Abstract
The choice between debt and equity financing has been directed to seek the optimal non current asset structure. Several studies show that a firm with high leverage tends to have an optimal non current asset structure and therefore it leads it to produce good performance, while the Modigliani-Miller theorem proves that it has no effect on the value of firm. The importance of these issues has only motivated researchers to examine the relationship between non current asset structure and firms financial performance. The objective of this study was to establish the relationship between non current asset structure and financial performance of non-financial firms listed at the Nigeria Stock Exchange in Nigeria between the period January 2008 to December 2013.Financial performance was measured by return on equity while non current asset structure was measured by debt ratio. Other control independent variables: Tangibility of assets, size of the firm and the growth of the firm. It is important to note that during this period Nigeria experienced political anxiety, leading to uncertainty in the securities market. This presents an interesting period of study considering the ups and downs of the trade cycle in the securities market. The beginning of this period also experienced the global financial crisis which was witnessed in the period around 2008-2009.The population of study consisted of all the 40 nonfinancial firms listed and duly registered with capital market authority of Nigeria. Secondary data used was obtained mainly from the annual audited and published books of accounts, financial statements and the NSE. Data analysis was done by use of regression analysis model with the help of a computer that was used to analyze regression statistics, Analysis of Variances and coefficients or gradients of variables and the constant. From the study, there exists a linear significant positive relationship between financial performance of the firm and debt ratio. Also, there is a positive insignificant relationship between financial performance and tangible assets. However, the results show that there exists a linear insignificant negative relationship between financial performance of the firm and size and growth of the firm.
CHAPTER ONE
INTRODUCTION
1.1 Background of the study
Non current asset structure refers to a mixture of a variety of long term sources of funds and equity shares including reserves and surpluses of an enterprise. The historical attempt to building theory of non current asset structure began with the presentation of a paper by Modigliani & miller (MM) (1958). They revealed the situations under which the Non current asset structure is relevant or irrelevant to the financial performance of the listed companies.
Non current asset structure decision is an important financing decision which cannot be overlooked, since many of the factors that contribute to business failure can be addressed using strategies and financial decisions that drive growth and achievement of organizational objectives (Salazar, Soto & Mosqueda, 2012). Financing decisions can result in a given non current asset structure which may lead to financial distress and corporate failure (Memba & Nyanumba, 2013). A great dilemma for management and investors alike is whether there exists an optimal non current asset structure.
To understand how companies finance their operations, it is necessary to examine the determinants of their financing or non current asset structure decisions. Company financing decisions involve a wide range of policy issues which have implications for capital market development, interest rate and security price determination, and regulation. Such decisions affect non current asset structure, corporate governance and company development (Green, Murinde and Suppakitjarak, 2002). Knowledge about non current asset structures has mostly been derived from developed economies that have many institutional similarities (Booth et al., 2001). It is important to note that different countries have different institutional arrangements, mainly with respect to their tax and bankruptcy codes, the existing market for corporate control, and the roles banks and securities markets play.
The relationship between non current asset structure and financial performance of the firm is one area of corporate finance that received considerable attention in the finance literature. How important is the concentration of control for the company performance or the type of investors exerting that control are questions that authors have tried to answer for a long time. Prior studies show that non current asset structure is related to financial performance of the firm, which is a key issue in corporate finance (Brigham and Gapenski, 2008).
To study the relationship of non current asset structure on financial performance of the firm will help us to know the potential problems in performance and non current asset structure. The study on non current asset structure attempts to explain the mix of securities and financing sources used by companies to finance investments (Myers, 2001). Brigham (2004) referred to Non current asset structure as the way in which a firm finances its operations which can either, be through debt or equity capital or a combination of both.
According to Myers (2001), there was no universal theory on the debt to equity choice but noted that there were some theories that attempted to explain the non current asset structure mix. Myers (2001) cited the trade-off theory which states that firms seek debt levels that balance the tax advantages of additional debt against the costs of possible financial distress.
The pecking order theory states that firms will borrow rather than issue equity when internal cash flow is not sufficient to fund capital expenditure (Myers, 2001). The theory concluded that the amount of debt will reflect the firms’ cumulative need for external funds.
The free cash flow theory on the other hand stated that dangerously high debt levels would increase firm value despite the threat of finance distress when a firms’ operating cash flow significantly exceed its profitable investment opportunities.
Financial performance is a subjective measure of how well a firm can use its’ assets from its’ primary business to generate revenues. Erasmus (2008) noted that financial performance measures like profitability and liquidity among others provided a valuable tool to stakeholders to evaluate the past financial performance and the current position of a firm. Brigham and Gapenski (1996) argued that in theory, the Modigliani and Miller model was valid however in practice, bankruptcy costs did exist and that these costs were directly proportional to the debt levels in a firm. This conclusion implied a direct relationship between non current asset structure and financial performance of a firm. Berger & di Patti (2006) concluded that more efficient firms were more likely to earn a higher return from a given non current asset structure, and that higher returns can act as a cushion against portfolio risk so that more efficient firms are in a better position to substitute equity for debt in their non current asset structure. This is an incidental of the trade-off theory of non current asset structure where differences in efficiency enable firms to alter their optimal non current asset structure either upward or downwards. In addition, Singh & Hamid (1992) in their research used data on the largest companies in selected developing countries and found that firms in developing countries used more of debt finance in financing their growth than was the case in industrialized countries. Abor (2005) also found a positive relationship between total assets and return on equity and those profitable firms in Ghana depended more on debt as a main financing option due to a Perceived low financial risk.
1.1.1 non current asset structure of a firm
Non current asset structure defines the decision made by a firm in the selection of sources of finance to raise their capital. The work by Modigliani and Miller (1958) on non current asset structure provided foundation upon which the debate in corporate finance about determinants of non current asset structure. Their assertion was that the mix between debt and equity under perfect market conditions is irrelevant and has no effect on the firm’s market value or its cost of capital. This assertion was also consistent with prior work of Burr (1938) who argued that a change in the firm’s non current asset structure has no effect on its investment value.
Many Nigerian researchers have contributed a lot to this field of knowledge. Kamere (1987) did a research on some factors that influence non current asset structure of public companies in Nigeria. From his research, he concluded that profitability was a very important and major factor that influenced non current asset structure decisions in firms in NSE. His observation was that those companies whose profits were very high borrowed very little, that is; they did not borrow so much since some of the profit would be ploughed back into the business. He further noted that those with small profit would not be able to plough back any substantial amount into the business; therefore, they were forced to seek additional funds from outside sources. In fact, this result concurred with the pecking order theory which argues that in the presence of asymmetric information, a firm would prefer internal finance over the other sources of finance, but would issue debt if internal funds were exhausted. However, Omondi (1996) in his research on non current asset structure in Nigeria came up with a conclusion that totally contradicted the Pecking order theory. In his research, he observed that those firms in NSE and with high returns on investments used relatively high debt. That is, those firms which recorded high profit were also found to have borrowed much.
Other similar researches that have been done include that of Musilo (2005): non current asset structure choices, a survey of industrial firms in Nigeria. His objective was to find out the factors that motivate management of industrial firms in choosing their non current asset structure. The research found out that industrial firms are more likely to follow a financing hierarchy than to maintain a target -debt to equity ratio, and that the models based on corporate and personal taxes, bankruptcy, and other leverage related cost are not as useful in determining the financing mix as are the models that suggest that new financing reveals aspects of the firm’s marginal asset performance. He further added that, the importance managers attach to specific non current asset structure theories is not related to managerial perceptions of market efficiency.
Jensen (1986) as quoted in Roy and Ming Fang (2000) observe that in order for to maintain their competitive capabilities, goals and objectives, reduce risks and continue with their existence, they need adequate knowledge about non current asset structure. He further notes that, they should direct their special attention to those factors that are likely to influence the governance structure of a firm to make strategic choices
1.1.2 Financial performance of a firm
Financial performance is a subjective measure of how well a firm can use its’ assets from its’ primary business to generate revenues. Erasmus (2008). A firm’s financial performance, in the view of the shareholder, is measured by how better off the shareholder is at the end of a period, than he was at the beginning and this can be determined using ratios derived from financial statements (Berger and Patti, 2002). Erasmus, (2008) noted that financial performance measures like profitability and liquidity among others provided a valuable tool to stakeholders to evaluate the past financial performance and the current position of a firm. Brigham and Gapenski (1996) argued that in theory, the Modigliani and Miller model was valid however in practice, bankruptcy costs did exist and that these costs were directly proportional to the debt levels in a firm. The value of the firm is linked to profit maximization. A firm that is expected to maximize its profits is concerned with maximizing its value (Bayer Michael R, 2006). One of the major issues of concern to firms is the availability and the inherent cost of capital. Firms therefore search for the lowest-cost financial structures depending on the costs and risks involved in the various financing strategies (Titman and Wessels, 1988). It should be noted that there are multiple financing sources, where the firms can depend on it to finance their investments. Financing sources categorize into two sources, the internal financing which includes common stock issuance, preferred stocks, reserves and retained earnings and external financing which consists short and long term loans and bonds issuance. Firms must choose the best financing sources to reach the optimal non current asset structure to be in harmony with firms’ requirements to take suitable financing decision and then reflect positively on their performance. The performance measure plays crucial role in management of firms to identify the general position where from, the ability of the firm to use non current asset structure optimally and enhance its performance will be assessed. The study used profitability as dependent variables to measure the firm performance to examine the effect of non current asset structure on firm performance. To achieve this, the study employed a measure of profitability by using the indicator which express of performance such as return on equity. Return on equity is a profitability measure that takes into consideration the return that shareholders can obtain from efficient utilization of capital by the management. ROE is measured by dividing net income after tax to book value of owner equity (Onalapo and Kajola (2010).
1.1.3 Non current asset structure and financial performance of a firm
The relationship between non current asset structure and firm performance is one of the argumentative topics in the field of corporate finance that has plagued the academic world for a number of years. At the genesis of non current asset structure is the work by Modigliani and Miller,(Modigliani & Miller,1958:261-297).Modigliani and Miller’s work sort to identify conditions under which non current asset structure decisions were irrelevant to the value of the firm albeit in a perfect capital market (Modigliani & Millert,1958:269).
The Modigliani and Miller (1958, 1963) seminal papers advanced the non current asset structure theory by considering non current asset structure without taxes and with taxes. They argued that in a perfect capital market, the value of the firm is independent of its non current asset structure; hence the firm’s overall cost of capital cannot be reduced as debt is substituted for equity. In the presence of corporate taxes, the firm’s value is positively related to its debt. But since firms deduct interest payments but not deduct dividend payments, leverage lowers tax payments. The cost of equity thus rises with leverage because the risk to equity rises with leverage. There have been substantial research efforts devoted by different scholars in determining what seems to be an optimal non current asset structure for firms, yet there is no universally accepted theory throughout the literature explaining the debtequity choice of firms. But in the last decades, several theories have emerged explaining firm’s non current asset structure and the resultant effects on their market values. Some of the theories that try to explain this behavior include among others; the static trade -off theory (Modigliani and Miller, 1963) which is based on firms’ observation of a target debt ratio, the pecking order hypothesis (Myers, 1984; Myers and Majluf, 1984) which is based on asymmetric information as the influence of financing behavior. The agency theory (Jensen and Meckling, 1976) which considers the costs to the shareholders and managers of a firm for holding debt.Although the non current asset structure issue has received much attention in developed countries, it has remained neglected in developing economies in Africa (Bhaduri;2002).The reason for this neglect is that until recently,developing economies have placed little importance to the role of firms in economic development (Bhaduri ;2002).Singh & Hamid, (1992) in their research, used data on the largest companies in selected developing countries and found that firms in developing countries used more of debt finance in financing their growth than was the case in industrialized countries. Abor, (2005) also found a positive relationship between total assets and return on equity and that profitable firms in Ghana depended more on debt as a main financing option due to a perceived low financial risk.
In Nigeria, financial constraints have been a major factor affecting firm’s performance. According to Salaan and Agboola (2008), the move towards a free market coupled with the widening and deepening of various financial markets has provided the basis for the corporate sector to optimally determine their non current asset structure. Since 1987, financial liberalization has changed the operating environment of firms by giving more flexibility to managers in choosing their firm’s non current asset structure (Salaan and Agboola , 2008).In Nigeria, in a survey of enterprise attitudes, Wagacha (2001) found that firms seemed to increase their borrowing after listing. For large listed firms the debt to equity ratios seemed to rise, while for the small firms they fell, indicating that market development favored large listed firms. Muthama, et al. (2013) did analysis of macroeconomic influences on non current asset structure of listed companies in Nigeria. The research concluded that macro-economic factors have strong influence on non current asset structure, GDP growth rate have positive influence on long term debt ratio and negative influence on total and short term debt ratio.
1.2 Research problem
The relationship between non current asset structure and financial performance of the firm is one of the fields of corporate finance that has been widely researched with no universally accepted explanations. Following the work of MM (1958 and 1963), much research has been done to determine the relationship that exists between non current asset structure and financial performance of the firm. Non current asset structure decision being an important financial decision, firms ought to exercise caution when making the decision as it may determine its survival in the market. Some non current asset structure decisions made by managers may not add value to the firm but may be meant for protecting the managers’ interests (Dimitris and Psillaki,2008)
Non current asset structure issue has received much attention in developed countries. However, it has remained neglected in developing countries. The reason for this neglect according to Bhaduri (2002) was, that until recently, developing economies have placed little importance to the role of firms in economic development as well as corporate sectors in many developing countries are faced with several constraints on their choices regarding sources of funds and access to stock markets which may either be regulated or limited due to underdeveloped stock markets. Consequently, in Nigeria, determining the actual effect a firm has on its market value has been a challenge among researchers. Particularly specifying what capital mix seems to optimize firm’s values has been a difficult puzzle to unravel. Although some studies has been done on the relationship between non current asset structure and firm performance they have not been conclusive enough. Kanyaru (2010) and Ondiek (2010) studied the relationship between non current asset structure and financial performance of firms listed at Nigeria Stock Exchange. Kaumbuthu (2010) studied the relationship between non current asset structure and financial performance of listed firms in the industrial and Allied sector. Munene (2006) studied the impact of profitability on non current asset structure of companies listed at NSE while Musili (2005) studied non current asset structure choice on industrial firms in Nigeria. Oginda (2013) studied on the relationship between non current asset structure and financial performance of listed firms in Nigeria using a two factor model. From the study, leverage gave strong negative relation while firm size gave weak positive relation.
According to Bhaduri (2002), not mush emphasize has been put on the role played by the firm in economic development in third world economies. For any meaningful development should do well by posting good performance. This study involved an investigation of the relationship that exists between non current asset structure and financial performance of the firms listed at the Nigeria Stock Exchange in the non-financial sector for the period between 2008 and 2013.To achieve this, the study established trends in variables for the period of six years. The study then established the direction of the trend in the variables. To achieve this study used secondary data from published books of accounts, the Nigeria Stock Exchange and Capital Markets Authority.
The research question for this study was; what is the relationship between non current asset structure and financial performance of non-financial companies listed at the Nigeria Stock Exchange?
1.3 Objective of the study
This study sort to establish the relationship between non current asset structure and financial performance of all nonfinancial companies listed at the Nigeria Stock Exchange.
1.4 Significance of Study
This study will be of great interest to the government of Nigeria in formulating non current asset structure policies that steer towards maximizing firm performance and value of the firm.
From a theoretical perspective, the study aims to contribute to the existing body of knowledge as well as make up for the paucity of scholarly papers in Nigeria on firm’s non current asset structure and its performance.
From a practical perspective, the findings of the study will be of invaluable assistance to managers of firms in their decision making process and their attempts to maximize their firm’s performance and value. Also, the findings of this study will aid in effective and efficient financing decisions of firms in Nigeria.
Consultants and financial analysts will find the study helpful in their financial and advisory services to firms on the subject of non current asset structure and financial performance of firms.
1.5 Limitations of the study
Though the study achieved the objective it had limitations in terms time constraint. The period of the study was short based on the fact that I have a full time job. The research was also affected in terms of financial constraints such that there was no resources to move to firms outside Nairobi County to collect data and hence had to rely on published reports at the Nigeria Stock Exchange.
It was discovered that some firms had not published their accounts or their audited final accounts could not be accessed and this posed a challenged limiting the number of firms to carry out research.
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