TITLE: A study on inflation and its impact on corporate performance

INTRODUCTION
Inflation- the household word used intensively today. (Jewell, 2000), defines inflation as
a persistent increase in price overtime, the rate of inflation measures the purchasing
power of money overtime, the rate of inflation measures the purchasing power of money
overtime. (Brooks and Weatherson, 2000)
In the following parts of the assignment, the impact of inflation on corporate
performance will be discussed.
Before coming to the impact of inflation, let’s understand what the causes of
inflation are.
According to Jewell, 2000, Inflation can be caused by significantly three factors:
1) Demand pull inflation: this occurs when the economy’s aggregate demand rises
above a significant level, from where the prices of goods and services shoot up
causing inflation, it occurs usually when employment of resources starts
increasing.
2) Cost push inflation: occurs usually when a particular cost variable (raw material)
increases, such as oil which is intensively being used in most of the production
process, as the oil price increase so does the cost of production increase, hence
reflecting on higher price of the product, leading to inflation
3) An excess rise in money supply (monetary inflation) – This indicates the quantity
of money in the economy, if the interest are low, the chances of increase supply of
money is possible, making the worth of money low, hence pushing up prices due
to demand pull inflation.
After discussing the causes of inflation, let’s discuss the impact on inflation in general.
The impacts of inflation would be,
• On the debtors as a gain and loss on creditors, savers, and fixed income earners
• On businesses, as they might suffer due to decline of purchasing power of
customers, on the contrary they might benefit by increase profits where the
inflation is caused by excess demand (demand pull inflation).
 • Due to inflation, the business planning and forecasting gets very difficult and
inaccurate due to the uncertainty in the price levels and demand.
• Inflation also impacts the burden of tax, as some taxes are directly related to
income and the spending (income tax, corporate tax and VAT)
After understanding the overall concept of inflation, the inflation impact on corporate
performance will be analyzed and well understood in the following parts.

IMPORTANCE OF THE STUDY

As discussed in the introduction, inflation is a house hold term. The impact of inflation
should be ascertained in order to reduce the intensity of the impact, this study on the
inflations impact on the corporate performance will achieve it. Hence the study is crucial
in our dynamic environment, where inflation plays a key role in the uncertainty of the
environment.

Literature review

 Hull and Alexander (1977) states in their journal article "The Impact of Inflation
on Corporate Financial Performance" that the better mean of assessing the impact
of inflation would be by using computer models. The author also states the steps
in the development of the new proposed models, computer outputs are shown
which help determining the future inflation rates.

 Papas (1987), emphasis in his journal " ASSESSING THE IMPACT OF

INFLATION ON BUSINESS PERFORMANCE UNDER CONDITIONS OF
LIMITED FINANCIAL DISCLOSURE: THE CASE OF FIRMS OPERATING
IN GREECE" that the financial statements being presented in the historical cost
seriously weakens the assessment of performance of firms under the influence of
inflation. Papas uses General Price Level Adjustment model to evaluate inflation
related performance under conditions of limited financial disclosure. The author
uses firms in Greece as his sample.
 Naceur and Ghazouani (2004) examines in their journal article "Does inflation
impact on financial sector performance in the MENA region?" the relationship
between inflation and financial sector performance in the MENA region (Middle
East and North Africa). The author indicates in the article that marginal change in
the inflation rate is harmless to the financial sector and the stock market
performance. Generalized Method of Moments (GMM) is used by the author to
establish the relationship between inflation and the performance on the MENA
regions financial sector.

 Reilly, (1997), in his article "The Impact of Inflation on ROE, Growth and Stock
Prices" Uses the constant growth dividend discount model (DDM),through this
method the author determines that growth rate of dividends are used to analyze
whether common stocks will be able to be an inflation hedge. It is added that there
has been periods of high and low inflation since 1956 and the negative impact of
inflation on the implied growth rate is confirmed, which helps explain why
investigators find consistent empirical results that common stock are poor
inflation hedges.

 Charles and jack (2006), indicates in their article "The Impact of Inflation
Measures on the Real Returns and Risk of U.S. Stocks" using different measures
of inflation impacts adversely on both the inflation record, as well as inflation-
adjusted stock returns. In their article they introduced a much more stable
measure, i.e. monthly Consumer Price Index (CPI) inflation rate, the authors used
the CPI to find out the real returns for the year 1913-2004, for which rates already
existed officially. With the help of the CPI for 1913-2004 the authors could
analyze the impact of inflation on the real standard deviation of stock returns and
conclude that, in contrast to the results for geometric mean returns, inflation
adjustments have little impact on estimates of return variability.

 Engsted and Tanggaard (2000),in their article "The relationship between asset
returns and inflation at short and long horizons" used Vector-autoregressive
 (VAR) model to measure multi period expected returns and inflation, to analyze
expected stock and bond returns and expected inflation at short and long horizons.
They applied the VAR approach on long-term US and Danish stock with bond
market data, and they found that differences are general point to large differences
between these countries, they also found that expected US bond returns and
expected Danish stock returns move closely with expected inflation at long
horizons but not at short horizons, but on the other hand for the US stocks and
Danish bond, expected return and inflation have a pretty weak relationship at all
horizons. Their finding contradict the results reported by Boudoukh and
Richardson (1993): the fisher model does not perform better as the horizon
increases. However for US bonds and Danish stocks, the model's performance
improves as the horizon increases.

 Ball and Sheridan, (2003) in their article " Does Inflation Targeting Matter? "
attempts to measure the effects of inflation targeting on macroeconomic
performance, they examined 20 member countries of the Organization for
Economic Co-operation and Development (OECD), 7 that adopted inflation
targeting during the 1990s and 13 that did not. They saw economic performance
varies greatly across individual countries, both targeters and nontargeters. But, on
average, they mention that there is no evidence that inflation targeting improves
performance as measured by the behavior of inflation, output, or interest rates.
when examined inflation-targeting countries alone, they say that their
performance improved, on average, between the period before targeting and the
targeting period. inflation fell and became more stable, and output growth also
stabilized. However, countries that did not adopt inflation targeting also
experienced improvements around the same times as targeters. There finding
suggests that better performance resulted from something other than targeting.
They methodology used is a standard "differences in differences" approach
regression (Xpost - Xpre = ao + a1D + e), as this could be misleading due to a
bias being found, to elimante the bias the authors then add the initial value of X to
the differences regression (Xp o s t-Xp r e = ao + a1D + a2Xpre +e)
 Bittencourt (2006) in his article " Inflation and Finance: Evidence from Brazil",
examined the impact of inflation on financial development in Brazil. The
available data for the period 1985 and 2002 permits the author to examine the
financial development in brazil. The available data based initially on time series
and then on panel time series data and analysis, and robust for different
estimators, specifications and financial development measures - suggest that high
and erratic rates of inflation presented harmful effects on finance at that time.

 Collard and Dellas (2004), in their article " The great inflation of the 1970s" The
authors try to find answer of the questions: Was the high inflation of the 1970s
mostly due to incomplete information about the structure of the economy (an
unavoidable mistake as suggested by Orphanides, 2000)? Or, to weak reaction to
expected inflation and/or excessive policy activism that led to indeterminacies (a
policy mistake, a scenario suggested by Clarida, Gali and Gertler, 2000)? They
analyze these question within the NNS model with policy commitment and
imperfect information, requiring that the model has satisfactory overall empirical
performance. They find that both explanations do a good job in accounting for the
great inflation. Even with the commonly used specification of the interest policy
rule, high and persistent inflation can occur following a significant productivity
slowdown if policymakers significantly and persistently underestimate "core"
inflation. There findings were that Inflation in the US reached high levels during
the 1970s, due to a large extent to what proved to be excessively loose monetary
policy.
 Martellato (2006) in his article " Inflation and Growth in the Euro Zone" the
author Determines whether the patterns of inflation and growth data observed in
the twelve members and Slovenia compare to what is predicted by the long-run
money demand equation in the euro area, the Balassa-Samuelson construct or the
New Keynesian model. The author then strains on the fact that inflation
disparities can be better analyzed in combination with growth disparities because
inflation and growth are mutually and strictly dependent occurrence of the
macroeconomic stability. There are different presumptions. The author
emphasizes that the models do not always give a role to the stock of money and
offer very different forecasts about the combined dynamics of real growth and
inflation. The author achieves his view by bringing together annual data for the
member countries showing that some convergence towards the pattern implied in
the area-wide money demand equation and they still do not follow a common
pattern. And also emphasis that the New Keynesian model does not assign any
explicit role to the stock of money.

 Rich and Steindel, 2005 in their article " A Review of Core Inflation and an
Evaluation of Its Measures" The authors offer a review of the concept of core
inflation and evaluates the performance of several proposed measures. They then
consider the rationale of a central bank in setting its inflation goal in terms of a
selected rate of consumer price growth and the use of a core inflation measure as
a means of achieving this long-term policy objective. authors then discuss the
desired attributes of a core measure of inflation, such as ease of design, accuracy
 in tracking trend inflation, and predictive content for future movements in
aggregate inflation. Using these attributes as criteria, they evaluate several
candidate series that have been proposed as core measures of consumer price
index (CPI) inflation and personal consumption expenditure (PCE) inflation for
the United States. The candidate series are inflation excluding food and energy,
inflation excluding energy, and median inflation, as well as exponentially
smoothed versions of aggregate inflation and the aforementioned individual
series. After various analyses author’s findings finally lead to conclude that there
is no individual measure of core inflation that can be considered superior to other
measures.

 Boyd and Champ(2003) in their article "Inflation and Financial Market

Performance: What Have We Learned in the Last Ten Years?" investigates the
relationship between inflation and financial market performance. The objective is
to review the extensive literature on this topic over the last ten years or so. After
the intensive review the author could deduce
o High inflation is not a “good sign” for equity markets or banks.
o For both stock market and banking industry size, there is evidence of
inflation threshold effects
o Based on a variety of tests in a variety of countries, asset returns do not
generally seem to conform to the predictions of monetary neutrality.
o It does not appear that, on average, banks are well able to hedge their real
profits against inflation, especially when inflation is relatively high.
o inflation, especially high inflation, seems to be so harmful to banks
o Asset return volatility is positively associated with inflation across
countries
From the above literature review its been learnt that inflation affects various aspects of an
organization and economy, we have also learnt about different methods of calculating
inflation along with views about the relevancy on methods in various aspect of the
business and economic environment
Most authors have an opinion that inflation affects various aspects of an
organization. For example Reilly (1997) in his article confirms that inflation ha a
negative impact on implied growth rate. But on the other hand, Naceur and Ghazauni
(2004) indicate that marginal rate of inflation is harmless to the financial sector. This
shows a mixed opinion
The above literature reviews will stimulate my study as I could use various
methods and learn from there research and knowledge provided.

Aims and objectives

The aims and objective that would be covered are;
• To review the relationship between inflation level and the corporate performance.,
From the literature review and by conducting interviews with the finance
managers of sample companies.
• To analyze the intensity of impact on corporate performance due to the changing
inflation rate in Oman.
Hypothesis
H(0) inflation does not impact on the corporate performance
H(a) inflation impacts on the corporate performance

Methodology
Overall approach: the rates of inflation will be ascertained by the ministry of economics’
website for a span of 7 years and for the same 7 years the net profits of 15 companies (as
a sample) will be provided and compared.
Time frame and data collection
The data collected will be mostly secondary data, as the data’s will be collected from the
MSM (Muscat Security Market) and the ministry of economics. The data will also consist
of few primary sources, as interviews of finance managers will be held. The time frame
of the data will be 7years.
Population and study sample
The study will be conducted on organization registered with the MSM, therefore the
sample selection will be 15 companies from MSM.
Sampling design
The sampling design, I will mainly use the probability sampling method, so each of the
companies in the MSM have a probability of being a sample.
Simple random sampling will be utilized here, as we want each organization to be
given an equal chance.
*The companies in the MSM will be shortlisted on the bases of existence of 10
years before utilizing the simple random sampling design.
Data Collection Method
• Firstly by using secondary source, that is by studying the net profits of the sample
companies and the inflation rate(by retrieving information from MSM and
ministry of economic) and then comparing it to find the relationship and level of
impact.
• Finally by using primary source, that is by arranging for interviews with the
finance managers of sample companies and finding out their opinion on the
impact of inflation in their companies.
Data analysis technique
as we want to measure the significance of the relationship between inflation and
corporate performance we would be making use of correlation technique, as this could
help us know if it is a positive or a negative correlation by showing us figures ranging
between -1 and +1.
We would also consider using regression technique to analyze and find the
intensity if the relationship.
Data presentation methods
• To illustrate the pattern of net profit and the inflation rates relating to the samples,
we would be using the histogram or bar charts and also line charts to analyze the
trend.
• To illustrate the correlation a scatter diagram will be used.

Limitations
As in Oman there seems to be no published articles in the field, the research will be based
mostly on secondary data. This could be vague if any data is carelessly collected.
The inflation rate hasn’t fluctuated a lot; this factor would not let in stating the level of
impact accurately as the other variables in the macro-economic also exists.

Time plan
time time
activity required remaining
(weeks) (weeks)
26
data for net profits from 15
companies 3 23
data for inflation through the 7
years 3 20
data analysis 3 17
interview of finance managers 7 10
compiling the data 2 8
project writing 4 4
draft and corrections 4 0
.
Budget
money
Activity required
(RO)
using internet for data collecting 5
transport 10
paper and other stationary 5
telephone expenditure 5
miscellaneous 2

TOTAL 27
.
References
Books:
• Bruce R. Jewell, 2000., An Integrated Approach to Business studies, 4th ed.
Longmann.
• Ian Brooks and Jamie Weatherson, 2000, The Business Environment challenges
and changes, 2nd ed. Pearson education limited.
Ejournals:
 Antonios A. Papas, 1987, "ASSESSING THE IMPACT OF INFLATION ON
BUSINESS PERFORMANCE UNDER CONDITIONS OF LIMITED
FINANCIAL DISCLOSURE: THE CASE OF FIRMS OPERATING IN
GREECE" digilib.lib.unipi.gr/spoudai/bitstream/unipi/324/1/t42_n1_25to43.pdf
 Samy Ben Naceur and Samir Ghazouani, 2004, Does inflation impact on financial
sector performance in the MENA region
papers.ssrn.com/sol3/Delivery.cfm/SSRN_ID856344_code363661.pdf
 Jones Charles, Wilson Jack W, " The Impact of Inflation Measures on the Real
Returns and Risk of U.S. Stocks", The Financial Review, Volume 41, Number 1,
February 2006 , pp. 77-94(18), Blackwell Publishing, url:
http://www.ingentaconnect.com/content/bpl/fire/2006/00000041/00000001/art000
05
 John Hull, Bill Alexander, 1977, The Impact of Inflation on Corporate Financial
Performance, Managerial Finance, Volume: 3, Issue: 3
url:http://www.emeraldinsight.com/10.1108/eb013403
 Frank K. Reilly, 1997, "The Impact of Inflation on ROE, Growth and Stock
Prices", FINANCIAL SERVICES REVIEW, Vol. 6 No. 1,University of Notre
Dame - Department of Finance. url:http://papers.ssrn.com/sol3/papers.cfm?
abstract_id=8336
 Tom Engsted and Carsten Tanggard, "The relationship between asset returns and
inflation at short and long horizons", 2000
http://papers.ssrn.com/sol3/papers.cfm?abstract_id=221669
 Laurence Ball and Niamh Sheridan, Does Inflation Targeting Matter, 2003.
http://papers.ssrn.com/sol3/papers.cfm?abstract_id=879205
 Manoel Bittencourt (2006), "Inflation and Finance: Evidence from Brazil"
http://papers.ssrn.com/sol3/papers.cfm?abstract_id=957255
 Fabrice Collard and Harris Dellas , 2004, " The great inflation of the 1970s"
http://papers.ssrn.com/sol3/papers.cfm?abstract_id=551622
 Dino Martellato, 2006 "Inflation and Growth in the Euro Zone"
http://papers.ssrn.com/sol3/papers.cfm?abstract_id=948392
 Robert Rich and Charles Steindel, 2005, "A Review of Core Inflation and an
Evaluation of Its Measures", Federal Reserve Bank of New York Staff Reports, no.
236, http://papers.ssrn.com/sol3/papers.cfm?abstract_id= 873860
 John Boyd and Bruce Champ, 2003 "Inflation and Financial Market Performance:
What Have We Learned in the Last Ten Years?"
http://papers.ssrn.com/sol3/papers.cfm?abstract_id= 1026081