Prof. Christopher Yenkey Presentation to the AMEDA General Membership 26 April, 2012

1. Clearing and Settlement Data as a Tool for Strategic Planning: New Methods and Findings from Kenya’s CDSC Prof. Christopher Yenkey Presentation to the AMEDA General Membership 26 April, 2012

2. Research overview • Interdisciplinary approach: • Combining Sociology with Economics to deepen our understanding of how markets develop • Current research I’ll discuss today: • The power of CDS data for modeling market development • What attracts new investors to the market? • How do they learn to trade their shares over time? How is market performance affected by increased experience of the investing population? • Time permitting, I’ll discuss other emerging market research I’m involved with

3. Investor-level data taken from CDS records: • Timing of market entry (date of first share ownership) • Trades (buys and sells in the secondary market) • Broker/intermediary • Location (Town of residence) Merge with GIS databases to map each investor • Name and mailing address removed to protect confidentiality; account numbers can be altered to insure anonymity but allow tracking of individuals

4. Survey data provides context for the communities where investors live: • Town-level attributes are estimated from 3 recent high quality national surveys: • Local wealth: % of town that is high, medium, low wealth • At-risk population (town population – poverty residents -existing investors) • Use of other financial products: • Bank accounts, credit cards, insurance, etc. • Exposure to IPO advertising campaigns: • Partnered with market research firm (Synovate) to quantify IPO advertising expenditures in each media outlet • Gives a district-level measure of IPO advertising exposure

5. Part 1: Who are your investors?What parts of your society have been mobilized into shareholding?

6. Growing investor Participation on the NSE: 93% of all Kenyan investors are new since 2006

7. The majority of Kenyan investors are individuals, with very few foreigners

8. About 70% of market capitalization is domestically owned

9. CDSC-Kenya ushers in electronic trading in late 2004, followed by a policy shift toward liberalization

10. 98% of new investors entered the NSEvia IPO subscription

11. The new investing population is wide but thin, with smaller portfolio values

12. At passage of Privatization ActTotal Investors: 140,000Total towns: 366

13. After all 7 IPOs Total Investors: ~ 1.4 mill.(+ 900%)Total towns: 563(+ 54%)

14. Investors are distributed similarly to the general population

15. Shareholding seems to be relatively more common in lower income areas

16. Measured as a portion of wealthy households, shareholding is less popular in the most wealthy districts

17. Of Kenya’s 68 districts, the most wealthy have some of the fewest investors per high income household

18. Shareholding also tends to be more popular in districts where financial literacy is lower

19. This data can be used to identify regions where investor recruitment would be beneficial

20. Additional investor recruitment opportunities in districts with higher financial literacy

21. Part 2: How are investors recruited?Using social networks to convey the benefits of share ownership to a larger portion of the society.

22. What draws investors into the market? • We already know that attributes of individuals and listing firms are highly influential: • Individuals: income, financial literacy, etc. • Firms: size, state-ownership, industry ( esp. telecom), advertising campaigns, etc. • What do we know about how existing investors recruit new investors? How do the experiences of existing investors influence the recruitment of new investors? Experience tells us that positive performance attracts increased attention. But studying the role of social networks in conveying the benefits of share ownership uncovers a new source of legitimation: How material information moves through the informal channels of a society influences investor recruitment and therefore market development.

23. How do the experiences of existing investors in earlier IPOs attract new investors in this IPO?

24. Think of each town in Kenya as a point/station in the network; each of the stations can broadcast and receive “signal”. Here, I model size of profits earned on earlier investments as the signal that each station in the network can send and receive. Do we think that influence is a local phenomena (only the experiences of other town residents matters), or does information about prior experience in the stock market (gains and losses) travel from town to town through the network?

25. Estimating how profits earned by earlier investors influences new investor recruitment via informal social networks • For each town (i) in each IPO (t), number of new investors should be: Firm-level fixed effects: captures size, industry, SOE vs. private, etc. Profit earned by town’s investors in last IPO: paper profits, total across all town investors Profits earned in all other towns in last IPO: weighted by geographic proximity Town-level attributes: at risk population, wealth, use of other financial products, geographic remoteness, # of existing investors N = 3,372 observations: 562 towns in 6 prior IPO periods.

26. A highly detailed yet conservative model • The model predicts the number of new investors that enter the market in this town in this IPO as a function of: • “Control” variables: geographic remoteness (how far from the nearest major city), town residents’ wealth, experience with other financial products, ethnic composition, conditions in the country at the time (inflation, GDP change, etc.) and the characteristics of the IPO firm (size, state vs. private ownership, etc.), and offer terms of the IPO (share price, minimum buy-in, advertising) • “Explanatory” variables: profits earned in the town in the previous IPO, profits earned by investors in other nearby towns (if existing investors don’t talk to potential investors in other towns, there should be no effect)

27. Profits earned in nearby towns are highly influential in attracting new investors Note: % increase in town’s new investors given a one standard deviation increase in the explanatory variable. All models are estimated with town-level control variables not shown here (town population, tribal populations, IPO advertising exposure, number of existing investors).

28. Profits are more influential than losses in recruiting new investors Note: Dummyvariable for gain vs. loss (t-1) interacted with both town and peer profit measures.

29. Remember the network metaphor: each town is a point in the network, surrounded by signals of profit The network effect requires two complimentary stimuli: A signal to be broadcast, and a receptor that’s sensitive enough to receive that signal The signal is the amount of profit earned in the last IPO (lots of profit = strong signal), but what local conditions might make the town more/less receptive to this signal?

30. Advertising moderates the effects of earlier gains and losses experienced by those around us Note: Interaction term is significant at the .001 level; all other variables in model set to mean values.

31. The number of existing investors moderates social network influence

32. Other community attributes that might moderate the recruitment of new investors • No. of existing investors in the town has a statistically significant but low magnitude moderating effect on profits of geographic peers. • Cell phone use strongly moderates the network effect: communities with higher rates of phone use are less influenced by their immediate neighbors (likely drawing information from longer distances) • Local wealth has no effect: communities across the SES spectrum are similarly affected • Use of other formal financial products has a small moderating effect, but falls just short of statistical significance (might be some reason to think that more financially literate areas are less reliant on/influenced by experiences of their neighbors, but the evidence falls short)

33. Kenyan society is characterized by a high degree of tribal diversity, with tribal groups clustered into localities Source: Ethno-linguistic map of Kenya, courtesy of Kenyan mission to the United Nations

34. Profits earned by tribally peers are just as influential in attracting new investors Note: % increase in town’s new investors given a one standard deviation increase in the explanatory variable. All models are estimated with town-level control variables not shown here (town population, tribal populations, IPO advertising exposure, number of existing investors).

35. Most Kenyan towns have a high concentration of a single, particular tribe The average Kenyan town has 8.7 times more of some particular tribe than the national average

36. In a socially diverse community, profits in the previous IPO recruit many new investors

37. But less social diversity reduces the positive influence of profits earned by nearby investors

38. The effect of geographic peers declines as the number of local shareholders increases, but the influence of tribal peers remains unchanged Change in geographic peer influence Change in ethnic peer influence Note: Estimates for subsample of all towns < 1,000 population- similar estimates result for towns < 10,000 population. Interaction term of no. investors and geo peer profit is significant at the .001 level; interaction with ethnic peer profit is not significant; all other variables in model set to mean values.

39. Bad news also flows through the network: the negative effect of living close to investors affected by stockbroker scandals “Peer scandal” is measured as the number of geographically proximate investors involved in one of two recent stockbroker scandals affecting approximately 135,000 investors: Francis Thuo (2005) and Nyaga (2008).

40. Consistent with the earlier network effects, all districts are affected by scandal, so bad news is often broadcast into the network

41. However, investors that are already in the market seem undeterred Note: 2 x 2 tables showing the percentages of investors subscribing for each of four IPOs according to involvement in a stockbroker scandal and participation in the previous IPO

42. Summary of findings: the role of social networks in recruiting new investors • Net of characteristics of listing firms and individual’s ability to pay for shares: • The experiences of nearby investors in the previous IPO is more influential than wealth, financial literacy, or geographic location of the communities in which investors reside. • Positive experiences are more beneficial than negative experiences are detrimental. • Peers’ experiences become less influential in places with higher exposure to IPO adverting campaigns, higher cell phone use, and more existing investors. • The social network also transmits bad news: existing investors tell potential investors about scandals and poor performance.

43. Part 3: How do new vs. experienced investors trade their shares?How might a more experienced investing population affect future market performance?

44. Trading behaviors of different types of investors • Much research on investor trading behaviors according to “sophistication”” • 1. New vs. experienced • 2. Low vs. high portfolio value • 3. Retail vs. institutional • 4. Rural vs. urban • The basic idea is that “unsophisticated” investors will under-recognize opportunities, but does this hold when we account for learning through experience?

45. Early price gains: who pays and who profits?

46. IPO trading volume is highest in early trading and declines over time for almost all IPOs

47. Early IPO share trading according to experience: first time investors are the most likely to speculate

48. The largest investors are by far the most likely to speculate in IPO shares

49. Small, inexperienced investors seem to learn to speculate like institutional investors 10.5x 4.9x 2.9x 4.3x 2.3x

50. Implications of learning processes on future market performance • IF high gains in IPO share trading drive market legitimacy, and… • IF these gains at least partly result from inexperienced investors, then… • WHAT happens to future market legitimacy when a larger portion of the investing population is more experienced? • Should we expect smaller peaks in share prices in early trading in future IPOs? • Can a 50% increase be as positive/desirable as 300%? Is a 30% gain enough to attract future investors? • Even the most sophisticated domestic investors seem to be vulnerable to the influence of high status shares when formulating trade strategies