ABSTRACT
The purpose of this study is to
empirically analyze the impact of capital structure on firm’s performance in
Nigeria; A sector by sector analysis. The annual financial statements of 15
firms listed on the Nigerian Stock Exchange from Four (4) sectors of the
Nigerian economy were used for this study which covered the period between
1997-2012. Multiple regression analysis was applied on performance indicators
such as Return on Asset (ROA) as well as Short-term debt to Total assets
(STDTA), Long term debt to Total assets (LTDTA) and Total debt to Equity (TDE)
as capital structure variables. The hypotheses were tested with ordinary least
square regression estimation technique and analyzed. Generally, the results
showed a negative and non-significant impact of capital structure on firm’s
performance. The study therefore, concludes that statistically, capital
structure is not a major determinant of firm performance. It recommends that
managers of firms should exercise caution while choosing the amount of debt to
use in their capital structure as it affects their performance negatively. That
firms should try to finance their activities with retained earnings and use
debt as a last option as this is consistent with the pecking order theory.
Finally, the study strongly recommends that firms should use more of equity
than debt in financing their business activities, this is because in spite of
the fact that the value of a business can be enhanced with debt capital, it
gets to a point that it becomes detrimental (negative) or unfavorable to the
business.
SYNOPSIS
INTRODUCTION
Capital structure is one of the
finance topics among the studies of researchers and scholars. It could be
defined as the way a company finance itself by combining long-term debt,
short-term debt, and equity. Capital structure shows how a company finances its
overall operations and growth by using different sources of funds. Capital
structure represents the major claims to firm’s assets. This includes the
different types of both equities and liabilities. Capital structure of a firm
is such a vital factor that it enhances its performance. A firm’s capital
structure refers to the mix of its financial liabilities. That is the mix of
equity to debt. It has been an important issue from the strategic management
standpoint since it is linked with a firm’s ability to meet the demands of
various stakeholders. Capital structure is the most significant discipline of
company’s operations. Capital structure decision is a vital decision with great
implication for the firm's sustainability. The ability of the organization to
carry out their stakeholders need is closely related to the capital structure.
The determination of a company’s capital structure is a difficult task to
achieve. After over half a century of studies on this great topic, economists
and financial experts have not reached an agreement on how and to which extent
firms’ capital structure impacts on their performance. The actual impact of
capital structure on firm performance in Nigeria has been a major problem among
researchers that has not been resolved. There is still no conclusive empirical
evidence in the literature about how capital structure impacts on firm
performance in Nigeria. The aim of the study was to examine the impact of
capital structure on firm performance in Nigeria. The specific objective were
to: (i) examine the impact of short-term debt to total assets on firm Return on
Asset (ROA), (ii) examine the impact of long-term debt to total assets on firm
Return on Asset (ROA) , and (iii) examine the impact of total debt to equity on
firm Return on Asset (ROA).
METHODOLOGY
This study adopted an ex-post
facto design. The study used secondary data collected from the annual report of
fifteen (15) firms listed on the Nigerian Stock Exchange which was extracted
from four (4) sectors of the economy. The period covered ‘between’ 1997 - 2012.
The sectors are: Consumer goods, Industrial goods, Healthcare and Conglomerates
sector(s). Capital structure represents the ‘independent variable’ while firm’s
performance represents the ‘dependent variable’. This implies that, performance
of firms in Nigeria depends on their capital structure. Return on Asset (ROA)
is used as the proxy for performance; while Short Term Debt to Total Assets
(STDTA), Long Term Debt to Total Assets (LTDTA), and Total Debt to Equity (TDE)
were used as proxy for capital
structure. Three (3) hypotheses were formulated, tested and analyzed in this
study with Ordinary Least Square (OLS) regression estimation technique/method
of analysis on the dependent variable performance proxied by Return on Asset
(ROA) and the independent variable capital structure proxied by Short Term Debt
to Total Assets (STDTA), Long Term Debt to Total Assets (LTDTA), and Total Debt
to Equity (TDE). Probability level of acceptance of p is when the p-value of the
coefficient estimate is greater than 0.05.
RESULTS
On the consumer goods sector the
objectives were properly captured and the results showed negative and
non-significant impact of capital structure on firm Return on Asset (ROA). The
coefficients of LTDTA, STDTA and TDE = (0.17), (0.30), (0.15), t-values =
(0.12), (0.51), (0.31), r2 = 0.73, Adj r2 = 0. 64, p =
0.3 >0.05, F-statistic = 1.24, D.W= 1.10.
On the industrial goods sector the
objectives were properly captured and the results showed positive and
non-significant impact of capital structure on firm Return on Asset (ROA). The
coefficients of LTDTA, STDTA and TDE respectively are 0.057, 0.072, (0.008),
t-values = (0.72), (0.70), (1.77), r2 = 0.46, Adj r2 =
0.32, p = 0.52 >0.05, F-statistic = 3.42, D.W= 0.5.
On the healthcare sector the
objectives were properly captured and the results showed negative and
non-significant impact of capital structure on firm Return on Asset (ROA). The
coefficient of LTDTA, and TDE = (0.21), (0.003), t-values = (2.12), (0.54);
while STDTA has positive but non-significant impact on firm Return on Asset
(ROA). The coefficient = 0.022, t-value = 0.23), r2 = 0.64, Adj r2
= 0.52, p = 0.23 >0.05, F-statistic =1.62, D.W= 1.3.
On the conglomerate sector the
objectives were properly captured and the results showed negative and
non-significant impact of capital structure on firm Return on Asset (ROA). The
coefficient of LTDTA, STDTA and TDE = (0.75), (0.02), (0.003); t-values =
(1.45), (0.15), (1.07), r2 = 0. 53, Adj r2 = 0. 44,
F-statistic = 1.22, p = 0. 34 > 0.05, D. W = 1.1.
CHAPTER ONE
INTRODUCTION
1.1 Background
to the Study
Capital
structure is one of the finance topics among the studies of researchers and scholars.
Its importance derives from the fact that capital structure is closely related
to the ability of firms to fulfil the needs of various stakeholders. Capital
structure represents the major claims to firm’s assets. This includes the
different types of both equities and liabilities. Capital structure of a firm
is such a vital factor that it enhances its performance (Uremadu and Efobi,
2012). A firm’s capital structure refers to the mix of its financial
liabilities. It has been an important issue from the strategic management
standpoint since it is linked with a firm’s ability to meet the demands of
various stakeholders. Capital structure is the most significant discipline of
company’s operations. Capital structure decision is a vital decision with great
implication for the firm's sustainability. The ability of the organization to
carry out their stakeholders need is closely related to the capital structure.
The determination of a company’s capital structure is a difficult task to
achieve. According to Uremadu (2004) capital
structure of a firm includes retained earnings,
debt and equity. This is in agreement with Pandey (2010) which states that the term
capital structure is used to represent the
proportionate relationship between debt and equity. Equity includes paid-up
share capital, share premium and reserve and surplus (retained earnings).
Capital
structure has been a major issue in financial economics ever since Modigliani
and Miller showed in 1958 that given frictionless markets, homogeneous expectations;
capital structure decision of the firm is irrelevant. By relaxing the
assumptions and analyzing their effects, theories seek to determine whether an
optimal capital structure exists or not, and if so what could possibly be its
determinants. The relationship between capital structure decisions and firm
value has been extensively investigated in the past few decades. Capital
structure could have two effects; according to Desai (2007) firms of the same
risk class could possibly have higher cost of capital with higher leverage.
Also, that capital structure may affect the valuation of the firm, with more
leveraged firms, being riskier and consequently valued lower than the less
leveraged firms. If the manager of a firm has the shareholders' wealth maximization
as his objective,
then capital structure is an important decision, for it could lead to an
optimal financing mix which maximizes the market price per share of the firm.
Every
business whether newly born or an ongoing, requires
fund to carry out its activities as no
success is achievable in the absence of fund. The needed fund may be for daily
running of a firm or for business expansion. This tells how important fund is
in the life of every business. This fund is referred to as capital. Capital therefore
refers to the means of funding a business. Firms that are willing to raise
capital for their activities normally source their funds through two major
sources. These sources are internal and external sources. The internal source
refers to the funds generated from within an enterprise which is mostly
retained earnings. It results from success enterprises earn from their
activities. Firms may in the same vein look outside to source for their needed
funds to enhance their activities. Any fund sourced not from within the
earnings of their activities is termed external financing. The external funding
may be by increasing the number of co-owners of a business or outright
borrowing in form of loan. Financing and investment are two
major decision areas in a firm. In the financing decision the manager is
concerned with determining the best financing mix or capital structure for his
firm. Capital structure decision is the mix of debt and equity that a company
uses to finance its business (Damodaran, 2001). Capital
structure theory is an essential reference theory in firm’s performance. The
capital structure refers to firms’ mixture of debt and equity financing. To
pursue a policy of an optimal capital structure, is one of the most important
and complex issues to resolve in an organization. Most firms’ capital
especially during the beginning of their businesses comes from combinations of
various debt and equity proportions. This is gotten from shareholders funds to
finance their company’s needs and balance their leverage which signifies good
standing of the firm. Debts can be acquired in form of bonds, short and long
term credit while equity can be acquired through participation of stakeholders
or common stocks and retained earnings. Following the work of Modigliani and
Miller (1958), a substantial amount of effort has been put forward in corporate
finance theory to determine the factors that influence a firm’s choice of
capital structure. The issue of finance has been identified as the major reason
for firms failing to start or grow. It is pertinent for firms in Nigeria to
make the best choice in financing their activities and grow over time.
After
over half a century of studies on this great topic, economists and financial
experts have not reached an agreement on how and to which extent firms’ capital
structure impacts on their
performance. However, this study contributes to the empirical studies on how
capital structure impact on firm performance in the Nigerian context.
1.2 Statement
of the Problem
The
actual impact of capital structure on firm performance in Nigeria has been a
major problem among researchers that has not been resolved. There is still no
conclusive empirical evidence in the literature about how capital structure
impacts on firm performance in Nigeria and this formed a knowledge gap that
needs to be filled. Therefore, it is on this premise that the researcher
embarked on this study. Meanwhile, according to Kochar (1997), poor capital
structure decisions may lead to a possible reduction/loss in the value derived
from strategic assets. Hence, the capability of a firm in managing its
financial policies is important, if the firm is to realize gains from its
resources. The raising of appropriate fund in an organization will aid the firm
in its operation; hence, it is important for firms in Nigeria to know the
debt-equity mix that gives effective and efficient performance, after a good
analysis of business operations and obligations.
A
firm’s capital structure refers to the mix of its financial liabilities. It has
long been an important issue from the strategic management standpoint since it
is linked with a firm’s ability to meet the demands of various stakeholders
(Roy and Minfang, 2000). Debt and equity are the two major classes of
liabilities, with debt holders and equity holders representing the two types of
investors in the firm. Each of these is associated with different levels of
risk, benefits, and control. While debt holders exert lower control, they earn
a fixed rate of return and are protected by contractual obligations with
respect to their investment. Equity holders are the residual claimants, bearing
most of the risk and have greater control over decisions.
An
appropriate capital structure is a critical decision for any business
organization. The decision is important not only because of the need to
maximize returns to various organizational constituencies, but also because of
the impact such a decision have on an organization’s ability to deal with its
competitive environment. Following the work of Modigliani and Miller (1958)
much research has been carried out in corporate finance to determine the
influence of a firm’s choice of capital structure on performance. The
difficulty facing companies when structuring their finance is to determine its
impact on performance, as the performance of the business is crucial to the
value of the firm and consequently, its survival.
Managers
have numerous opportunities to exercise their discretion with respect to
capital structure decisions. The capital structure employed may not be meant
for value maximization of the
firm but for protection of the manager’s interest especially in organizations
where corporate decisions are dictated by managers and shares of the company
closely held (Dimitris, and Psillaki, 2008). Even where shares are not closely
held, owners of equity are generally large in number and an average shareholder
controls a minute proportion of the shares of the firm. This gives rise to the
tendency for such a shareholder to take less interest in the monitoring of
managers who pursue interest different from owners of equity.
Any investment decision taken by a firm’s manager affects the performance
of the firm. What will be the appropriate percentage of the capital, debt, and
equity so as to maximize profitability of the firm given that each source of
finance has a cost and benefit attached to it, makes it a major and difficult
decision to be taken by the managers. It is always very difficult for firms to
identify or get the right combination of debt and equity (capital structure)
which will ultimately satisfies them or brings favourable and profitable
results for the firms. However, not all business or firm use a standardized
capital structure; hence they differ in their financial decisions under various
terms and conditions. It is therefore a difficult situation for these firms to
determine the capital structure in which risk and costs are minimum and that
can raise the value of shareholders wealth and maximize profit. Decisions as to
the right source to obtain funds for investment purposes are often very
difficult one. Factors such as the shareholders liability, bankruptcy cost,
uncertainty and taxes complicate the decision of capital structure for firms.
Similarly, the difficulty facing firms in Nigeria has to do more with the financing – whether to raise debt
or equity capital. The issue of finance is so important that it has been
identified as an immediate reason for business failing to start or grow. Thus,
it is necessary for firms in Nigeria to be able to finance their activities
properly and grow over time, if they want to play an increasing and predominant
role in creating value added, as well as income in terms of profits. From the
foregoing, it is therefore important to understand how firms financing choices
affects their performance.
However,
many scholars over time have examined the impact between capital structure and
firm’s performance. Some were of the view that capital structure has positive
and significance impact on firm’s performance, others reported negative impact
while others were of the view that both positive and negative relationship
exist between capital structure and firm’s performance. While some authors work
such as Akintoye (2008) lacked empirical analysis a study of this nature should
have and the study covered ten years.....
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