DOCENTES: Jean Carlos

The importance of corporate governance in Sri Lanka emerged with the commencement of share trading in Sri Lanka in 1896 to finance the tea plantations under the Colombo Share Brokers Association (CSBA) (Wickremasinghe 2007). The requirement of funds for the development of the plantation industry was the primary objective of the colonial rulers for initiating share trading in Colombo. In 1904, CSBA changed its name to Colombo Brokers Association. By 1948 there were 140 listed companies of which 120 were from the plantation sector.

65 Following independence in 1948, private sector participation in the economy was low. Government policies for nationalisation of the private sector organisations encouraged public sector participation in the economy. Consequently, by 1976 the number of listed companies dropped down to 76. Liberalisation in the economy in 1977 resulted in Sri Lanka adopting more open market orientated policies, which led to the growth of private sector participation and capital market development in the late 1980s. The country depended on foreign direct investment to develop the infrastructure and fuel economic growth. In 1985, the Colombo Stock Exchange (CSE) was incorporated, which marked a milestone in the history of share trading in Sri Lanka. Currently there are 236 companies listed representing 20 business sectors. Market capitalization increased from Rs 263 billion in 2003 to Rs 824 billion in 2007, which corresponds to approximately 30% of country’s gross domestic product (The LMD 50 2008). The CSE was reported as one of the best performing markets in the world (Sri Lanka Today 2009).

Some of the contributing factors for the CSE’s high performance were the declining interest rates for savings, high economic growth and a high profile share offering. With the declining interest rates and the negative real rates, there was a temptation to invest in more risky stocks that offered higher return on investment compared to fixed income savings instruments by the investors. Even though investor confidence was affected by intermittent terrorist activity, the stock market performance was resilient. Dips in the stock market performance due to heightened terrorist activity, which were followed by the upward trends, probably reflected the increasing dominance of local investors who account for nearly two thirds of the turnover of the CSE. These local investors seem to have factored in conflict-related uncertainties on the economy (Institute of Policy Studies 2007).

Sri Lanka was the first country in the Indian subcontinent to pursue economic liberalisation and it has continued deregulation of the financial sector (Peagam 1995). Since 1990, Sri Lanka has lifted the controls on foreign banks and foreigner’s investment in equities and dismantled foreign exchange controls. In addition, Sri Lankan authorities have introduced the creation of mutual funds, merchant banks, venture capital companies, joint venture brokerage firms with foreign partners and central depository system for paperless money.

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Capital Market Performance

Prerequisites for the efficient market hypothesis are the availability of information freely, competition among investors and effective communication among market participants. The CSE has addressed these and many other related issues. The studies conducted by Abeysekera (2001) and Wickremasinghe (2007), indicated that stocks traded in the CSE do not behave in a manner consistent with the weak form of the efficient market hypothesis. According to Abeysekera (2001), the emerging stock markets are not as informationally efficient as the developed country stock markets. Therefore it is not unreasonable to expect the CSE to have a lower level of information efficiency than a well developed market due to the fact that CSE has experienced tremendous changes in culture and operations as a result of organizational and technological changes.

The companies listed in the CSE have recorded a steady growth rate of 20% over the last number of years despite the war. Resilience of the corporate sector is clearly evident in these results (Singapulli et al. 2009).

The equity market in 2003 showed a record performance. On the Colombo Bourse, the all share price index (ASPI) appreciated by 30% at the end of 2003, which was mainly influenced by the peace process and subsequent peace talks between government and the Liberation Tigers of Tamil Elam (LTTE), towards a stable political environment. A successful donor conference, tax amnesty, a low interest rate scenario and economic development were followed by strong corporate earnings. These all indicated the aggressive investment opportunities available in the securities market in Sri Lanka (Securities and Exchange Commission of Sri Lanka 2003).

The Colombo stock market was buoyant in the first quarter of 2007, due to lower interest rates, inflation and better performance of the corporate sector. But from the middle of the second quarter there was a decline in activity due to a volatile political and security environment as well as rising inflation and interest rates (Securities and Exchange Commission of Sri Lanka 2007). Yet the ASPI increased significantly from 1062.1 in 2003 to 2541 in 2007 (Table 3.1).

67 By the end of the three decade old war in May 2009, the Colombo stock market reported record earnings. It was one of the best performing stock markets in the world. The performance of the stock market is attributed to the peaceful conditions prevailing in Sri Lanka, fall in bank interest rates and the rapid drop in inflation. Market capitalisation reached a record high of Rs. 1000 billion in October 2009. Increase in capitalization in the stock market is a sign that the development in the country is favourable. The end of the internal conflicts has also contributed to the improvement of the economic environment, leading to an increase in tourist arrivals and an inflow of foreign funds (Daily News 2009).

Historically, Sri Lankan stocks have traded at a lower value compared to other emerging markets such as Vietnam and Egypt, due to Sri Lanka experiencing an internal war which increased the political risks of the country. However, as a result of the end of the war, country risk declined sharply. Corporate earnings were resilient and robust in the past despite the uncertainty that prevailed in Sri Lanka. Therefore, in the present, environment stocks should be valued on par or higher than other emerging markets (Singapulli et al. 2009). In October 2009, Reuters reported CSE as the best performing stock market in the world for the year to date (Daily News 2009).