 7.8 million, 72.4 million, 3.7 million and Rs.80.3 million with annual growth rate of 6.2 percent, 14.7 percent, 6.5 percent, 1.8 percent and 1.2 percent respectively from Rs.57.7 million, 2.4 million, 43.1 million, 3.2 million and 73.1 million respectively. Table 25: Revenue, investments, profits and assets

(Rs. in million)

S.N Particulars Year 1996 Year 2003 Annual rate growth*(%)

1 2 3 4 5 6

Revenue Investments Net profits after tax Reserves Net assets block Total assets

17.2 57.7 2.4

43.1 3.2

73.1

30.7 94.8 7.8

72.4 3.7

80.3

7.2 6.2

14.7 6.5 1.8 1.2

Source: Annual reports of National Productivity & Economic Development Centre Limited



The company considered the dividend policy to be active and primary finance function. It regularly paid dividend during the study period. The rate of dividend on paid up value was 15 percent in all the years except in 1997, in which it paid 25 percent dividend. It segregated certain portion of net profits in all the years to dividend equalisation funds to maintain stability in dividend payment. The company earned profits in all the years during the study period. It did not pay any stock dividend during the study period. 2.7.3. Dividend behaviour

Table 26 reveals that the amount of dividend was constant in all the years to Rs.1.2 million except Rs.2 million in 1997, whereas there was fluctuating trend of net profits during the period that ranged from Rs.2.4 million to Rs.11.7 million. The highest net profit was in 2000 and the lowest net profit was in 1996. The range of dividend payout on net profits was 10.3 percent to 51.3 percent during the study period. Table 26: Revenue, profits and dividends: year 1996 to year 2003

(Rs. in million)

Years Revenue Net profits Dividends Payout ratio *

(%) 1996 1997 1998 1999 2000 2001 2002 2003

17.2 20.6 20.7 25.5 31.6 33.5 22.7 30.7

2.4 3.9 3.2 6.3 11.7 2.7 4.7 7.8

1.2 2

1.2 1.2 1.2 1.2 1.2 1.2

50 51.3 37.5 19

10.3 44.4 25.5 15.4

*Ratio of equity dividends to net profits Source: Annual reports of National Productivity & Economic Development Centre Limited

The rate of return in the form of dividend on paid up value was 15 percent in all the years except in 1997. The rate of dividend on net worth ranged from 1.5


percent to 3.8 percent. The company thus had smooth pattern of dividend payment during the study period. Table 27: Dividend rates

Years Dividend as

% of paid up value



market price**


capital

1996 1997 1998 1999 2000 2001 2002 2003

15 25 15 15 15 15 15 15

2.3 3.8 2.1 1.9 1.6 1.7 1.6 1.5

0 0 0 0 0 0 0 0

0 0 0 0 0 0 0 0



Table 28 revealed that the company had retained earnings only in year 1997. It used share capital as external sources of financing. The share capital was also constant to Rs.7.9 million in all the years during the study period. The company being a consultant did not require short-term as well as long-term loans, neither required to retained earnings. It had not used any loans during study period. Table 28: Share capital, loans and retained earnings

(Rs. in million)

Years Total Paid-up

Capital Long-term

loans Short-term


1996 1997 1998 1999 2000 2001 2002 2003

7.9 7.9 7.9 7.9 7.9 7.9 7.9 7.9

0 0 0 0 0 0 0 0

0 0 0 0 0 0 0 0

0 1.4 0 0 0 0 0 0

Source: Annual reports of National Productivity & Economic Development Centre Limited


The above analysis revealed that the company maintained dividend equalisation funds from its profit to pay a constant rate of dividend. As it had not used external loans as well as retained earnings as sources of financing, its financing policy also did not have any influence to its dividend policy. 2.7.5. Findings

The dividend policy of the Centre had the following characteristics.

(a) Primary policy variable in the financial policymaking. (b) A target payout ratio was maintained with stable rate. (c) Financing pattern did not have significant influence.

2.8. Conclusions

The study reveals the dividend policy being treated as an active and primary variable in the financial policymaking. This is characterised by the regular payment of dividend. Standard Chartered Bank Nepal Limited, Salt Trading Company Limited and National Productivity & Economic Development Centre Limited pursued the policy of target dividend payout. In case of National Productivity & Economic Development Centre Limited, dividend equalisation fund was also created to pay target dividend. The dividend behaviour of Standard Chartered Bank Nepal Limited and Nepal Insurance Company Limited were uninterrupted and fluctuating, while that of Salt Trading Company Limited and National Productivity & Economic Development Centre Limited was at stable rate on paid up value. The dividend behaviour of People’s Finance Limited, Soaltee Hotel Limited and Unilever Limited were interrupted. The foremost factor determining dividend policy was the level of profits of the enterprises. In all the cases the amount of dividend was in accordance with the level of profits except in the case of National Productivity & Economic Development Centre Limited. Financing policy was the other important factor influencing the dividend policy. In four enterprises, the financing policy was to


rely on the external sources of funds. Consequently, investment requirements did not have any adverse influence on the dividend policy of these enterprises. In the cases of the enterprises, whose emphasis was on using internal sources of funds, still it did not constraint the dividend payment. In case of stock dividend, need to increase share capital as per the directives of the regulator, goal of future expansion and shareholders’ demand were the major determinants. References

Brealey, Richard A.and Stewart C. Myers, 2003, Principles of Corporate Finance Seventh Edition, Tata McGraw-Hill Publishing Company Limited, New Delhi.

Hunt, Williams and Donaldson, 1971, Basic Business Finance: Text & Cases, Richard D. Irwin Inc. Standard Chartered Bank Nepal Limited, Annual Reports fiscal years 1994/95–2003/04, New

Baneswor, Kathmandu. People’s Finance Limited, Annual Reports fiscal years 1994/95-2003/04, Tripureswor, Kathmandu. Nepal Insurance Company Limited, Annual Reports fiscal years 1994/95 – 2002/03, Kamaladi,

Kathmandu. Soaltee Hotel Limited, Annual Reports fiscal years fiscal years 1994/95 – 2003/04, Tahachal,

Kathmandu. Salt Trading Limited, Annual Reports fiscal years 1994/95 – 2003/04, Kalimati, Kathmandu. Unilever Limited, Annual Reports fiscal years 1994/95- 2003/04, Heritage Plaza, Kathmandu. National Productivity & Economic Development Centre Limited, Annual Reports fiscal years

1995/96–2002/03, BID Balaju, Kathmandu.

Institutional Investment in Nepalese Securities Market 1. Introduction

Nepalese securities market has a history of institutionalisation of about three decades. However, it has not fully developed to contribute meaningfully in the economic development of the country. Total market capitalisation value reached to Rs. 61365.89 million by the end of the fiscal year 2004/05, which is 12.17 percent of the GDP. Total paid up capital of listed securities has reached to Rs. 16771.84 million and the average annual value of securities trading in the stock exchange is Rs. 1341.65 million. The average percentage of turnover on market capitalisation for the last 12 years is only 4.21, which indicates low level of liquidity in the market. The average annual public issue for the last 12 fiscal years is Rs. 597.07 million. Till the fiscal year 2004/05, the total amount of issued securities is Rs. 8.6 billion consisting of 76.6 percent common stock, 2.7 percent preferred stock, 8.3 percent collective investment schemes and 12.3 percent debentures. This shows not only the low supply of securities in the market but also the lack of diversification of securities instruments. If we particularly see the trend of debenture issue from the fiscal year 1993/94 to 2004/05 there were only four issues of debentures. There is also wide variation in the interest rate of those debentures ranging from 6 to 14 percent. The government securities market is yet to be integrated with the corporate bond market that could provide benchmarking interest rate and lead to the development of full-fledged debt market in the country. There are only two mutual funds with total amount of capital mobilisation of Rs. 613.09 million by the end of the fiscal year 2004/05. There is no encouraging issue of securities from corporate sectors other than banks and financial institutions. Thus, the insufficient supply of securities and diversification in the securities instrument and issuing companies has been limiting the scope for institutional investment in the market.

Study conducted by Securities Board of Nepal in the Fiscal Year 2005/06


There is significant fluctuation in the market price of the securities. In the last 12 years, there is a variation of about 448 points in the price index. The highest price index recorded was 545.82 points in the fiscal year 2000/01 while the lowest was 97.98 points in the fiscal year 1993/94. There is up to 223 points price index variation in a single year and up to 18.3 points price index variation within one day transaction. Such a variation in the price of the securities indicates the irrational behaviour of the market. This irrational behaviour of the market can be attributed to the absence of institutional investors and naïve nature of retail investors. In addition, there is lack of professional merchant banking and stock exchange services that could support the investors to make informed decision through proper investment counselling, providing access to the corporate and market information based on adequate researches. The above scenario depicts that securities market in Nepal is yet to be matured to be a major source of fund raising. For the proper growth and stability of the securities market, initiatives should be taken towards promoting institutional investment. In this perspective, SEBON has conducted this study to assess the status of institutional investment and provide appropriate policy recommendations for the promotion of institutional investment in the market. 2. Importance of Institutional Investors

Institutional investment has important role in sustainable development of securities markets. Institutional investors, as compared to the retail investors, are more equipped and resourceful to judge investment value and thus make prudent decisions on buying and selling securities. In view to the importance of the institutional investment, different developed and emerging markets have taken due consideration to increase the involvement of institutional investors in the market. In India, huge amount of funds is being mobilised through the institutional investors. Not only domestic institutions are involved as institutional investors in the Indian securities market, foreign institutions are also sufficiently being encouraged to play a significant role as foreign institutional investors (FIIs). Under the SEBI (FII) Regulations, 1995, pension funds, mutual funds, insurance companies, investment trusts, banks, university funds, endowments,


foundations, charitable trusts and charitable societies proposing to invest on behalf of broad based funds, are also eligible to be registered as FIIs. They are allowed for providing services as asset management companies, institutional portfolio managers, trustees, etc. and are allowed to invest in almost every sort of products in the stock markets including primary and secondary markets in India. Major roles and importance of institutional investors can be pointed out as follows.

Institutional Investor through collective investment schemes add up new instrument and increase investors participation in the market, which will stimulate the issuers to raise funds through issuing securities as they will have confidence on the subscription of proposed issues,

They can supply the securities held by them as and when the demand arises and such activities can significantly contribute to stabilize the market price of the securities,

Their involvement stimulate demand and supply of corporate bonds, They can play the role of debenture trustee that will facilitate the issue of

corporate bonds, They can provide efficient investment services to the risk averse

investors through the mobilization of various types of collective investment schemes,

They are able to make rational analysis of the information provided by the issuer and also pressurize them for the regular flow of credible information, which to the greater extent can contribute in improving confidence of the retail investors.

3. National Policy and Institutional Investment

Review of National Plans reveals that the government of Nepal has well recognised the institutional investment as one of the major requirements for capital market development in the country. There is continuity in bringing different programs related to the promotion of institutional investment in the securities market since the Eighth National Plan. The long-term approach of the national plans is to increase the participation of the institutional investors like


mutual funds, pension funds, employees provident funds, insurance companies etc. in the securities market thereby making at least 50.0 percent of the total transaction through such investors. In the Eighth Plan (1992-1997), there was a policy for encouraging the investment of Employees Provident Fund and the Insurance Companies in the securities market. However, neither there was any initiatives taken by the government to implement this plan nor the institutions who were supposed to make their investment in the securities market felt their accountability and took initiatives according to the plan. In the plan there was a program of introducing institutional investors to operate collective saving schemes. Accordingly, within the plan period Citizen Unit Scheme and NCM Mutual Fund were brought into operation with limited regulatory parameters of Securities Board of Nepal. The Ninth Plan (1997-2002) had incorporated the program for encouraging domestic as well as foreign institutions to operate mutual funds. It also had a program of establishing credit rating agency and trading of the government securities in the stock exchange. All these programs were not implemented in the plan period. However, legislative initiatives were taken during the fiscal year 2004/05 for the trading of government securities in the stock exchange. The Tenth Plan (2002-2007) has a program for legal reform and development of investment regulatory system to mobilise the contractual savings in the securities market. The plan has quantitative target regarding saving mobilisation by Citizen Investment Trust to be at least Rs. 6.69 billion, out of which at least 50 percent would be invested in corporate securities. The plan has equally emphasised to raise the share of Citizen Investment Trust in the securities transaction to be at least one billion. The plan also has program for increasing number of collective savings schemes. If we see the present status of contractual savings mobilisation in the securities market, the Citizen Investment Trust has collected Rs. 6.2 billion by the end of the first nine months of the fiscal year 2005/06, which is very near to the target. The Trust has invested almost all the collection; however its investment in the


corporate securities is only 4.6 percent of the total investment, which is far below the quantitative target of the plan. Also, the participation of the Trust in the secondary securities transaction is estimated to be almost negligible. Similarly, regarding program for increasing number of collective savings schemes, no achievements have been made till the end of the fiscal year 2005/06. One of the major objectives of the Tenth Plan was to issue bonds through securities markets to meet the mid-term and long-term financing requirements of the development projects and gradually reduce foreign loan. If this objective is to be fulfilled, there must be the participation of institutional investors in the market. However, neither there is increasing participation of the institutional investors in the market, nor any initiatives have been made to issue such types of securities instruments. 4. Present Status and Trend of Institutional Investment

Generally, the institutional investors of securities market are government sponsored provident funds, collective investment funds, private pension funds, bank/trust institutions, and insurance companies. In Nepal, Citizen Investment Trust, Employees Provident Fund, NCM Mutual Fund and the insurance companies are the existing as well as potential institutional investors. We have seen that the national plans have also brought various programs to encourage institutional investment in the securities market. However, the actual achievement shows that there is no serious initiative towards the implementation of the programs. The status and trend of the institutional investment also justify this fact. 4.1 Citizen Investment Trust

Citizen Investment Trust (CIT) was established under the Citizen Investment Trust Act, 1990. The objective of establishing CIT was to expand investment opportunities by encouraging general public to save capital and to bring dynamism in the capital market. As per the provision in the Act, the Trust can operate subsidiary company to promote capital market as per necessity.


CIT has collected funds by operating various schemes such as Employees Savings and Growth Scheme, Citizen Unit Scheme, Gratuity Fund Scheme and Investor's Account Scheme. The Trust has invested the funds in corporate securities, government bonds, term loans, and borrowings. The capital base, trend of fund collection and investment of CIT is given in Table 1. Table 1: Trend of Fund Collection and Investment of Citizen Investment Trust

(Rs. in million)

Particulars Fiscal Year

1999/00 2000/01 2001/02 2002/03 2003/04 Capital 35.9 42.2 48.7 54.2 61.1 Paid up Capital 24.0 27.6 31.2 35.2 40.0 Reserve Fund 11.9 14.6 17.5 19.0 21.1 Fund Collection 583.9 1145.7 1709.7 3294.5 4923.4 Employee Savings and Growth Scheme 353.1 673.4 803.2 1523.5 2501.3

Citizen Unit Scheme 143.3 336.8 645.2 837.4 1003.9 Gratuity Fund Scheme 33.5 53.9 118.2 656.3 1053.7 Investor's Account Scheme 54.0 81.6 143.1 277.3 364.5 Investment 647.1 933.3 1449.0 2635.4 3347.5 Corporate Securities 15.0 44.3 60.9 63.5 153.5 Government Bonds 511.3 702.0 1066.1 2021.9 2318.0 Term Loans 102.5 144.5 322.0 503.8 488.3 Borrowings 18.3 42.5 - 46.2 87.7

Source: CIT As revealed by Table 1, the capital base of CIT by the end of the fiscal year 2003/04 reached to Rs. 61.1 million and the total fund collection reached to Rs. 4923.4 million, while the total investment was Rs. 3347.5 million. It clearly shows that although there has been significant increase in total fund collection, the core capital of CIT is very low. Similarly, total investment is also far lower than total fund collection, and out of the investment, the investment in corporate securities is insignificant. On the basis of its small capital base, there is no


possibility that the CIT can provide trust services for large issue of debentures and mutual funds. Regarding the investment of CIT in securities markets, it is very low compared to the investment in other areas. Most of its investment is in government bond and term loans. Out of total investment, only 4.58 percent investment was made in corporate securities in the fiscal year 2003/04, which was only 2.41 percent in the fiscal year 2002/03. Though there is increasing trend of investment in the corporate securities, it is still very nominal as compared to the increase in investment in other areas. Among the fund collection schemes, the Citizen Unit Scheme was particularly brought into operation, as an open-ended mutual fund scheme, whose major investment, in principle, should be in the corporate securities. However, its investment is also very nominal in corporate securities. Out of the total investment of the scheme, the investment in corporate securities was only 6.36 percent in the fiscal year 2003/04, which was even lower in the preceding years. Table 2: Performance Trend of Citizen Unit Scheme

(Rs. in million)


1998/99 1999/00 2000/01 2001/02 2002/03 2003/04 Total amount of unit sold 54.46 187.37 336.78 645.26 837.47 1003.87 Total amount of unit repurchased

11.99 44.12 110.63 280.62 432.15 536.27

Total Investment 36.22 143.88 236.40 371.50 414.43 417.04 Corporate Securities 2.72 2.03 6.75 10.50 15.43 26.54 Other Investment 33.5 141.85 229.65 361.0 399.0 390.50 Net Income 5.10 16.71 19.98 35.26 37.40 36.26 Dividend (%) 11 11 9 8.5 8 7 Number of Unit Holder 2587 4601 6270 8299 9087 9871

Source: Citizen Investment Trust


4.2 NCM Mutual Fund

NCM mutual fund was brought into operation in the fiscal year 2002/03 with the approval of Securities Board of Nepal. The objective of NCM mutual fund was to provide returns to the fund holders by professional management of their funds. In the current situation of lack of sufficient securities instruments, this fund scheme has provided opportunities to the risk averse type of investors to invest in the capital market. NCM mutual fund is close-ended mutual fund with ten years of maturity period, which has also been listed in the stock exchange. The total amount of the mutual fund is Rs. 100.0 million with par value of Rs. 10 per unit. NIDC Capital Markets Ltd. and Nepal Industrial Development Corporation are the fund manager and the trustee of the fund. The trend of performance of NCM Mutual Fund is depicted in Table 3. Table 3: Performance Trend of NCM Mutual Fund

(Rs. in million)


2002/03 2003/04 2004/05 Outstanding Unit (in '000) 10,000 10,000 10,000 Net Assets Value 105.69 118.02 144.92 Net Assets Value per unit (Rs.) 10.57 11.80 14.49 Net Income 2.14 2.55 6.66 Dividend (%) 5 5 5 Investment 110.32 103.12 136.21 Corporate Securities 84.43 91.38 124.47 Investment in Other Sectors 25.89 11.74 11.74 No of Company Invested 29 31 35 No of Unit holders 2882 2882 2559 Institutions 19 19 20 Individuals 2863 2863 2539

Source: NIDC Capital Markets Ltd.


Total investment of NCM mutual fund was Rs. 136.21 million in the fiscal year 2004/05, out of which investment in the corporate securities was 91.38 percent. Its portfolio of investment includes securities of 35 listed companies. The investment trend of the fund shows that the fund has made major portion of investment in corporate securities and has played a significant role in the securities markets with the increased investment in corporate securities. The unit holders of the fund include institutions and individual. Out of 2559 unit holders in the fiscal year 2004/05, 20 are institutions. The participation of institutions as unit holders of NCM mutual fund shows that the mutual fund can attract institutional investors in the securities markets. 4.3 Employees Provident Fund

Employees Provident Fund (EPF) is an autonomous body incorporated under the Employees Provident Fund Act, 1962. EPF mobilises savings collected through compulsory provident fund contributions on the part of employers and employees, among others, in civil, army and police services. Contributions, earnings, and distributions are completely tax-free. Upon retirement or otherwise ending employment, the employees (or their beneficiaries) receive tax-free lump sum payments of the principal amount deposited and any accumulated earnings. The EPF made investment as per the investment policy developed by it, which is presented in Appendix 1. The total fund of the EPF was Rs. 35,681.0 million in fiscal year 2002/03 and its total investment was Rs. 19,042.3 million. The growth of investment of the fund is far lower than the growth of sources over the past five years. Out of the total investment in the fiscal year 2002/03, the investment in corporate securities is only 1.19 percent. With this meagre investment of EPF in the corporate securities, it is almost impossible to achieve the long-term target of the Tenth Plan to make at least 50 percent institutional investment in the securities market. The trend of fund collection and mobilisation of the EPF is presented in Table 4.


Table 4: Fund Collection and Mobilization of Employees Provident Fund (Rs. in million)


1998/99 1999/00 2000/01 2001/02 2002/03 Total Funds 1,9042.3 22,118.2 2,6215.0 30,308.0 35,681.0 Provident Funds 17,301.6 20,018.7 2,3710.0 27,349.0 32,283.0 Reserve Fund 1,517.7 1,805.8 2,071.0 2,285.0 2,278.0 Other Provisions 233.0 293.7 434.0 674.0 1,120.0 Total Investment 14,677.4 16,387.9 17,959.0 18,587.0 19,401.0 Corporate Securities 59.3 67.3 130.0 231.0 231.0 Other Investment 1,4618.1 16,320.6 17,829 18,356.0 19,170.0 Loan 3,360.0 4,566.9 6,738.0 9,801.0 14,098.0 Cash and Bank Balance 380.9 220.8 467.0 831.0 989.0 Other Assets 324.0 942.6 1,051.0 1,089.0 1,193.0

Source: Employees Provident Fund 4.4 Insurance Companies

As institutional investors, insurance companies may act as principal for their own account, and thereby invest the assets of the insurance company in a wide array of financial instruments, i.e., share, debenture etc. in order to produce sufficient income to meet their obligations in the form of promised insurance benefits (GMA (1998)). In Nepal insurance business is regulated by Insurance Board. There were 17 insurance companies registered with Insurance Board till the end of the fiscal year 2002/03, and most of them are listed in stock exchange. Under the provisions of Insurance Act and Regulation, Insurance Board has adopted the policy of facilitating the insurance companies to invest in the priority sectors. The investment guidelines developed and implemented by Insurance Board is presented in the Appendix 2. Accordingly, insurance companies have invested in the National Saving Certificate and Government Bonds, fixed deposit, share and in loan to insurance policy holders. The aggregate total capital base of the insurance companies, which constitutes paid up capital, reserve fund, insurance fund and other liabilities, was Rs.12, 367.2 million in the fiscal year 2002/03. The aggregate total investment was Rs.


10,419.3 million. Out of total aggregate investment of insurance companies in the fiscal year 2002/03, the aggregate portion of investment in corporate securities was only 1.30 percent, which is very nominal portion of their huge sources. Table 5 presents the trend of sources and uses of funds of insurance companies. Table 5: Capital base and Investment of Insurance Companies

(Rs. in million) Particulars Fiscal Year

1998/99 1999/00 2000/01 2001/02 2002/03 Total Capital 6,257.3 8125.0 9830.2 10,978.1 12,367.2 Paid up Capital 467.9 452.9 768.2 1,084.8 1,184.8 Reserve Fund 611.0 554.1 720.4 1,345.0 1,112.0 Insurance Fund 3,862.2 4,288.5 5,080.2 6,629.8 8,051.6 Other Liabilities 1,316.2 2,829.5 3,261.4 1,918.5 2,018.8 Investment 5,252.0 7,206.5 8,397.6 10,054.2 10,419.3 Corporate Securities 53.64 153.26 - - 135.59 Other Investment 5,198.36 7,053.24 - - 10,283.7

1 Cash and Bank Balance 121.7 158.7 502.1 322.8 543.1 Fixed Assets 146.2 159.8 256.6 190.9 217.1 Other Assets 737.4 600.0 673.9 410.2 1,187.7

Source: Insurance Board 5 Legal and Regulatory Gaps

Review of relevant legal provision revealed that there are no major hurdles to the institutional investors to make investment in the corporate securities. However, the existing regulatory and enforcement issues of the institutions are inadequate and conflicting (to some extent) to encourage their investment in the securities market. The Securities Ordinance, 2005 has brought the fund management services under the purview of securities market regulation. It has incorporated the provisions that provide basic legal framework for the management and operation of the investment funds. However, such funds operated by the Citizen Investment Trust


and the Employees Provident Fund, which were established under special Acts before the issuance of the Securities Ordinance, are regulated under their specific Acts. There are no provisions incorporated in those specific Acts that recognise the regulatory role of Securities Board of Nepal. Due to this reason, the fund mobilisation activities of different funds have remained unmonitored, which ultimately is creating dilemma in promoting institutional investment in the securities market. Citizen Investment Trust Act, 1991 and the Employees Provident Fund Act, 1962 have respectively established the Citizen Investment Trust and the Employees Provident Fund as fund management institutions. As per these Acts, the government appoints majority of the directors including chief executive officer, has right to suspend the board of directors, approves bylaws and the rules and their accounts are audited by Auditor General. Thus, the overall operational as well as regulatory authority of the Citizen Investment Trust and Employees Provident Fund rests on the government. However, in the present context of following liberal economic policy, the government should only be the facilitator, and the regulation of Citizen Investment Trust and Employees Provident Fund by the government may not help them to professionalise in the productive investment of their huge collection of the funds. The Employees Provident Fund Act, 1962 has provision as per which it can invest its savings and assets in the stocks and debentures issued by the banks and finance companies up to the 25 percent of the issue. However, it is to be noted that the Act has restricted its investment in the securities issued by the companies other than bank and finance. The Companies Ordinance, 2005 incorporates regulatory provisions regarding the procedure of issuing mutual fund and debenture. It has also made provision for the requirement of trustee, contract between debenture trustee and debenture issuer, and role and responsibility of debenture trustee. However, the Ordinance has not made clear about the criteria for the establishment and operation of trustee services. In this situation there is urgent need for the operation and


regulation of trustee services to facilitate the issue of debentures and mutual funds. The Pension Fund Act, 1985 regulates the operation of pension funds. It also allows the fund to purchase and sell share or debenture of corporate body or public limited company and can invest in suitable area with due consideration of security. But, in the absence of an agency to administer the Act, the establishment and operation of pension funds have still remained under the clouds. The Foreign Investment and Technology Transfer Act, 1992 does not restrict for the investment by the Foreign Institutional Investors in Nepal, however, there is lack of provisions for the regulation of foreign portfolio investment in the securities market. Similarly, the recently passed NRN Ordinance also lacks the provisions and procedures for portfolio investment by NRN. 6. Summary and Conclusion

Sustainable development of securities market is not possible without active involvement of institutional investors. With the operation of collective investment funds, the institutional investors help in increasing participation of general investors in the securities market. Involvement of institutional investors in the market stimulates the issuer to issue different types of securities instruments including bonds and debentures. The involvement of prominent institutional investors like Citizen Investment Trust, Employees Provident Fund, and Insurance Companies in the securities market is very insignificant in Nepal. They have huge amount of funds under their management; however, the unproductive mobilisation of their funds has resulted to the sluggish fund management business in the country. There are various programmes in the national plans to encourage the investment of these institutions in the securities market for the productive mobilisation of their funds. However, these programmes are not duly implemented, which could also be attributed to the absence of special regulator for these institutions. Thus, the legal


and regulatory gaps in this respect should be duly addressed. Further, the government should have strong commitment to implement the programs as envisaged in the national plans. In view of the importance of foreign portfolio investment in the market, The Foreign Investment and Technology Transfer Act, 1992 and NRN Ordinance, 2005 should be amended to clear the procedural aspects and provision for the regulation of such investment in the securities market. Weak regulatory mechanism, inefficient and limited services, insufficient basic market infrastructures, lack of professionalism in the service providers, weak information disclosure practices etc. are the other critical issues of the securities market, which also need to be addressed. References

Citizen Investment Trust, 2004, Annual Report 2003/04, Putalisadak, Kathmandu. Employees Provident Fund, 2004, Special Annual Issue, volume 62, Social Security Management

and Planning Department, Pulchowk, Lalitpur. Employees Provident Fund, Investment Policy, 2004, Central Office, 2004, Pulchowk, Lalitpur. Insurance Board, 2003, Annual Report 2002/03, Chabahil, Kathmandu. Insurance Board, 2005, Investment Guidelines, 2005, Chabahil, Kathmandu. GMA Capital Markets Limited, July 1998, Capital market development project 2, Final Report to

the Asian Development Bank 2, 1-332. Government of Nepal, National Planning Commission, July 1998, Ninth Plan (1997- 2002),

Printing Department, Singhadurbar, Kathmandu. Government of Nepal, National Planning Commission, March 2003, Tenth Plan (2003-2007),

Printing Department, Singhadurbar, Kathmandu. Ministry of Law, Justice and Parliamentary Affair, Securities Ordinance, 2005, Nepal Gazette, part

2, 23rd September 2005, Kathmandu. Ministry of Law, Justice and Parliamentary Affair, Companies Ordinance, 2005, Nepal Gazette,

part 2, 9th October 2005, Kathmandu. Ministry of Law, Justice and Parliamentary Affair, Bank and Financial Institutions Ordinance,

2005, Nepal Gazette, part 5th August 2005, Kathmandu. Ministry of Law, Justice and Parliamentary Affair, Non-resident Nepali Ordinance, 2005, Nepal

Gazette, part 2, 2nd September 2005, Kathmandu. Ministry of Law and Justice, Employees Provident Fund Act, 1962, Law Books Management

Board, 1999, Babarmahal, Kathmandu.


Ministry of Law, Justice and Parliamentary Affair, Citizen Investment Trust Act, 1991Law Books Management Board, 1994, Babarmahal, Kathmandu.

Ministry of Law, Justice and Parliamentary Affair, Insurance Act, 1992, Law Books Management Board, 1994, Babarmahal, Kathmandu.

Ministry of Law, Justice and Parliamentary Affair, Pension Fund Act, 1985, Law Books Management Board, 1994, Babarmahal, Kathmandu.

Ministry of Law and Justice, Foreign Investment and Technology Transfer Act, 1992, Law Books Management Board, 1995, Babarmahal, Kathmandu.

Nepal Rastra Bank, 2005, Unified Directives to Bank and Financial Institutions, 2005, Central Office, Baluwatar, Kathmandu.

Nepal Rastra Bank, Mid-January 2005, Banking and Financial Statistics, no. 44, Bank and Financial Institutions Regulation Department, Central Office, Baluwatar, Kathmandu.

Securities Board of Nepal, 2004, Annual Report 2003/04, Thapathali, Kathmandu. SEBI Manual (as amended by SEBI (amendment) Act 2002), Securities and Exchange Board of

India (Foreign Institutional Investors) Regulations, 1995, Taxmann Allied Services Pvt. Ltd., New Delhi.

SEBI Manual (as amended by SEBI (amendment) Act 2002), Securities and Exchange Board of India (Mutual Funds) Regulations, 1996, Taxmann Allied Services Pvt. Ltd., New Rohtak Road, New Delhi.

Rajeshwer, Ch, July 2004, Perceptions and performance, Chartered Financial Analyst, 10, 7


Appendix 1 The following are the relevant provisions of Employees Provident Fund's Investment Policy-2004. Section 2.2 of Employees Provident Fund's Investment Policy-2004 states, among others, the maximum limit of investment in the share/ debenture shall be 25.0 percent. Section 6.1 states that as per the Section 19(C1) of the Employees Provident Fund Act, 1962 the investment in the shares of bank or finance company shall be as follows: The Fund can invest in the promoter's share and public's share (issue) and

Preference shares of the bank or finance company. The Fund can invest only in the share of national or regional level bank or

finance company. The bank or finance company whose share the Fund is going to hold/ is to

hold has to be licensed for the establishment. The Fund can invest in the promoter's share of bank or finance company

only in the condition of being the Fund's permanent representative in the board of directors of such bank or finance company.

The Fund can also purchase the promoter's share of bank or finance company licensed as 'A' group from the secondary securities markets. The valuation of the share purchased as above should not exceed 10.0 percent of net worth of the bank or finance company. But such valuation in any case should not exceed current market price.

The Fund shall specify the other conditions as per the necessity. Section 6.2 states that as per the Section 19 (C3) of Employees Provident Fund Act, 1962, the Fund's investment in the debenture of company or corporate body shall be as follows:


The company or corporate body, issuing debenture should have three years' track records of profit.

The debenture should be redeemable. The Fund shall purchase at least 10.0 percent of debenture issued. The Fund shall not purchase the debenture of the corporate body if the

debt-equity ratio of such corporate body exceeds 60:40 after issuing debenture.

The Fund shall specify the other conditions as per the necessity. Section 11.4 of the Employees Provident Fund's Investment Policy, 2004 states that the authority of deciding whether to investment or not in the share/ debenture of bank or finance company or corporate body shall be in the board of directors.


Appendix 2 The following is the recent investment guidelines given by Insurance Board (Insurance Board) to life insurance companies with respect to investment in securities markets. Life Insurance Companies could make investment in Citizen Unit Scheme

of Citizen Investment Trust not exceeding 5.0 percent of total investment amount.

Life Insurance Companies could make investment in Preference Share, Debenture and bonds of the commercial banks, development banks and finance companies not exceeding 10.0 percent of total investment amount.

Life Insurance Company could make investment in Ordinary Share of public limited companies not exceeding 5.0 percent of total investment amount.

The following is the investment guidelines given by Insurance Board (Insurance Board) to non-life insurance companies with respect to investment in securities markets. Non-life Insurance Companies could make investment in Citizen Unit

Scheme of Citizen Investment Trust not exceeding 20.0 percent of total investment amount.

Non-life Insurance Companies could make investment in Preference Share, Debenture and Bonds of commercial banks, development banks and finance companies not exceeding 10.0 percent of total investment amount.

Non-life Insurance Companies could make investment in Ordinary Share of Housing Development Finance Company Ltd. not exceeding 5.0 percent of total investment amount.

Non-life Insurance Companies could make investment in Ordinary Share of public limited company other than mentioned in 3 above not exceeding 5.0 percent of total investment amount.

seb on journal issue 3

Documents

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dynamic market

market place

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nepalese capital market

capital market sector