POLYTECHNIC UNIVERSITY OF THE PHILIPPINES 1

IMPACTOF TRANSACTION COST ON STOCK INVESTMENT

RETURNS

A Thesis
Presented to the Faculty of the Graduate School
Polytechnic University of the Philippines
Sta. Mesa, Manila

In Partial Fulfilment of the Requirements for the Degree

Master in Business Administration

by

Ma. Gila S. Gallego

Aug 2018
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Chapter 1

THE PROBLEM AND ITS SETTING

Introduction

Investment in equity stocks has been done by individuals or portfolio managers for

capital appreciation and/or dividend income. The investors aim at maximizing the

return, with differing attitudes towards risk and costs. Alongside with the growing

number of investors in the stock market, transaction costs are being considered as part

of the hindrances which prevents investors to freely invest in stocks. Basically, they aim

to minimize their costs and tries to avoid the risk of getting losses in handling their

investment.

According to the study conducted by Securities and Exchange Commission Office of

Investor Education and Advocacy, fees may seem small but over time they can have a

major impact on the investor’s portfolio. Transaction fees are charged at the time

investors’ buy, sell or exchange an investment. As with any fee, transaction fees will

reduce the overall amount of their investment portfolio.

Due to the current infrastructure projects initiated by the government, they have

to raise enough revenue to finance their projects. This situation gave rise to the

enactment of Increase in the Stock Transaction Tax under the Republic Act No. 10963

otherwise known as “Ta x Reform for Acceleration and Inclusion (TRAIN) Law”. Under

the Republic Act No. 10963, there shall be levied, assessed and collected on every sale.

Barter, exchange, or other disposition of shares of stock listed and traded through the

local stock exchange other than the sale by a dealer in securities. a tax at the rate of six-

tenths of one percent (6i 1 0 of 1 0/o) of the gross selling price or gloss value in money

of the shares of stock sold. Bartered" exchanged or otherwise disposed which shall be

paid by the seller or transferor.

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From the standpoint of Mr. Ramon Monzon, The Philippine Stock Exchange will

become less competitive to foreign investors, after Congress passed a measure raising

tax on stock transactions. The bicameral conference committee on Wednesday night

increased the stock transactions tax to 0.6 percent from 0.5 percent as a part of the

government’s move to raise revenues to fund infrastructure projects. Monzon said the

local bourse already has the highest friction cost in the region at 0.5 percent and this

would increase to 0.6 percent. (www.thestandard.com)

Theoretical Framework

The framework employed by the research is based on the widely acceptable

principles and techniques used by many financial institutions as a guide in managing

transaction costs.

Transaction Cost Economics Theory (TCE) provides a credible conceptual lens

for evaluating trading favors’ economizing features as compared to alternative, real

world governance mechanisms to manage transactions. TCE provides a road map to

reflect on the practice of trading favors. It enables an investigation of various complex

contexts in which trading favors occurs, and allows for a realistic analysis of the

phenomenon through the concepts of bounded rationality and bounded reliability, while

assuming economizing properties of this practice. According to Williamson, there are

three core assumptions about the nature of the “assets” involved in a transaction and

about economic actors’ behavior underlie TCE: asset specificity, bounded rationality,

and opportunism. Asset specificity means that particular assets (physical, organizational,

or human) involved in a transaction or class of transactions cannot be easily redeployed

elsewhere without significant loss of economic value. Differences in degree of asset

specificity are largely responsible for observable differences in transaction costs: the

more specific the assets, the costlier the transaction, because more safeguards must be
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introduced in contract content and process to protect the owner of the specific asset

against economic loss. (Verbeke and Kano 2013)

Jorgensons’ Neoclassical Theory of Investment assumes that are rational profit

maximizers operating in a perfectly competitive world , able to easily calculate and

balance the marginal benefits and marginal costs of investment decisions. For the neo-

classical firm, the marginal benefits of investment can be represented as the addition to

future expected output that will occur with increments to the capital stock. The marginal

cost can be represented by the cost associated with buying or renting additional unit of

capital. A profit maximizing investor will adjust the capital stock until the marginal benefit

of additional investment (in terms of present value of future revenue) is equal to the user

cost of capital. So investment increases as the cost of capital decreases and decreases

as output and revenue increases. (Baddeley, 2017)

The Financial Theory of Investment developed by James Duesenberry assumes

that the market rate of interest represents the cost of capital to the firm which does not

change with the amount of investment it makes. It means that unlimited funds are

available to the firm at the market rate of interest. In other words, the supply of funds to

the firm is very elastic. In reality, an unlimited supply of funds is not available to the firm

in any time period at the market rate of interest. As more and more funds are required by

it for investment spending, the cost of funds (rate of interest) rises. (Seven New Theories

of Investment)
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Conceptual Framework

Figure 1. Research Paradigm

This study sought to assess the impact of transaction cost on stock investment

returns. The researcher adopted the systems approach of Input – Process – Output

Model as the research paradigm of the study.

In this research study, input variables are the profile of the respondents in terms

of gender, age, civil status, monthly gross income and education attainment Moreover,

the impact of transaction cost on stock investment returns will be assessed in terms of

the investor’s knowledge and experience on stock trading, transaction cost, stock

investment returns and their knowledge and preference on stocks and transaction

costs. These variables will undergo transformation process within the system thru
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presentation, analysis, and interpretation of the data gathered through questionnaire.

The output will be assessed impact of transaction cost on stock investment returns. A

feedback mechanism was installed and is considered the key to system controls.

Statement of the Problem

This study will assess the impact of transaction cost on stock investment returns

Specifically, the study sought answers to the following problems.

1. What is the profile of the respondents in terms of:

1.1.1 Gender

1.1.2 Age

1.1.3 Civil Status

1.1.4 Monthly Gross Income

1.1.5 Educational Attainment

2. How do the respondents assess the impact if transaction cost in terms of the

following areas:

2.1.1 Stock Trading

2.1.2 Transaction cost

2.1.3 Stock Investment Returns

2.1.4 Knowledge and Preference on Stocks and Transaction Costs

3. Is there any significant difference in the respondent’s assessment on the impact

of transaction cost on sock investment returns when they are grouped according

to profile?
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Hypothesis

There is no significant difference in the respondents’ assessment on the level of

impact of transaction cost on stock investment returns when they are grouped according

to their profile.

Scope and Limitations of the Study

The study focused on determining the impact of transaction cost on stock

investment returns of selected retail investors in Metro Manila. Findings of this study

must be considered in light of study limitations. First, small sample size limited the

research analysis. The sample is small for several reasons. Limitation on the availability

of complete information of all local investors is difficult to collect due to the large

number of respondents and client confidentiality of data will be the two problems to be

encountered. It impedes the use of a systematic sample.

The Securities and Exchange Commission and the Philippine Stock Exchange maintain

records of registered companies, trading participants, and investors, respectively, but the

issue on updated information poses a reliability concern. Thus, available list of investors

will not be taken.

Second limitation is the perceptual measure of factors. On the other hand, the

measure of impact of transaction costs is arbitrary. Investor preference is always relative

to something and the principles may not be generalizable. For instance, stock trading

benchmark for one profile may not be applicable to another. Even within the same

profile, the level of knowledge may affect investment returns.

Third, this study will focus on determining impact of transaction cost on stock

investment returns as perceived by the investors in terms of: Stock Trading, Transaction
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cost, Stock Investment Returns and Knowledge and Preference on Stocks and

Transaction Costs.

The researcher has likewise no control to the responses of the respondents

towards the variables used in the study as they are based on how they perceived the

situation in the real context.

Significance of the Study

Meeting the primary objectives of the study is geared towards being beneficial to

the following entities.

Listed Companies. This study will provide companies the opportunity to identify impact

of transaction cost on stock investment returns of individual investors that would affect

their future policies and strategies.

Investors. By identifying the impact of transaction costs on their stock

investment returns, they could identify and create their own strategies in reducing the

cost and maximizing the return of their portfolio. This study will affect their future

financial plans regarding taking risks in doing stock trading.

Aspiring Investors. In providing actual experiences and strategies adopted by

investors before them, these may guide them to develop a strategy that could be deeply

embedded in their minds.

MBA Students. Well educated students can contribute to economic

development. This study can enhance the students’ knowledge and awareness on

business/investing which they can use for their personal development and may expose

them to new discoveries and develop new strategies and they may provide actual and

more relevant investment experiences.

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The Academe. In establishing a basis for future research, the construction of this

study may be of use as basis for future researchers and students. The findings of the

research program may also have implications on how subjects like investment and

portfolio management, economics and security analysis should be taught.

Government Leaders. This study contains information that may help

government leaders in developing the economy through various programs like

Taxation and design of policies as well as in program implementation. There may be

elements beyond the control of the business sector that may be addressed through

public policy. This stems from the recognition that the government may have an

influence on the impact of transaction cost on stock investment returns. Thus,

developing policies that may help businesses and the PSE retain their competitiveness

and provide investors opportunity to maximize their return by minimizing and optimizing

the transaction cost may be vital for economic development.

Future Researchers. This study will serves as reference of future researchers

who want to conduct study in similar field.

Definition of Terms

To convey the study clearly, the following terms are defined conceptually and

operationally.

Investor. Investors in stocks or stockholders are those who own shares of stock of a

publicly listed company, at least until the time that they decide to sell them.

Stockholders are accorded certain rights set by the PSE. These rights are accorded to

them by the company they have now become part owners of.

Investment. These are stocks or bonds that are laid out for a certain period with an

expectation of profit in the near future.

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Government. This is the governing body of the Philippines. It controls and regulate the

Philippines and protect its residents. It regulates the tax imposed to the securities

transacted by the investors.

Listed Companies. These are companies that are bought and sold by investors and

regulated by the Philippine Stock Exchange and the Securities and Exchange

Commission.

Stock. This (also capital stock of a corporation) constitutes the equity stake of its

owners. It represents the residual assets of the company that would be due to

stockholders after discharge of all senior claims such as secures and unsecured debt.

Stock Market. It is a place where the buying and selling of stocks takes place governed

by an organized exchange.

Transaction costs. This refers to the charges involved in buying and selling of stocks.

This includes the stockbroker’s commission, clearing fee, PSE transaction tax and Stock

transaction tax.
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Chapter 2

REVIEW OF LITERATURE AND STUDIES

This chapter includes all the reviews of the studies and literatures the researcher

considered. It discusses different reference materials gathered to strengthen the results

of the study.

Stocks

Common stocks also known as equity shares have one important

investment characteristic and one important speculative characteristic. Their investment

value and average market price tend to increase irregularly but persistently over the

decades, as their net worth builds up through the re-investment of undistributed

earnings. Most of the time, common stocks are subject to irrational and excessive price

fluctuations in both directions, as the consequence of the ingrained tendency of most

people to speculate or gamble as described by Benjamin Graham. (Chandra, 2017)

Equity shares represent ownership capital. Equity shareholders collectively own

the company. They bear the risk and enjoy the rewards of ownership. In stock market

parlance, it is customary to classify equity shares as blue-chip shares, growth shares,

income shares, cyclical shares, defensive shares and speculative shares. Blue chip

shares are shares of large, well-established, and financially strong companies with an

impressive record of earnings while growth shares, are shares of companies that have a

fairly entrenched position in a growing market and which enjoy an above average rate of

growth as well as profitability. On the other hand, Income shares are shares of

companies that have fairly stable operations, relatively limited to growth opportunities,

and high dividend payout ratios while cyclical shares are shares that have pronounced

cyclicality in their operations. Furthermore, Defensive shares are shares that are
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relatively unaffected by the ups and downs in general business conditions while

speculative shares tend to fluctuate widely because there is a lot of speculative trading

in them. (Chandra, 2017)

As defined by the Philippine Stock Exchange, Stocks are shares of ownership in

a corporation. When investors buy stocks of a publicly listed company, they become a

stockholder or shareholder of a company. In other words, they become part-owner of

that company. As such, investors participate in that company’s growth and future profits.

Conversely, they may also lose if the company suffers a loss or performs below market

expectations. On the other hand, according to the Securities and Exchange

Commission, the shares of stock may be classified as common, founders, preferred, par

or no-par value shares, voting or non-voting shares and redeemable shares. Common

shares must always be voting shares. Common shares can be par value shares or no-

par shares. Preferred shares must always be par value shares. Preferred shares can be

voting or non-voting shares. The preferred shareholders may be given preference in the

distribution of the assets of the corporation in case of liquidation and in distribution of

dividends, or such other preferences as may be stated in the articles of incorporation.

Stock Market

The primary function of stock markets is to serve as a mechanism for

transforming savings into financing for the real sector. From a theoretical perspective,

stock markets can accelerate economic growth by mobilizing and boosting domestic

savings and improving the quantity and quality of investment. Better savings mobilization

may increase the rate of saving and if stock markets allocate savings to investment

projects yielding higher returns, the increasing rate of return to savers will make savings

more attractive. Consequently, more savings will be channeled into the corporate sector

(El-Wassal, 2013).
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A stock market is a place where stocks are bought and sold. The Philippine stock

market is the place where people can invest in ‘publicly listed’ companies in the

Philippine Stock Exchange (PSE). The Philippine Stock Exchange, Inc. (“PSE” or the

“Exchange”) is a private organization that provides and ensures a fair, efficient,

transparent, and orderly market for the buying and selling of securities. The PSE is a

Self Regulatory Organization (SRO) as granted by the SEC. As such, the PSE acts as

the “police” of the stock market and it is the SRO status that empowers it to formulate

marketplace rules, and impose penalties or sanctions to market participants who will not

comply with these rules. (PSE Information Primer, 2017)

Efficient stock markets make corporations compete on an equal basis for funds

and help make investment more efficient. Beyond this aspect of their role in the

economy, stock markets perform many other important functions. Stock markets can

perform an “act of magic” by permitting long-term investment to be financed by funds

provided by individuals, many of whom wish to be able to withdraw them at will. In

addition, stock markets can increase the efficiency of the financial system through

competition among different classes of financial instruments. This, in turn, can augment

the return on savings for those who save, and can as well lower the cost of raising funds

to borrowers. Stock markets also may improve accounting and tax standards as

investors request more and better information in order to compare different corporations’

performance. It logically follows that, as a result, it would be in the corporation’s best

interest to provide that information to facilitate thorough comparisons between

competing corporations. One outstanding benefit of the existence of stock markets is the

potential imposition of greater discipline in the area of economic management: being

sensitive to policy changes, particularly monetary policy, stock markets, through their

very existence, help enhance policy creditability (El-Wassal, 2013).

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As mentioned (2013) in his study “The Development of Stock Markets: In search

of a theory, one of the most important aspects of stock market development is liquidity.

Liquid markets offer a number of benefits: i) they render financial assets more attractive

to investors, who can transact in them more easily. In addition, liquid markets allow

investors to switch out of equity if they want to change the composition of their portfolio;

ii) liquid markets permit financial institutions to accept larger asset-liability mismatches;

iii) they allow companies to have permanent access to capital through equity issues; and

iv) liquid markets allow a central bank to use indirect monetary instruments and

generally contribute to a more stable monetary transmission mechanism. With liquid

markets, the initial investors do not lose access to their savings for the duration of the

investment project for they can easily, quickly and cheaply sell their stake in the

company. Consequently, more liquid markets could ease investment in long-term,

potentially more profitable projects, thereby improving the allocation of capital and

enhancing prospects for long-term growth. Put another way, the more liquid the stock

market, the larger the amount of savings that are channeled through stock markets.

There are five dimensions of market liquidity, which are: tightness, immediacy,

depth, breadth and resiliency. Tightness refers to low transaction costs, such as the

difference between buy and sell prices. Immediacy represents the speed with which

orders can be executed and settled, and thus reflects among other things, the efficiency

of the trading, clearing and settlement systems. Depth refers to the existence of

abundant orders, either actual or easily uncovered of potential buyers and sellers, both

above and below the price at which a security would be trading on the market. Breadth

means that orders are both numerous and large in value with minimal impact on prices,

and resiliency usually denotes the speed with which price fluctuations resulting from

trades are dissipated. A comprehensive measure of liquidity would quantify all the costs

associated with trading, including the time cost and the uncertainty of finding a
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counterpart and finalizing the transaction. Yet no single measure unequivocally

measures tightness, immediacy, depth, breadth and resiliency. Due to the difficulties

involved in elaborating such a measure, the most commonly used indicators of liquidity

by analysts are traded value/GDP and turnover ratio.

Traded Value/GDP Traded value is a volume-based indicator. Volume-based

indicators are most useful in measuring market breadth, i.e. the existence of both

numerous and large orders in volume with minimal transaction price impact. Traded

value/GDP equals the total value of shares traded on the stock market divided by GDP.

It measures the organized trading of shares as a percentage of national output and

therefore should positively reflect stock market liquidity on an economy-wide basis.

Turnover Ratio since traded value can be given more meaning by relating it to the value

of outstanding volume of shares being considered, turnover ratio is commonly used as a

second indicator of liquidity. Turnover ratio gives an indicator of the number of times the

outstanding volume of shares changes hands. Turnover ratio equals the value of total

shares traded divided by market capitalization. In some sense, turnover ratio as an

indicator of liquidity complements traded value/GDP. While the former captures market

trading relative to the size of the economy, the latter measures trading compared with

the size of the stock market. A small, liquid market will have a high turnover ratio but a

small traded value/GDP ratio.

A high turnover ratio is often used as an indicator of low transaction cost.

However, some analysts consider turnover as a good indicator of speculative activity in a

given market. As noted earlier, the turnover is derived by dividing the one-year average

market capitalization by total annual traded value. A value of 100 per cent means that

the two terms are equal and that, on average, each share has changed hands once

during the year in question. Higher turnover ratio means that shares have frequently

changed hands, which may reflect a tendency to speculation. Finally, making use of both
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indicators traded value/GDP and turnover ratio can provide a more comprehensive

picture of the liquidity of stock markets than the information provided by the use of only

one of them.

The demand for equity (investors) is the second building block of the stock

market. Potential shareholders/investors have preferences over risk-return combinations

for the funds they invest in – some prefer high risk-high return combinations, while

others prefer low risk-low return. In general, these investors have three main concerns.

First, since equity is one of the most risky investment alternatives, shareholders

invariably expect a higher return. Second, shareholders need to monitor the use of their

funds and require a disclosure of information that enables them to make sure that the

management runs the firm in a way that maximizes their returns on investments. Third,

investors are always keen to be able to liquidate their shares at any point in time. Still,

investors will be willing to hold shares with a higher expected return in a liquid and

informative stock market.

From the macroeconomic point of view, there are a number of other

factors that significantly affect the demand for shares and, in turn, the development of

stock markets. Economic growth and per capita GDP are crucial –and strongly linked –

determinants of stock market development. Higher economic growth rates allow more

people to invest in shares. A rise in per capita income increases an individual’s ability to

save or invest. However, the increase in per capita income should be considered with

caution, for individuals will only invest after satisfying their basic needs. That is to say

that a sizeable per capita increase in income if realized from a low base will be largely

directed toward more consumption, and thus will not significantly increase investment, if

it does so at all. In other words, it is not only the increase in per capita GDP that matters,

but also and perhaps even to a greater extent the level of the per capita GDP.
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Greater individual financial wealth and positive economic prospects bring about

changes in saving and investment habits as well as in risk-sharing behavior of individual

households. In their search for higher returns, individuals may shift from deposits into

bank accounts to investment in shares. In this regard, financial markets in less-

developed countries are likely to remain small unless economic growth in these

countries can catch up with the rest of the world. El-Wassal also concluded that “in

general, economic progress in all regions, with a few exceptions, was the fundamental

force behind stock market growth”. One might argue –keeping other factors constant–

that there may be some sort of “multiplier” effect between economic growth and stock

market growth. That is, the higher the per capita GDP and the greater the wealth per

capita, the more investment there will be in stock markets, and the more liquid that

market will be. Greater liquidity will induce more companies to list their shares because

of the increase in price per share. Ultimately, higher levels of investment and growth will

be attained. It is worth noting that income inequalities may weaken the link and the

possible multiplier effect between economic growth and stock market development. Put

differently, the larger the share of the population living at the subsistence level, the

smaller will be the percentage of the population economically able to participate in the

stock market. To account for the possibility of having a low per capita GDP base along

with income inequalities, the saving rate could be used as a reasonably good proxy for

the relationship between economic growth and per capita income and the individual’s

ability to invest in stock markets.

Stock market development requires a deep and diverse investor base. The lack

of a diversified investor base and heavy reliance on captive sources of funding are two

of the main factors behind the shallowness and insufficient liquidity of stock markets.

The investor base should be diversified and composed of institutional investors (e.g.

mutual funds, pension funds and insurance companies) and other financial institutions
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dealing in different levels of risk and targeting different economic sectors. These

institutional investors can play a crucial role in the accumulation of funds and their

channeling into stock markets. Institutional investors are, in fact, usually the largest

investors in stock markets in developed economies.

In general, institutional investors can support the development of stock markets

in various ways: i) they enhance market competition and act as a balancing influence in

bank-dominated financial systems and represent an alternative savings vehicle to banks

for individual investors; ii) institutional investors also help to address the problem of

information asymmetry between company management and individual investors as they

impose discipline on company management via transactions in company stocks; iii)

institutional investors may encourage more issuance of shares, which in itself increases

the liquidity of the market; iv) a wide range of investors who differ in their risk

preferences and expectations results in rapid price discovery from trading and reduces

vulnerability to shocks that would otherwise destabilize the market; and v) institutional

investors also support the emergence of market makers, which improves market liquidity

However, institutional investors should not be so large that they dwarf and dominate the

market but large enough to take risks and position themselves advantageously as

described by El-Wassal in his study.

Institutional factors represent the first supporting block of stock market

development. These include a wide range of factors such as regulations affecting public

issuers of securities, market intermediaries, asset management, supervision and

enforcement tools, trading payments and settlement systems and corporate governance

and transparency. An adequate institutional framework is expected to have a significant

positive impact on the development of a stock market. On the one hand, investors will

feel more confident regarding property rights and information transparency, which could

encourage them to invest in stock markets. On the other hand, by reducing the cost of
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transactions and increasing market liquidity, equity would be a more attractive source of

financing for firms.

An adequate regulatory framework is crucial to the development of stock

markets. A strong and transparent regulatory and legal framework needs to be

developed for public issuers of securities, market intermediaries, asset management

products, payment and settlement processes and transparency requirements.

Regulations need to address asymmetries of information between issuers and investors,

clients and financial intermediaries and between counterparties to transactions; and

should ensure smooth functioning of trading and clearing as well as settlement

mechanisms that will prevent market disruption and foster investor confidence.

The core of regulating public issuers is to ensure full timely and accurate

disclosure of relevant information to investors so as to enable them to make informed

decisions. Disclosure obligations should be imposed on issuers both at the moment of

authorization for public offering and on an ongoing basis. One of the main

responsibilities of the regulator is to ensure that mechanisms are put in place to ensure

the reliability of the information provided by issuers. In this regard, adequate corporate

governance is needed to ensure effective accountability of management to

shareholders.

The main purpose of regulating market intermediaries is to ensure that brokers,

dealers, and financial analysts enter and exit the market without disruption, conduct their

business with their clients with due care, and conduct fair trade using stock markets.

Tools for regulating intermediaries include licensing requirements and market business

conduct obligations Regulation of asset management seeks to ensure professional

management and adequate disclosure of investments to the investors. In addition, stock

market regulations should ensure the smooth functioning of the market by ensuring fair

access to adequate price formation, by limiting the disruptive effects that the failure of an
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intermediary could have on the market, and by ensuring that market participants settle

their trading obligations in an orderly and timely manner. A distinction can be made

between the three essential elements of securities regulations: the legal framework itself,

supervision of the legal framework and enforcement of relevant laws. Supervision and

enforcement are tools used to assure compliance with the legal framework.

The International Finance Corporation (IFC) has introduced seven regulatory

indicators to assess regulatory frameworks of stock markets. These indicators address

the following areas: whether companies listed in a stock market publish price-earnings

information, accounting standards, the quality of investor protection, whether the country

has a securities and exchange commission or not, restrictions on dividend repatriation

by foreign investors, restrictions on capital repatriation by foreign investors and

restrictions on domestic investment by foreigners. Finally, it must be noted that

excessive regulation can stifle stock market development. In principle, stock markets

should not be over-regulated in areas where free market forces should prevalent and

should not be under-regulated where a normal regulatory framework should be in place

to support market confidence.

He also mentioned that stock markets can be differentiated by their trading

systems. Trading systems vary in the way transactions are handled, types of

transactions made, types of information available to market participants, and the process

of matching orders to sell and buy. Electronic trading systems can increase liquidity and

improve efficiency by reducing transaction costs and increasing information availability.

Modern trading systems may also attract new pools of liquidity by providing affordable

remote access to investors. (El-Wassal,2013)

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Stock Returns

According to prospect theory people pay much more attention to the changes of

wealth, rather than final asset positions which include current wealth. Their experiments

suggest that individuals tend to be riskseeking with respect to losses and risk averse

with respect to gains. Many studies have found that people’s risk attitudes would change

with circumstances, and the outcomes with gains or losses will affect the subsequent

risk-taking behaviors of investors (Hsu and Chow, 2013; Huang and Chan, 2014).

Therefore, investors’ different attitudes toward gains and losses will affect their

relationship between risk and return, and we believe it is an important reason for the

existence of both positive and negative relation between risk and return.

Aharon, Grundy and Zeng (2013) argued that the limited success of the

empirical portion of Fama and French is largely related to their measures of expected

profitability and expected investment. They have showed that valuation formula applies

at the firm level and not, as in the Fama French empirical investigation, at the per share

level. This is because changes in the number of shares, due either to new issues or

repurchases, are likely to mitigate the correlation between the expected change in

investment per share and expected returns. For example, consider a firm that issues

equity. Whether book equity per share increases or decreases will depend on the firm's

BM at the time of the share issue, and an expected increase in book equity need not

imply an expected increase in book equity per share. Their empirical work demonstrates

that the coefficient on the expected change in investment is significantly changed when

the variables are estimated at the firm level rather than at the per share level. They

confirmed that the coefficient of expected investment is small and insignificant at the per

share level. However, at the firm level the coefficient is negative and significant, as

predicted by the valuation formula. Further, in a robustness test they have examines

whether the predictions of the valuation formula hold in portfolios formed on the basis of
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BM and confirm that the negative correlation between expected investment and realized

returns holds in both low-BM and high-BM portfolios. Their firm-level analysis also

confirms the Fama French per share result that the coefficients on both BM and

expected profitability are significantly positive and the coefficient on size is significantly

negative.

As mentioned by Menggen Chen , (2015) in her study "Risk-return tradeoff in

Chinese stock markets: some recent evidence", Asset pricing models always imply a

positive relationship between risk and return under the assumption of investor risk

aversion, as summarized in Lettau and Ludvigson (2003). In Sharpe-Lintner-Mossin

mean-variance equilibrium of exchange, the expected excess return from holding an

asset is proportional to the covariance of its return with the market portfolio (its “β”), as a

proxy of risk. Merton (1973) proposed an intertemporal capital asset pricing model

(ICAPM) and suggested that the conditional expected excess return on the stock market

should vary positively with the market’s conditional variance, as the proxy of risk. This

risk-return tradeoff is so fundamental in financial economics and usually is described as

the “first fundamental law of finance” (Ghysels et al., 2005).

Investment

According to Benjamin Graham “An investment operation is one which, upon

through analysis, promises safety of principal and an adequate return. Operations not

meeting these requirements are speculative”. Investors are prone to errors in investment

management as they tend to trade excessively and spend a lot on investment

management. A good proportion of investors indulge in day trading in the hope f making

quick profits. However, more often that not the transaction costs wipe out whatever

profits they may generate from frequent trading. (Chandra, 2017)

Successful investing is about owning businesses and reaping the huge rewards

provided by the dividends and earnings growth of the nation. The higher the level of the
 POLYTECHNIC UNIVERSITY OF THE PHILIPPINES 23
investment activity, the greater the cost of financial intermediation and taxes, the less the

net return that shareholders as a group to receive. The lower the cost that investors as a

group incur, the higher the rewards they reap. So to enjoy the winning returns generated

by business over the long term, the intelligent investor will reduce to the barebones

minimum the costs of financial intermediation. (Wiley, 2017)

In an article by Abacus (2013), the capital asset pricing model (CAPM) states

that assets are priced commensurate with a trade-off between undiversifiable risk and

expectations of return. Without the CAPM, investors are left with a market where stock

prices generally respond positively to good news and negatively to bad news, with

market sentiment and crowd psychology playing a role that is never easy to determine,

but which at times appears to produce tipping points, sending the market to booms and

busts.

Transaction Costs

Transaction costs are consists of brokerage cost, market impact cost, and

securities transaction tax and other charges. Brokerage cost is the brokerage paid to the

broker. Due to the heightened competition is stock broking, brokerage cost has fallen

steeply. Market impact cost is the difference between the actual transaction cost price

and the “ideal price”, the latter being defined as the price at which the trade will occur if

the market for the stock were perfectly liquid or infinitely deep (Chandra, 2017).

As stated in the Revenue Regulations No. 9-2018 with subject Rules and

Regulations Implementing the Increase in the Stock Transfer Tax Under Republic Act

No. 10963, Otherwise Known as the "Tax Reform for Acceleration and Inclusion (Train)

Law, Tax on Sale, Barter or Exchange of Shares of Stock Listed and Traded through the

Local Stock Exchange shall be levied, assessed and collected on every sale. Barter,

exchange, or other disposition of shares of stock listed and traded through the local
 POLYTECHNIC UNIVERSITY OF THE PHILIPPINES 24
stock exchange other than the sale by a dealer in securities. a tax at the rate of six-

tenths of one percent (6i 1 0 of 1 0/o) of the gross selling price or gloss value in money

of the shares of stock sold. Bartered" exchanged or otherwise disposed which shall be

paid by the seller or transferor.

There are four basic charges involved in buying and selling stocks as

enumerated by the Philippine Exchange Commission. The first type is the Stockbroker’s

commission plus 12% Value Added Tax on commissions. The commission amount is

ranging from 0.25% to 1.5% of transaction amount or a minimum of Php 20.00,

whichever is higher. The second type is the clearing fee; it is calculated by multiplying

0.01% on the transaction amount. Next is the PSE transaction fee which is calculated by

multiplying 1/200 of 1% on the transaction amount. Lastly, the stock transaction tax

which is calculated by multiplying 0.5% on the transaction amount but it was recently

increased to 0.6%. Furthermore, the above charges vary depending on the stockbroker’s

fee structure.

According to Attig, Cleary, El Ghoul, and Guedhami (2013), Institutions with a

long investment horizon are expected to actively participate in corporate governance to

safeguard their investments. There are several reasons to believe this will be the case.

First, the stability of their shareholdings will likely result in “relationship investing,” which

makes short-term trading increasingly unattractive and monitoring increasingly desirable,

particularly in the presence of high “exit” costs such as large blockholdings, high

transaction costs, tax timing, and rebalancing costs. Alternatively, the large institutional

shareholdings not only can mitigate the free-rider problem, but they may also have an

indirect disciplinary influence on incumbent managers through the potentially adverse

price impact on stocks of the investee firms in the case of exit strategies pursued by

long-term institutional investors (Admati and Pfleiderer, 2009).

 POLYTECHNIC UNIVERSITY OF THE PHILIPPINES 25
In addition, long-term institutional investors tend to hold stable and diversified

stakes in nearly all the largest publicly traded firms as a result of their indexing

strategies. This decreases their desire to trade frequently and increases their

governance commitment, all else being equal. However, institutional investors with a

long-term investment horizon may vote in favor of entrenched management as their

relationship investing may convert into a mutually beneficial business relationship. As a

result, this relationship investing may make long-term institutional investors more

pressure sensitive and direct their votes in favor of management’s decisions. Arguably,

market liquidity may make the threat to exit of long-term institutional investors less

credible, as they may be tempted to “vote with their feet” rather than engaging in

monitoring. In the end, they have argued that the presence of institutional investors with

long-term investment horizons leads to improved monitoring and information quality,

which, in turn, reduces agency costs and information asymmetry problems. This will

result in a lower cost of equity, all else remaining equal. More generally, the evidence in

their study suggests that long-term institutions are associated with more efficient

monitoring and information efficiency, plausibly as a result of their fiduciary obligation to

improve firms’ corporate governance and maximize long-term value. (Attig, Cleary, El

Ghoul, and Guedhami,2013)

On the other hand, Securities transaction tax (STT) is a levy on securities

transactions. It applies to every sale, barter exchange or other disposition of shares of

stock listed and traded through a local stock exchange other than sale by a dealer in

securities, and shall be paid by the seller or transferor as described by Ramon Monzon.

Under the recently-enacted tax law, the STT was increased from one-half of one

percent (0.5 percent) to six-tenths of 1 percent (0.6 percent) of the gross selling price or

gross value in money of the shares of stock sold, bartered, exchanged or otherwise

disposed (Business Inquirer, 2018).

 POLYTECHNIC UNIVERSITY OF THE PHILIPPINES 26
When a negotiated trade takes place, the counterparty may default or when a

trade takes place on an exchange, the exchange may default in its payout. Clearing

costs are costs experienced in resolving such defaults. . The Securities Clearing

Corporation of the Philippines (SCCP) operates as a central securities clearing institution

in the Philippines and thereby manage and support the clearance of trades in securities

listed and executed on the PSE or other official securities market in the Philippines. It

acts as a Central Counterparty to trades executed at the PSE.

Taxation policies have a great influence on investor participation in stock markets

since investors are concerned with the after-tax real return on investment. Unequal

taxation favoring other alternative forms of investment such as bank deposits would shift

investor interest from investing in equities. In many countries, equities are subject to

double and even triple taxation. First, there is taxation at the corporate level before the

distribution of dividends. Second, there may be taxation at the individual level and if

returns on equities are taxed, there may be triple taxation. Prudent corporate tax policies

help to develop stock markets since high corporate taxation can limit the after-tax profit

available for dividends distribution, which may in turn negatively affect investors’

willingness to invest. Tax policies not only affect investor participation in the market, but

also affect the supply of equities. That is, tax incentives to going public could encourage

companies to go public and thus increase the supply of equities. (El-Wassal,2013)

Furthermore, Settlement costs are cost associated with the transfer securities

and funds when a trade is done. With the advent of dematerialization, elimination of

stamp duty on dematerialized trades, and improvement of banking technology,

settlement cost has come down substantially (Chandra, 2017).

According to the study of Dutt and Jenner (2013), they have argued that the low

volatility effect is not beneficial after controlling for the presence of low liquidity and high
 POLYTECHNIC UNIVERSITY OF THE PHILIPPINES 27
trading costs. Similarly Liang and Wei (2012) show that low liquidity stocks command a

risk premium. However, they have found out that low volatility stocks still earn higher

stock returns even after controlling for low liquidity. Indeed, they find that low volatility

stocks still earn higher returns even after removing the 10% least liquid stocks from the

sample. They also also find some evidence that the low volatility effect is weaker for

firms who experience operating performance improvements/surprises, consistent with

the idea that the low volatility effect might merely reflect the information associated with

positive earnings surprises.

The Journal of Finance (2013) provides a highly tractable framework for studying

optimal trading strategies in the presence of several return predictors, risk and

correlation considerations, as well as transaction costs. The optimal portfolio tracks an

aim portfolio, which is analogous to the optimal portfolio in the absence of trading costs

in its trade-off between risk and return, but is different since more persistent Their

framework constitutes a powerful tool to optimally combine various return predictors

taking into account their evolution over time, decay rate, and correlation, and trading off

their benefits against risks and transaction costs. Such dynamic trade-offs are at the

heart of the decisions of “arbitrageurs” that help make markets efficient as per the

efficient market hypothesis. Arbitrageurs’ ability to do so is limited, however, by

transaction costs, and their model provides a tractable and flexible framework for the

study of the dynamic implications of this limitation.

Verbeke and Kano (2013) explains the transaction cost theory(TCE) in which it

provides a credible conceptual lens for evaluating trading favors’ economizing features

as compared to alternative, real world governance mechanisms to manage transactions.

TCE provides a road map to reflect on the practice of trading favors. It enables an

investigation of various complex contexts in which trading favors occurs, and allows for a

realistic analysis of the phenomenon through the concepts of bounded rationality and
 POLYTECHNIC UNIVERSITY OF THE PHILIPPINES 28
bounded reliability, while assuming economizing properties of their practice. Yet, the

TCE-based analysis of trading favors presented in their study is not without its

limitations.

The return on the transactions account is dominated by the return on riskless

bonds in the investment portfolio and with a small fixed component of the transactions

cost, there is not sufficient reason to arrive at the next observation date with assets in

the transactions account to have the option not to transact at that time. Rules that

govern infrequent adjustment are typically categorized as time dependent or state

dependent. Time-dependent rules depend only on calendar time and can optimally result

from costs of gathering and processing information. State-dependent rules depend on

the value of some state variable, typically reaching some trigger threshold, and can be

the optimal response to a transactions cost (Abel, Eberly and Panageas, 2013).

According to Fausto (2018) in his article Paying Attention To Fees published in

the COL Experts Corner, when it comes to investing, investors’ main focus is usually to

find the vehicle that will give them high returns based on their track record or even their

own forecasts. What most people don’t realize is how much they pay for an investment

also plays a huge role in how much their returns will be, especially over a long period of

time. A 1% difference in cost may probably not matter that much in the short term. But

compounded over time, these little expenses can end up eating a great portion of your

returns.
 POLYTECHNIC UNIVERSITY OF THE PHILIPPINES 29

Chapter 3

RESEARCH METHODOLOGY AND PROCEDURE

This chapter discusses the methods of research, description of the respondents,

research instrument, data-gathering procedure and statistical treatment.

METHOD OF RESEARCH

This study used descriptive method with questionnaire as its main instrument.

The method clearly indicates that the study is all about a certain characteristics of

respondents (investors) towards the impact of transaction cost on their stock

returns. Descriptive study simply describes a phenomenon. This method enables

the researcher to interpret the theoretical meaning of the findings and the

hypothesis development for further studies. This method also describes the

attributes of the respondents' profile, the conditions being required in relation to

the impact of transaction cost on stock investment reuturns.

Population, Sample Size, and Sampling Technique

This study will be based on purposive sampling technique, the alterative use of

probability sampling is not considered due to limited access of resources. There

were 841,532 retail accounts according to the Stock Market Profile Report for

2017 of the Philippine Stock Exchange, Inc. The number of investors in Luzon is

approximately 244, 044 or 29% of the total number of retail investors. The

sample size for this study is 271 based on the above data. The researcher will

contact the potential respondents with the use of telephones, e-mails, face to
 POLYTECHNIC UNIVERSITY OF THE PHILIPPINES 30
face interaction, and social media explaining the purpose of this study.

These samples will be selected based on knowledge, connection, and

judgment of the researcher in all investors from the National Capital Region.

Descriptive of the Respondents

Data sets in this study will be drawn from 271 investors from the National Capital
Region. The respondents will be composed of investors with different age,
gender, civil status, monthly gross income and educational attainment. Stock
investor who invests in the stock market in the current and previous years will be
included in the study.

Research Instrument

The researcher will carefully construct the questionnaire in a way in which

anyone could understand the survey and complete it in a reasonable amount of
time. Before arriving at the final questionnaire, it will be reviewed by several
academic researchers. The questions will be formulated based on the objectives,
research questions, and hypothesis of this study. The survey questionnaire will
consist of close-ended questions to be formulated which aims to ensure more in-
depth information is provided. A cover letter will be attached to the survey to
explain the purpose of this study and its relevance, and to seek their agreements
to participate in this research. Contact information of the researcher will be
provided in case a respondent has any questions.

The range and interpretation of the five-point scale are shown below:

Scale Range Interpretation

5 4.51-5.00 Strongly Agree

4 3.51-4.50 Agree

3 2.51-3.50 Neutral

2 1.51-2.50 Disagree
 POLYTECHNIC UNIVERSITY OF THE PHILIPPINES 31
1 1.00-1.50 Strongly Disagree

The questionnaire will be designed to assess the impact of transaction cost on

stock investment returns. The questions will be organized into two sections. First

section will look specifically on the investors’ profile. Second section will include

the statements divided into four categories: Stock trading, Transaction Cost,

Stock Investment Returns and Knowledge and Preference on Stocks and

Transaction costs and that will be rated depending if they agree or disagree on

the said matter as well as the range of data.

Data-Gathering Procedure

The study will be based on primary and secondary data. Primary data for this

study will be collected through the questionnaire containing mostly closed-ended

questions. Secondary data is collected from books, magazines, journals, and the

internet.

After the questionnaire is validated, it will be distributed to selected respondents.

During the distribution phase, the background and purpose of the research will

be explained in which confidentiality and anonymity is guaranteed. Participation

in this research will be voluntary and the respondents have the option to refuse to

divulge personal information. The process of administrating the questionnaire will

ensure anonymity.

There will be two primary avenues in finding participants: the researcher will e-

mail the questionnaire through network of contacts and social networking sites.

The participants will not receive any benefit for completing the survey- most will
 POLYTECHNIC UNIVERSITY OF THE PHILIPPINES 32
be doing so because they either wanted to support the research, or support the

individual asking them to complete the survey.

The data will be recorded and updated simultaneously as responses are being

received. The results will be organized in Microsoft Excel spreadsheet. The

responses of each question will be assigned with numerical values for the data

analysis, and then process it through SPSS.

For this, survey, the primary data will be collected through the questionnaire. As

being used in this study, the data that will be gathered and treated from the

investors’ perspective which includes age, gender, civil status, monthly gross

income and educational attainment and their assessment on the impact of

transaction cost on stock investment returns.

Statistical Treatment of Data

Once the researcher has received the responses, the data will be captured into a

Microsoft Excel Spreadsheet. Statistical analysis will be carried out on the

quantitative data by using SPSS package. The data will be checked and

described using frequency tables and descriptive statistics.

The study used the following statistical tool in analyzing the responses of the

respondents.
 POLYTECHNIC UNIVERSITY OF THE PHILIPPINES 33
1. Frequency and Percentage Distribution. This is used to describe the

respondents’ characteristics, which are nominal in nature. The formula is

presented below.

Where:

P = Percentage

f = frequency

N = Total number of Respondents

2. Weighted Mean. This is an average computed by assigning different

weights to some of the individual values. This will be used to assess the level of

impact of transaction cost on stock investment returns of the retail investors. The

formula of weighted mean is presented below:

∑fw
WM =
n

Where:

WM = Weighted Mean

Σ𝑓𝑓= sum of the frequency and unit weight

n = total number of respondents

3. Analysis of Variance (ANOVA). This is the initial step in identifying factors that

are influencing a given data set. After the ANOVA test is performed, the analyst

is able to perform further analysis on the systematic factors that are statistically

contributing to the data set’s variability. ANOVA test results can then be used in

an F-Test on the significance of the regression formula overall.

 POLYTECHNIC UNIVERSITY OF THE PHILIPPINES 34
Formula:

Where:

F = Anova Coefficients

MST = Mean sum of squares due to treatment

MSE = Mean sum of squares due to error

MST = SST

p–1

Where:

SST = Sum of squares due to treatment

p = Total number of populations

n = Total number of samples in a population

MSE = SSE

N–p

SSE = Σ (n-1)S2

Where:

SSE = Sum of squares due to error

S = Standard deviation of the samples

N = Total number of observations

 POLYTECHNIC UNIVERSITY OF THE PHILIPPINES 35
4. F- Ratio. It is the ratio of two mean squares. In this study, it is the value

resulting from a standard statistical test used in ANOVA and regression analysis

to determine if the variances between the means of two populations were

significantly different.

5. Likert Scale. This is used to interpret items in the questionnaire. This feature

the responses based on the respondents’ assessment on the impact of

transaction cost on stock investment returns.

 POLYTECHNIC UNIVERSITY OF THE PHILIPPINES 36

Survey Questionnaire

Dear Respondent,

The undersigned is doing a research study entitled “Impact of Transaction

Cost on Stock Investment Returns” as part of the requirements for the Degree
Master in Business Administration.

In this regard, I seek your earnest cooperation and patience to answer

the questionnaire on the topic. I sincerely appreciate your kind effort and rest
assured that all information shall be treated with utmost confidentiality.

Ma. Gila Gallego

MBA Candidate

Name (Optional): _________________________

Contact Number: ______________________

Gender: ☐Male ☐ Female

Age:
☐ Under 20
☐ 20-30 years old Civil Status
☐ 31-40 years old ☐ Single
☐ 41-50 years old ☐ Married
☐ Above 50 years old ☐ Widow/widower
☐ 51 and above
Monthly gross income Education Attainment:
☐ Under Php 10,000 ☐ Elementary
☐ Php10,001 – Php 20,000 ☐ High School or equivalent
☐ Php 20,001 – Php 50,000 ☐ Vocational/technical School
☐ Php 50,001 – Php 100,000 ☐ College undergraduate
☐ Above Php 100,000 ☐ Bachelor's degree
☐ Master's Degree
☐ Doctoral Degree
 POLYTECHNIC UNIVERSITY OF THE PHILIPPINES 37
Stock Trading

Q1. How do you conduct your stock trading?

☐ Traditional ☐ Online
Q2. Category of investor
☐ Long-term investor ☐ Day trader ☐ Both

Q3. Years of experience in the market

☐ Less than 1 year ☐ 1-3 years ☐ More than 3 years

Q4. Number of companies where investment is made

☐ Less than 5 ☐ 6-10 companies ☐ More than 10 companies
Q5. Total estimated size of investment in stocks
☐ Less than Php 10,000 ☐ Php 10,001 – Php 50,000 ☐ Php 50,001-
Php 100,000
☐ Php 100,001-Php 500,000 ☐ Php 500,001 – Php 1,000,000 ☐ More
than Php 1 M

Q6. What is your source of investment in stocks?

☐ Income ☐ Savings ☐ Debt/Financing ☐ Both ☐ Others
_____________

Q7. How frequent do you invest in stocks

☐ More than once a day ☐ Once a day ☐ Weekly ☐ Monthly ☐
Others _________

Transaction cost

Q8. Transaction costs are charges involved in the buying and selling of stocks.
Kindly tick your level of understanding about the transaction cost on stock
investments.

☐ Very low ☐ Low ☐ Medium ☐ High ☐ Very high

Q9. How do you agree with the statement “Transaction costs directly impact on
my stock portfolio’s return?”
 POLYTECHNIC UNIVERSITY OF THE PHILIPPINES 38
☐ Strongly disagree ☐ Disagree ☐ Don’t know ☐ Agree ☐ Strongly
agree

Q10. How much did you actually pay for your transaction cost on your stock
investment for the past year?
☐ Less than Php 5,000 ☐ Php 5,001- Php 10,000 ☐ Php 10,0001-Php
20,000 ☐ Php 20,0001-Php 50,000 ☐ More than Php 50,000

Stock Investment Returns

Q11. What percentage of annual return on investment do you earn from your
stocks?
☐ Less than 1% ☐ 1%-5% ☐ 5%-10% ☐ 11%-20% ☐ 21%-50% ☐
More than 50%

Q12. How much percentage of total stock investment are you willing to pay for
transaction fees on your stock investment?
☐ Less than 0.25% ☐ 0.25%-0.5% ☐ 0.5%-1% ☐ 1%-2% ☐ More
than 2%
 POLYTECHNIC UNIVERSITY OF THE PHILIPPINES 39
Knowledge and Preference on Stocks and Transaction Costs

Q13. Kindly tick the appropriate option which describes you the most.

Legend: SD. – Strongly Disagree, D – Disagree, N – Neutral, A – Agree, S.A – Strongly Agree
S.D S.A
S.No. Statements . D N A .
1. I am comfortable with the
transaction fees being charged
on my stock account.
2. I fully understand the transaction
fees being charged on my stock
investment
3. I don’t possess enough
knowledge about stock market.
4. I find it easy to transact with my
stock broker
5. When I am uncertain how to act
in a given situation, I ask advice
from my broker.
6. I don’t perform technical
analysis of the company, I’d
rather trust on the decision of
my broker.
7. My broker provides me with
accurate information about the
stock market.