International Journal of Economics and Finance; Vol. 10, No.

12; 2018
ISSN 1916-971X E-ISSN 1916-9728
Published by Canadian Center of Science and Education

The Role of Stock Market Development in Influencing the Firms

Performance: A Study Based on Pakistan Stock Market
Sophee Sulong1, Qasim Saleem1 & Zeeshan Ahmed2
1
Department of Finance and Economy (FEB), University of Sarawak (UNIMAS), Kota Samaharan, Malaysia
2
Department of Lahore Business School (LBS), University of Lahore (UOL), Gujrat Campus, Punjab, Pakistan
Correspondence: Qasim Saleem, Department of Finance and Economy (FEB), University of Sarawak
(UNIMAS), Kota Samaharan, Malaysia. E-mail: qami2006@yahoo.com

Received: September 23, 2018 Accepted: October 17, 2018 Online Published: November 5, 2018
doi:10.5539/ijef.v10n12p104 URL: https://doi.org/10.5539/ijef.v10n12p104

Abstract
The study aims to examine the role of stock market development in influencing the performance of non financial
firms listed on Pakistan Stock Exchange from 2001 to 2017. Stock market development is a foremost issue of
debate nowadays in emerging and developing economies. The theories and empirical studies strongly refer that
stock market development is a tool to mobilize the savings and investment to promote the industrialization and
firms performance. This study is an effort to establish the empirical relationship between stock market
development and firm‟s performance. Three indicators of stock market development like stock market
volatility,stock market liquidity and stock market liquidity are used for assessing the book and market
performance of firms. For this purpose two-step system Generalized Method of Moments (GMM) estimator was
employed in a dynamic panel model for empirical testing of hypothesis. The findings indicates that stock market
volatility is a significant factor which which attempts to decrease the firm performance. On the other hand, stock
market capitalization and stock market liquidity significantly causes the increase in firm firm performance.
Keywords: stock market development, stock market capitalization, stock market liquidity, Pakistan Stock
Exchange, firm performance
1. Introduction
A well-developed financial system improves the efficiency of capital allocation with more productive
investments (Rafael et al., 1999). Furthermore, equity markets are illiquid and highly concentrated which play a
prominent role in the development of the stock market and are considered as main factors of stock market
development. It seems to assume that stock market measures the ability of firms to mobilize the capital and their
performance (Bokpin & Ishaq, 2008). Notably, the equity markets and firms operating in stock markets are
facing the serious issues related to their performance after the financial crisis. A large part of the savings of an
economy is intermediated with productive investments through financial markets and intermediaries (Levine,
1997). Since capital accumulation is a fundamental determinant for the long-term growth of any firm and an
efficient financial system is essential for the development of an economy. Therefore, stock market development
plays an important role for predicting the future economic growth and survival of firms (Kunt & Maksimovic,
1996; Singh, 1997; Levine & Zervos, 1998).
Developed stock markets are more liquid, less volatile, highly concentrated and is associated with high stock
market capitalization. Existing models suggested that stock market development is a multifaceted concept
involving issues of market size, liquidity, volatility, concentration, integration with world capital markets, and
institutional development. The development of stock market is likely to be affected by stock market volatility,
stock market capitalization, and trading volume. All these indicators play a decisive role for the development of
stock market which in turn increases the performance of firms. This leads to the expectations that as the stock
market develops, firms would prefer equity financing over debt financing in return less burden on firms‟ profits
(Agarwal & Mohtadi, 2004).
Numerous studies has been done in relation to macroeconomic factors and firm specific factors in the way of
stock market development at aggregate and firm level. In Pakistan number of studies has been done on stock
market development but no empirical study has been done on the role of stock market development in influencing

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the firms performance. The study enlarge the theoretical span of stock market development which influence the
firms‟ performance in a dynamic panel model. This is the first empirical study that addresses the role of stock
market development in influencing the performance of non-financial firms‟ listed on Pakistan Stock Exchange.
The study have provided new insight about the role of stock market development in influencing the firms‟
performance. The study also incorporated the additional measure of firm performance (Tobin Q) which is a
market measure of firms‟ performance. It has provided a better explanation about the role of stock market
development in the market performance of firms such as Tobin „Q‟. Moreover, the study attempts to contribute
in the existing empirical evidence through dynamic panel model.
1.1 Stock Market Development in Pakistan
It is widely known in finance research that the development of the stock market is very important for economic
development and for firms operating in any country. Pakistani stock market is one of the emerging and developing
market in this stage which affects the overall economy and companies‟ performance. It is one of the most leading
and liquid stock exchange of financial capital established in Pakistan. There are 35 sectors listed on Pakistan Stock
Exchange, which contribute to total stock market capitalization.
According to the Pakistan Economic Survey (Government of Pakistan, 2007), for the fiscal year 2006–07,
Pakistan‟s GDP is estimated to be US$143 billion. This makes stock market capitalization approximately 49 per
cent of GDP. KSE 100 index is the most popular way that tracks the overall stock prices in the market. It is a
market capitalization-weighted index of 100 stocks which included the largest market capitalization firms from
each of the 35 sectors. The securities traded in the market included ordinary shares, preference shares,
redeemable certificates and term-finance certificates (corporate bonds). where ordinary shares is the most traded
security.
Table 1 shows that market capitalization has an increasing trend which means the higher market capitalization of
firm and higher liquidity of stocks traded in the market. A total 652 companies were listed in 2010 with share
capital of Rs. 910 billion, and a market capitalization of Rs 2774.5 billion and total share volume was Rs 42,959
million. Stock market capitalization tends to have an increasing trend and reached to an amount of Rs 7,306 in
2015, indicating a major determinant of stock market development.
Table 2 shows that PSE-100 index has an upward trend from 2001-2007 and reached its peak with 14075.83
points. The declining trend can be observed in 2008 due to the world financial crisis and big loss due to
variations in market capitalization, high stock market volatility, stock market liquidity and uncertain behavior.
Moreover, firms‟ performance is badly affected by these factors and investors are reluctant to invest in stock
markets due to poor performance of the stock market (Economic Survey of Pakistan, 2009). The Pakistan Stock
Exchange (PSE) 100 index started to decrease from 12022.46 points in 2010 to 11347.66 points in 2011. This
decrease is only 674.8 points in the index, but aggregate market capitalization had increased from 2775 Billion in
2010 to Rs 3317 billion in 2011.

Table 1. Pakistan stock exchange

Description 2010 2011 2012 2013 2014 2015
Total Listed Companies 652 639 591 569 559 560
New Companies Listed 8 1 3 4 4 6
Funds Mobilization (Billion) 112 31 115 30 38 29
Total Listed Capital (Billions) 910 944 1,070 1,116 1,153 1,178
Total Market Capitalization (Billions) 2,775 3,317 3,493 5,337 7,023 7,306
Total Share Volume (Millions) 42,959 28,018 38,100 54,319 48,494 38,328
Average Daily Share Volume (Millions) 173 117 150 221 237 186
Source: State Bank of Pakistan, Economic Survey and Pakistan Stock Exchange (2010-2015).

Table 2. PSE 100 Index (Pakistan) yearly returns

Years Beginning Price Ending Price Gain or Loss Percent Gain/ Loss
2001 1507.59 1273.06 -234.53 -15.56%
2002 1273.06 2701.42 1428.36 112.20%
2003 2701.42 4471.82 1770.4 65.54%
2004 4471.82 6218.46 1746.64 39.06%
2005 6218.46 9556.61 3338.15 53.68%

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2006 9556.61 10040.5 483.89 5.06%

2007 10040.5 14075.83 4035.33 40.19%
2008 14075.83 5865.01 -8210.82 -58.33%
2009 5865.01 9386.92 3521.91 60.05%
2010 9386.92 12022.46 2635.54 28.08%
2011 12022.46 11347.66 -674.8 -5.61%
2012 11347.66 16905.33 5557.67 48.98%
2013 16905.33 25261.14 8355.81 49.43%
2014 25261.14 32131.28 6870.14 27.20%
2015 32131.28 32816.31 685.03 2.13%
2016 32816.31 47806.97 14990.66 45.68%
Source: Pakistan Stock Exchange (2010-2016).

1.2 Problem Statement

Most of the researchers think that stock market development is good for country‟s growth and firm performance
(Valeriano, 1999; Kunt & Levine, 1996; Singh, 1997; Levine & Zervos, 1998; Booth et al., 2001; Morck et al.,
1988; Yermack, 1996; Gompers et al., 2003). Some scholars believe it is not by (Stiglitz, 1994; Shleifer &
Vishny, 1986; Bencivenga & Smith 1991; Bhide, 1993; Singh, 1997). There is some ambiguity about this issue.
How this issue will be resolved and what is actual truth and scenario?. As an emerging market, Pakistan Stock
Market is not stable and highly volatile due to unanticipated market shocks. Also, the stock market volatility
affects the stock market liquidity, and it happens because of too much variation of stock market prices. This
leads to low level of investors‟ confidence due to reliability issues in the stock market, and as a result, it
indicates the unreliable economic growth and firm‟s stock prices (Ali et al., 2010).
1.3 Study Objective
The study attempts to investigate the general objective about the role of stock market development in influencing
the performance of non-financial firms. For this purpose, the study developed the specific objectives. First, to
analyze the role of stock market volatility in influencing the firm performance. Secondly, to analyze the impact
of stock market capitalization on firm‟s performance. Thirdly, the study aims to analyze the impact of stock
market liquidity on the performance of non-financial firms listed on Pakistan Stock Exchange.
2. Literature Review
Firms Performance is the mainstream theme of corporate finance and is a crucial component for financing
decisions. The firms‟ performance and the components of the firms‟ performance are the most extensive research
area in the field of finance. A well-developed stock market minimizes the cost, maximizes the benefits and
increases the firms‟ performance (Myers & Majluf, 1984). In this way, they can achieve the objective of
maximization of shareholder‟s wealth.
The amount of book and market values of equity depends upon the stock market development. Firm performance
depends upon this development of the stock market and other firm-specific factors. These factors are the firm‟s
characteristics, availability of funds, market timing, market conditions, business risk, macroeconomic conditions
and development of stock markets which directly affect the firms‟ performance. Moreover, performance of firm
changes over the period of time with the growth and changes in regulatory framework as well as capital market
conditions (Mahmud & Qayyum, 2003). Along with these factors, stock market development is one factor which
is also likely to affect the performance of firms.
Moreover, the factors like stock market capitalization, stock market volatility and stock market liquidity play an
immense role in the development of stock market. As the stock market continues to develop, investors and firms
are confident about their investment. Firms are sure about their investments and future stream of incomes which is
likely to increase the performance of firms. Moreover, performance of firm changes over the period of time with
the growth and changes in regulatory framework as well as capital market conditions (Mahmud & Qayyum,
2003). Along with these factors, stock market development is one factor which is also likely to affect the
performance of firms.
The pecking order hypothesis suggested that firm issues equity in the stock market when stock market overvalues
it or develops. In the case of information asymmetry in the market, they use profits to meet their financing needs,
but this profit depends upon the performance of firms. Pandey (2001) postulated that increases in profitability
induces the firms to utilize the internal funds for their investments and are less likely to go for debt financing. High

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profitable firms have better performance, and they are in a good position to go for internal financing. But as the
stock market goes to develop, share trading in the market becomes over values which consequently reduces the
debt-equity ratio when the stock market develops.
Market capitalization ratio, GDP growth, Stock market liquidity, investment, returns on stock market is
determinative factors for stock market development (Garcia & Liu, 1999; Levine & Zervos, 1998b; Bekaert &
Harvey, 2000; Edison & Warnock, 2003; La Porta et al., 1997; Rajan & Zingales, 2003; La Porta et al., 2006).
Henry (2000) found a strong relationship between the growth rate of investment and changes in stock market
valuation measured by returns on the stock market, turnover ratio, and trading volume as a share of GDP.
Alti et al. (2012) argued that in emerging markets, the quality of information flow is poor, and investors wait for
subsequent confirmation news to set stock prices which leads to persistence in firms returns. Walkshausl (2013)
argued in a study that the effect of stock market volatility is associated with the quality of firms. Stock market
capitalization indicates the firm‟s ability to allocate the funds in investment projects and provide significant
opportunities for risk diversification to investors (Sukcharoensin, 2013). Firms are having more liquid stocks have
better operating performance and capital gains. Levine and Zervos, 1998 measured the stock market liquidity as
the value of stock trading to the size of the stock market. Stock market liquidity can also be measured through
trading volumes which is a source of information for investors and a signal of new information release. Trading
volumes are an increasing function of the stock market development which develops a significant role in firm
performance (Hamon & Jacquillat, 1992; Krigman et al., 1999).
The study cannot ignore the market capitalization, stock market volatility, and stock market liquidity that
determine the firms‟ performance. A strong theoretical reason believes that market capitalization, volatility of the
stock market and liquidity of stocks matters in investment decisions that affect the firm performance (Frank &
Goyal, 2009; Graham & Leary, 2011).
3. Methodology
3.1 Sample Selection
The data is collected from financial statement of firms listed on Pakistan Stock Exchange over the period
2001-2017. The sample size of this study is consisted upon 206 non financial firms and ratio data is used for
empirical testing of the hypothesis. The study have used accounting ratios and market ratios in a dynamic panel
model. In developing our research, we selected a series of dependent variables to measure the firm‟s
performance; focusing on market ratio which is Tobin Q and accounting ratios are return on assets (ROA), return
on equity (ROE) and return on investment (ROI). Independent variables are stock market volatility (SMV), stock
market capitalization (Mkt Cap) and trading volume (TV) which are determinants of stock market development
(SMD). We also considered other control variables such as liquidity ratio, firm size, leverage, asset tangibility ,
board size and board committee, that are commonly used to measure the firm performance (Cochran & Wood,
1984; Kakabadse et al., 2001; Simpson & Kohers, 2002; Wenzel & Thiewes, 1999; Wokutch & McKinney,
1991).

Table 3. Variable definitions for regression equations

Variables Symbols Measurements Scale Formula
Dependent Variables
Tobin Q: T „Q‟ The market value of equity and liabilities in relation to their book values MV/BV
Return on Assets: ROA Net income earned by a company as a percentage of the total assets NI/ TA
Return on Equity: ROE The rate of return on the owner‟s equity employed in the business NI/ Equity
Return on Investment: ROI Net income earned the total investments NI/ Total Inv
Independent Variables
Stock Market Volatility: SMV Standard Deviation of Daily Market Price Index St. Dev
Stock Market Capitalization: MktCap Total stock market capitalization of the firms as a proportion of GDP MktCap/GDP
Stock Market Liquidity: SMV The total value of shares traded to GDP TV/GDP
Control Variables
Liquidity: Liq Liquidity is current ratio CA/CL
Firm Size: FS Log of Total sales Log (Sales)
Leverage: LEV Total debt-to-equity ratio Debt/Equity
Tangibility: Tang Total fixed assets divided by total assets FA/TA
Board Size: BS Total number of directors on the board
Board Committee: BC Total number of board committees in the company

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3.2 Model Specification

The study focused on the formulation of a model for empirical estimation of the impact of stock market
development on firm performance. Firm performance is an important factor which increases the shareholder's
wealth. All the models were designed based on theoretical and empirical evidence. In this way, the study
developed the following dynamic panel model for empirical testing.
𝐹𝑃𝑖𝑡 = 𝛽1 𝐹𝑃𝑖𝑡−1 + 𝛽2 𝑆𝑀𝐷𝑖𝑡 + 𝛽3 𝐿𝑖𝑞𝑖𝑡 + 𝛽4 𝐹𝑆𝑖𝑡 + 𝛽5 𝐿𝑒𝑣𝑖𝑡 + 𝛽6 𝑇𝑎𝑛𝑔𝑖𝑡 + 𝛽7 𝐵𝑆𝑖𝑡 + 𝛽8 𝐵𝐶𝑖𝑡 + 𝜀𝑖𝑡 (1)
The lagged value of dependent variable is included as independent variable to make the model as dynamic. This
shows the speed of adjustment and mean reversion behavior of firm performance. Last year‟s firm performance
affect the current year‟s firm performance. FPit represent the firm performance, SMDit represents stock market
development, Liqit represents liquidity, FSit represents firm size, Levit represents leverage, Tangit represents
tangibility, BSit represents board size and BCit represents board committee.
𝐹𝑃𝑖𝑡 = 𝛽1 𝐹𝑃𝑖𝑡−1 + 𝛽2 𝑆𝑀 𝑖𝑡 + 𝛽3 𝐿𝑖𝑞𝑖𝑡 + 𝛽4 𝐹𝑆𝑖𝑡 + 𝛽5 𝐿𝑒𝑣𝑖𝑡 + 𝛽6 𝑇𝑎𝑛𝑔𝑖𝑡 + 𝛽7 𝐵𝑆𝑖𝑡 + 𝛽8 𝐵𝐶𝑖𝑡 + 𝜀𝑖𝑡 (2)
FPit represent the firm performance, SMVit represents stock market volstility, Liqit represents liquidity, FSit
represents firm size, Levit represents leverage, Tangit represents tangibility, BSit represents board size and BCit
represents board committee.
𝐹𝑃𝑖𝑡 = 𝛽1 𝐹𝑃𝑖𝑡−1 + 𝛽2 𝑀 𝐶𝑎 𝑖𝑡−1 + 𝛽3 𝐿𝑖𝑞𝑖𝑡 + 𝛽4 𝐹𝑆𝑖𝑡 + 𝛽5 𝐿𝑒𝑣𝑖𝑡 + 𝛽6 𝑇𝑎𝑛𝑔𝑖𝑡 + 𝛽7 𝐵𝑆𝑖𝑡 + 𝛽8 𝐵𝐶𝑖𝑡 + 𝜀𝑖𝑡 (3)
FPit represent the firm performance, MktCapit represents stock market capitalization, Liqit represents liquidity, FSit
represents firm size, Levit represents leverage, Tangit represents tangibility, BSit represents board size and BCit
represents board committee.
𝐹𝑃𝑖𝑡 = 𝛽1 𝐹𝑃𝑖𝑡−1 + 𝛽2 𝑆𝑀𝐿𝑖𝑡 + 𝛽3 𝐿𝑖𝑞𝑖𝑡 + 𝛽4 𝐹𝑆𝑖𝑡 + 𝛽5 𝐿𝑒𝑣𝑖𝑡 + 𝛽6 𝑇𝑎𝑛𝑔𝑖𝑡 + 𝛽7 𝐵𝑆𝑖𝑡 + 𝛽8 𝐵𝐶𝑖𝑡 + 𝜀𝑖𝑡 (4)
FPit represent the firm performance, SMLit represents stock market liquidity, Liqit represents liquidity, FSit
represents firm size, Levit represents leverage, Tangit represents tangibility, BSit represents board size and BCit
represents board committee.
3.3 Statistical Analysis
The study used the dynamic panel model for the empirical estimation of hypothesis. The dynamic model is the
one that has a lag value of the dependent variable as an independent variable (Davidson & Mackinnon, 2004).
However, the error term in the dynamic panel model is correlated with lag dependent variable even though it is
not serially correlated (Baltagi, 2008). Using dynamic panel data, the assumptions of serial correlation and
heteroskedasticity in error term can be violated. Fixed effect and random effect cannot solve this issue in a
dynamic regression model due to the correlation between lagged regressors and error term (Wawro, 2002).This
impact was captured through the most advanced econometric tools and techniques (GMM) through xtabond2.
3.4 Results
A valid model should fulfill the validity of instrumental variables (Arellano & Bond, 1991) and is normally
distributed. First, the study tested the non-existence of serial correlation among error terms usually first and second
order serial correlation test. Specifically, the differenced residuals should provide significant negative value in
first-order serial correlation with no evidence of second-order serial correlation. Secondly, the study tested the
exogeneity of instruments with no over identified restrictions which ensures the consistency of estimates and is
captured through Sargan and Hansen test. This test ensured that instruments were valid and were not correlated
with the error term.
3.5 Descriptive Statistics
Descriptive statistics summarize and describe the data in such a way which is easier to interpret. These descriptive
statistics detect the unusual behavior of data and outliers. The summaries about data sample and measure which are
mean, standard deviation, minimum and maximum values of the variables used in this study. The results related to
the descriptive statistics presented in Table 4.
The result shows that Tobin Q has the average value of 0.571 with a standard deviation of 0.713. It indicates that on
average the market value of equity and liabilities are 57.1% to book value of equity and liabilities. On the other
hand, the average value of return on assets is 0.101 while the standard deviation is 0.303. Firms listed on Pakistan
Stock Exchange maintain the net earnings 10.1% of their total assets. The average value of return on equity is
0.266 with a standard deviation of 0.871. This indicates that on average, firms in Pakistan have the net incomes of
26.6% of total shareholders‟ equity. The average value of return on investment is 0.688 while it has the standard
deviation of 1.830.

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Stock market volatility has the average value of 0.491 with a standard deviation of 0.278. The result shows that the
average value of market capitalization of firms listed on Pakistan Stock Exchange is 0.877 while it has the standard
deviation of 0.692. Trading value shows an average value of 0.295 with a standard deviation of 0.311.

Table 4. Descriptive statistics

Variables Mean Std Dev Min Max Obs
TQ 0.571 0.713 0.000 5.618 4420
ROA 0.101 0.303 -1.008 2.899 4420
ROE 0.266 0.871 -1.939 6.791 4420
ROI 0.688 1.830 -3.497 8.947 4420
SMV 0.491 0.278 0.0005 0.999 4420
MCAP 0.877 0.692 0.050 2.593 4420
TV 0.295 0.311 0.011 1.681 4420
Liquidity 1.425 1.365 0.100 9.910 4420
FS 9.136 0.836 6.574 16.540 4420
Tang 0.538 0.156 0.250 0.799 4420
Lev 0.421 0.159 0.100 0.699 4420
BS 9.238 1.865 5.000 14.000 4420
BC 7.367 1.959 4.000 12.000 4420

3.6 Correlation Analysis

Correlations analysis is a method of statistical evaluation, which is used to see the strength of the relationship
between two or more variables. There may be a perfect positive correlation, perfect negative correlation, partial
correlation and no correlation. An important concern with this correlation analysis is that all the explanatory
variables are partially correlation, therefore multicollinearity problem does not arise.
Table 5 shows that Return on assets has a positive correlation with Tobin Q (0.2841), further ROE has a positive
correlation with Tobin Q (0.1363) and ROA (0.3889). Return on investment has a positive correlation with Tobin
Q (0.1607), return on assets (0.2590) and return on equity (0.1351). Stock market volatility has a positive
correlation with Tobin Q (0.0337), return on assets (0.0197), return on equity (0.0214) and return on investment
(0.0022).
Stock market capitalization has positive correlation with Tobin Q (0.0734), return on assets (0.0543), return on
equity (0.0343) and stock market volatility (0.0374) whereas negative correlation with return on investment
(-0.0084). Trading volume has positive correlation with Tobin Q (0.2020), return on assets (0.1380), return on
equity (0.0636), and return on investment (0.0634), stock market volatility (0.0206) and stock market
capitalization (0.0056). Liquidity has positive correlation with Tobin Q (0.2726), return on assets (0.0877), return
on equity (0.0039), and return on investment (0.0686), stock market volatility (0.0126), stock market capitalization
(0.0268) and trading volume (0.3223).
4. Results
4.1 Stock Market Volatility and Firms Performance
Table 6 shows the results related to the impact of stock market volatility calculated by standard deviation of daily
market price index on Tobin Q, ROA, ROE and ROI. The lag value of dependent variable is considered as
independent variable to make the model as dynamic panel model. The findings of this study suggested that lagged
value of dependent variable has a significant impact on current level of Tobin Q, ROA, ROE and ROI value. The
significance indicates that the model is dynamic in nature. This shows the mean reversion behavior where past
performance affects the current level of performance.
Stock market volatility has a significant negative impact on market performance of firms listed on Pakistan
Stock Exchange. The findings of this study suggested that stock market volatility adversely affect the
development of stock market. Moreover, stocks are traded in the market at lower prices and firms operating in
Pakistan face the risk of a decrease in their earnings. These firms are not in a good position about their
operations and investments. The stock market is not developed while facing high volatility in the stock market
and is more likely to increase the business risk. This particular situation shows that stock market volatility
decreases the performance of firms. Therefore, it has statistically significant impact in firm level investment
decisions and market performance (Morck et al., 1990). Stock market volatility creates the uncertainty in the

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market and firms in the market are unsure about their performance. This particular situation has a negative
impact on the performance of firms and they suffer. Low stock market volatility would likely to have strong
operating performance as low volatility improves the firm‟s access to capital. Moreover, stock market volatility
affect the market conditions adversely and stock price decreases. It creates uncertainty in the market and firms
operating in the market are unsure about their income streams. It increases the business risk in the market and
decreases the firm performance (Dutt & Jenner, 2013). Therefore, an increase in stock market volatility
decreases performance. Moreover, it also increases the uncertainty in the market and the level of stock market
development decrease. This particular situation increases the business risk and decreases the firm performance.
Consequently, the firm‟s performance decreases and they suffer (Agrawalla, 2006).
4.2 Stock Market Capitalization and Firms Performance
Table 7 shows the relationship between stock market capitalization and performance in a multiple dynamic linear
regression model. The significance of lagged value of dependent variable shows that model is dynamic in nature.
Firms temporarily deviate from current level of performance and then revert back with a mean reversion
behavior. The result shows that stock market capitalization significantly and positively affects the performance
of firms. It indicates that firms with better market capitalization are operating well and have better prices of
stocks traded in the market. It tends to increase the development of the stock market which is more likely to
increase the firm performance (Ahmad et al., 2012). This particular situation increases the performance of firms
and shareholders get positive returns on their equity investments. Firms with better market capitalization have
better performance in the shape of their profits (Ewing & Thompson, 2016). This optimism increases the
performance of firms and firms operating in such an environment get some positive returns on their investments.
The higher the stock market capitalization of firms, the higher the funds available for the firms. This shows the
positive relationship between market capitalization and the profits of firms (Matthew & Odularu, 2009).
4.3 Traded Volume and Firms Performance
Table 8 shows the relationship of trading volume with firm performance in a multiple linear dynamic regression
model. The lagged value of dependent variable is significant indicating that model is dynamic in nature.
Moreover, the results indicates that trading volume is a significant factor lies in the stock market which tends to
increase the firm performance. A high trading volume indicates that stock have better liquidity position in the
market and buying and selling is easy. Shares are traded in the market easily, which is more likely to increase the
market performance of firms. Therefore, it is concluded that firms with better trading volume have better
liquidity position of their stocks which in turn increase their market performance (Hamon & Jacquillat, 1992;
Krigman et al., 1999).
5. Conclusions
The study analyzed the nexus between stock market development indicators and performance of non financial
firms listed on Pakistan Stock Exchange over the period 2001-2017 in a dynamic panel model. The study
concluded about the three significant stock market development indicators like stock market volatility, stock
market capitalization and trading volume. The study identified that stock market volatility significantly causes
the decrease in firm performance. However, stock market capitalization and trading volume of firms results an
increase in firm performance. The study found that the increase of stock market development helps to increase
the firm performance and market value of firms. Stock market develops with low market volatility, high stock
market capitalization and high traded volume. Firms operating in a developed stock market are efficient in
operations and have a consistent stream of income. These firms have better investment opportunities which tends
to increase their performance. Moreover, they have better stock prices, high liquidity of stocks and low volatility
in the market. Investors prefers to invest in a well developed stock market which in turn results an increase in
firm performance.
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Appendix
Table 5. Correlation analysis
TQ ROA ROE ROI SMV MCap TV Liq FS Tang Lev BS BC
TQ 1.0000
ROA 0.2841 1.0000
ROE 0.1363 0.3889 1.0000
ROI 0.1607 0.2590 0.1351 1.0000
SMV 0.0337 0.0197 0.0214 0.0022 1.0000
MCap 0.0734 0.0543 0.0343 -0.0084 0.0374 1.0000
TV 0.2020 0.1380 0.0636 0.0634 0.0206 0.0056 1.0000
Liq 0.2726 0.0877 0.0039 0.0686 0.0126 0.0268 0.3223 1.0000
FS 0.1313 0.2237 0.1237 0.1291 0.0334 0.0995 -0.0531 -0.0147 1.0000
Tang -0.1422 -0.1145 -0.0695 -0.0164 -0.0400 -0.0161 -0.1627 -0.2022 0.0166 1.0000
Lev -0.0572 0.0350 0.0802 -0.0051 -0.0226 0.0105 -0.0125 -0.1815 0.0271 0.0104 1.0000
BS 0.1319 -0.0280 -0.0287 0.0163 -0.0270 0.0160 -0.1755 0.0711 0.1747 -0.0191 -0.0211 1.0000
BC 0.0799 -0.0235 -0.0137 0.0066 -0.0235 0.0082 -0.1424 0.0630 0.1515 -0.0136 -0.0201 0.1120 1.0000
Note. Table 5 presents the correlation matrix between the dependent variable and the explanatory variables. It shows the direction of
relationship between the variables. All the independent variables are partially correlated that indicates no multicollinearity issue. The
correlation is among Tobit Q, Return on Assets, Return on Equity, Return on Investment, Stock Market Volatility, Stock Market Capitalization,
Trading Volume, Liquidity, Firm size, Asset Tangibility, Leverage, Board size, Board Committee. “***”, “**” and “*” shows the significance
level at 1%, 5% and 10% respectively,

Table 6. Estimation results of Tobin Q, return on assets, return on equity and return on investment based on stock
market volatility
Variables TQ TQ ROA ROA ROE ROE ROI ROI
Constant 0.325*** 0.071 0.068 0.014 0.150*** 0.291* 0.712** -0.153
FP(t-1) 0.823*** 0.756*** 0.491*** 0.645*** 0.461*** 0.330*** 0.255*** 0.090**
SMV -0.276** -0.238** -0.602** -0.051** -0.134** -0.112** -0.979** -0.503**
Liq 0.006 0.005*** -0.013** 0.115**
Firm Size 0.043*** 0.024*** 0.058*** 0.160*
Leverage -0.219** 0.043 -0.020** 1.368**
Tangibility -0.412** -0.123** -0.152* 0.786
Board Size 0.074*** -0.009** -0.070** 0.14
Board Committee -0.072** -0.006 0.02 -0.171
Time Dummy Yes Yes Yes Yes Yes Yes Yes Yes
AR(1) 0 0 0 0 0 0 0 0
AR(2) 0.1 0.2 0.105 0.057 0.253 0.528 0.056 0.558
Sargan / Hansen Test Overid 0.177 0.286 0.112 0.422 0.13 0.524 0.831 0.6
Number of Instruments 95 143 67 119 85 178 87 143
Number of firms 260 260 260 260 260 260 260 260
Note. Table 6 reports the results related to two step system GMM dynamic panel model. Dependent variable is Firm Performance, and
independent variable is Stock Market Volatility which represents the yearly standard deviation of Stock Market Index/return from 2001 to 2017.
Column 1 to 2 presents the results related to the effect of stock market volatility on TQ. Column 3 to 4 present the results related to the effect of
stock market volatility on ROA. Column 5 to 6 present the results related to the effect of stock market volatility on ROE. Column 7 to 8 present
the results related to the effect of stock market volatility on ROI. Tobin Q is calculated as market value of assets and liabilities over book value
of assets and liabilities. Return on Asset is calculated as net income divided by total assets. Rest is liq represents liquidity ratios and is
calculated as current assets to current liabilities, Firm size is the log values of total sales, leverage ratio is total debt over total assets, tang is the
tangible assets to total assets, whereas board size is total number of board of directors, Board committee is total number of directors in audit
committee as corporate governance variables. The significant value of AR (1) shows the existence of first order serial correlation that null
hypothesis of no first difference autocorrelation among the error terms is rejected. However, AR (2) is insignificant showing that no second
order serial correlation in level regression among error term. Sargan / Hansen test overid value is insignificant, indicating the validity of
instruments and are not over identified. Overall, the results of AR (1), AR (2) and Sargan / Hansen test shows that GMM is correctly specified
with no identification issues. Figures in parentheses shows the standard errors; “***”, “**” and “*” shows the significance level at 1%, 5% and
10% respectively.

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Table 7. Estimation results of Tobin Q, return on assets, return on equity and return on investment based on stock
market capitalization
Variables TQ TQ ROA ROA ROE ROE ROI ROI
Constant 0.191 -0.14 -0.03 -0.187** 0.009 0.233 0.636*** -1.832**
FP(t-1) 0.781*** 0.852*** 0.754*** 0.540*** 0.433*** 0.351*** 0.076*** 0.092***
Mkt Cap 0.079*** 0.065*** 0.060*** 0.029*** 0.087** 0.051*** 0.319***
Liq 0.007** 0.004** 0.005 0.114***
Firm Size 0.012 0.044*** 0.067*** 0.164**
Leverage -0.057 -0.365 0.246*** 0.728
Tangibility -0.529** -0.251** -0.357** 0.698***
Board Size 0.034** 0.019** 0.040** 0.176
Board Committee -0.024** 0.022*** 0.023 -0.214***
Time Dummy Yes Yes Yes Yes Yes Yes Yes Yes
AR(1) 0 0 0 0 0 0 0 0
AR(2) 0 0 0.061 0.103 0.288 0.414 0.639 0.58
Sargan / Hansen Test Overid 0.082 0.239 0.123 0.207 0.108 0.472 0.627 0.621
Number of Instruments 73 178 91 167 85 167 85 143
Number of firms 260 260 260 260 260 260 260 260
Note. Table 7 reports the results related to two step system GMM dynamic panel model. Dependent variable is Firm Performance, and
independent variable is Stock Market Capitalization which represents the Stock market capitalization as proportion of GDP from 2001 to 2017.
Column 1 to 2 presents the results related to the effect of stock market volatility on TQ. Column 3 to 4 present the results related to the effect of
stock market volatility on ROA. Column 5 to 6 present the results related to the effect of stock market volatility on ROE. Column 7 to 8 present
the results related to the effect of stock market volatility on ROI. Tobin Q is calculated as market value of assets and liabilities over book value
of assets and liabilities. Return on Asset is calculated as net income divided by total assets. Rest is liq represents liquidity ratios and is
calculated as current assets to current liabilities, Firm size is the log values of total sales, leverage ratio is total debt over total assets, tang is the
tangible assets to total assets, whereas board size is total number of board of directors, Board committee is total number of directors in audit
committee as corporate governance variables. The significant value of AR (1) shows the existence of first order serial correlation that null
hypothesis of no first difference autocorrelation among the error terms is rejected. However, AR (2) is insignificant showing that no second
order serial correlation in level regression among error term. Sargan / Hansen test overid value is insignificant, indicating the validity of
instruments and are not over identified. Overall, the results of AR (1), AR (2) and Sargan / Hansen test shows that GMM is correctly specified
with no identification issues. Figures in parentheses shows the standard errors; “***”, “**” and “*” shows the significance level at 1%, 5% and
10% respectively.

Table 8. Estimation results of Tobin Q, return on assets, return on equity and return on investment based on traded
volume
Variables TQ TQ ROA ROA ROE ROE ROI ROI
Constant 0.323*** 0.278*** 0.027*** -0.333*** -0.035 0.01 -0.514 -0.755
FP(t-1) 0.673*** 0.789*** 0.530*** 0.0515*** 0.484*** 0.276*** 0.343*** 0.243***
Mkt Cap 0.256*** 0.059*** 0.081*** 0.0732*** 0.161*** 0.246*** 0.549*** 0.440**
Liq 0.030*** 0.003 -0.019 0.005
Firm Size 0.049*** 0.038*** 0.069*** 0.199***
Leverage 0.097** 0.051 -0.004 -0.128
Tangibility 0.081*** 0.015 -0.142 0.168
Board Size 0.059*** 0.013*** -0.059*** -0.107
Board Committee 0.077*** 0.019*** 0.002 0.038
Time Dummy Yes Yes Yes Yes Yes Yes Yes Yes
AR(1) 0 0 0 0 0 0 0 0
AR(2) 0.1 0.092 0.094 0.091 0.211 0.689 0.785 0.31
Sargan / Hansen Test Overid 0.179 0.113 0.168 0.366 0.689 0.294 0.546 0.256
Number of Instruments 73 195 91 148 91 148 79 131
Number of firms 260 260 260 260 260 260 260 260
Note. Table 8 reports the results related to two step system GMM dynamic panel model. Dependent variable is Firm Performance, and
independent variable is Stock Market liquidity which represents the traded volume as proportion of GDP from 2001 to 2017. Column 1 to 2
presents the results related to the effect of stock market volatility on TQ. Column 3 to 4 present the results related to the effect of stock market
volatility on ROA. Column 5 to 6 present the results related to the effect of stock market volatility on ROE. Column 7 to 8 present the results

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related to the effect of stock market volatility on ROI. Tobin Q is calculated as market value of assets and liabilities over book value of assets
and liabilities. Return on Asset is calculated as net income divided by total assets. Rest is liq represents liquidity ratios and is calculated as
current assets to current liabilities, Firm size is the log values of total sales, leverage ratio is total debt over total assets, tang is the tangible assets
to total assets, whereas board size is total number of board of directors, Board committee is total number of directors in audit committee as
corporate governance variables. The significant value of AR (1) shows the existence of first order serial correlation that null hypothesis of no
first difference autocorrelation among the error terms is rejected. However, AR (2) is insignificant showing that no second order serial
correlation in level regression among error term. Sargan / Hansen test overid value is insignificant, indicating the validity of instruments and are
not over identified. Overall, the results of AR (1), AR (2) and Sargan / Hansen test shows that GMM is correctly specified with no identification
issues. Figures in parentheses shows the standard errors; “***”, “**” and “*” shows the significance level at 1%, 5% and 10% respectively.

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