study examines the relationship between capital structure and market value of a
company, it is motivated by a desire to explain debt (leverage) used by five
manufacturing companies listed in Nigeria stock exchange in 2012 financial
year. Debt financing were discussed, income gearing, cost of capital, cost of
debt, the weighted average cost of capital, capital structure and its effect on
share price/cost of capital, the relationships between the use of financial
leverage and share price. It also discussed financial innovation for improving
capital structure, issues and theories of capital structure, the role of the
capital market in share prices valuation, factors that influence share prices
and behaviour of share prices. In light of this discussion, a number of
questions arose to determine if shareholders fund has a significant impact on
the market value of the firm. This then led to the formulation of two hypotheses
which were analyzed using the ordinary least square regression technique on the
companies. The findings revealed that the two performance variable has
significant impact on the market value of the firm. The result of this study
was observed that variable of equity (shareholders fund) has a significant
relationship with the market value. It was recommended among others that
Nigerian companies should try to ascertain the optimal capital structure to be
adopted as a policy in order to create a balance in satisfying the shareholders
desire and management of capital structure decision. It was concluded that any
researcher that intends to research on this area in finance in the future
should investigate into other factors influencing the market value apart from
TABLE OF CONTENTS
Background to the study
Statement of problem
Objectives of the study
Significance of the study
Scope of the study
Limitation of the study
Definition of terms
Chapter Two: Literature
Cost of capital
2.4.1Cost of debt
2.4.2Cost of equity
average cost of capital
Capital structure and its effect of
share prices/cost of capital
The relationship between the use of
financial leverage and share prices
hypothesis net operating income (NIO)
hypothesis net income theory (NI)
Financial innovation for improving
2.7.1Debt for equity
2.7.2Debt for debt
Issues and theories of capital structure
The role of capital market in share
2.9.1 The factors that influence share price
of share price
The random hypothesis
Chapter Three: Research
Method and Design
Description of population of the study
Sources of data collection
Method of data presentation
Method of data analysis
Chapter Four: Date
Presentation, Analysis and Interpretation
Presentation of data
Chapter Five: Summary
of Findings, Conclusion and Recommendation
Summary of findings
1.1 Background to the Study
One of the cornerstones of the modern
corporate finance theory is the capital structure irrelevancy proposition
(Modigliani & Moller 1958). Modigliana & Moller (1958) conclude that
the market value of any firm is independent of its capital structure. It is
observed that the options capital structure is closely related to the growth
potential of the firms (McConnel & Servaes 1995; Jung, Kim & Stulz
1996) and some other valuables such as the size and the industry
Debt policy and equity ownership
structure matter and the way in which they matter differ between firms (McConnell
& Servaes). Leland and Pyle (2007) propose that managers will take
debt/equity ratio as a signed by the fact that high leverage implies higher
bankruptcy risk (and cost) for low quality firms since managers always have
information advantage over the outsiders, the debt structure may be as a signal
to the market. Rose model suggests that the value of firms will rose with the
leverage since increasing leverage increases the market perception of value.
Suppose there is no agency problem i.e.
management acts in the interest of all shareholders, the manager will maximize
the firm’s value by choosing the optional capital structure, highest possible
debt ratio; high quality firms need to signal their quality to market, which
the low quality firms try to imitate.
According to this argument, the debt
level should be positively related to the value of the firm. Assuming
information asymmetry, the pricing order theory (Myers & Majurf 1984)
predicts that firms will follow the peeking order as optimal financial
strategy. The reason behind this theory is that if the managers act on behalf
of the owners, they will issue securities at a higher price than they are truly
The more sensitive the security, the
higher the cost of equity capital, since the action of the manager is giving a
signal to the market that the securities are overpriced. Stulz (1990) urge that
it can have both positive and negative effect on the value of the firm (even in
the absence of corporate taxes and bankruptcy cost). He develops a model in
which debt financing can both alleviates the over investment problem. Stulz
(1990) assumes that managers have no equity ownership in the firm and receive
utility by managing a larger firm. The “power of manager” may motivate the self
interest managers to undertake negative present value projects. To solve this
problem shareholders force firms to issue debt. But if firms are force to pay
out funds, they may have to forgo positive present value project. Therefore,
the optimal debt structure is determined by balancing the optimal agency cost
of debt and the agency cost of managerial discretion.
According to Stulz (1990), McConnel and
Servaes (1995) Jung, Kim, (1996), the influence of the debt on the firm’s value
depends on the presence of growth opportunities. For firms facing low growth
opportunities, debt ratios are negatively related to the firm’s value.
Capital structure is the mixture of
permanent sources of funds a firm uses in financing its operations, primarily
represented by long term debt, preference stock common equity, debenture which
exclude all short term credit i.e. overdraft.
The amount of debt that a firm uses to
finance its asset is called leverage. A firm worth a lot of debt in its capital
structure is said to be highly levered while a firm worth no debt is said to be
Pandy (2005, p.5) posited that the mix
debt equity is known as a firm’s capital structure. The manager should
rigorously strive to obtain the optimum capital structure for the
organizational being. It should be noted that the firm’s capital structure is
seen as a mixed or when it’s market value of shares is maximized or when it’s
weighted average cost is minimized. An appropriate capital structure is a
critical decision for any business organization and this decision is very
important not just because of its need to maximize shareholder’s wealth or
increase the market value of companies, but also because of the impact such
decision has on the company’s ability to deal with the competitive environment.
In other developing countries of the
world and Nigeria in particular, not much has been written on the conceptual
linkage between market value of companies and capital structure, therefore the
financial manager should seek that capital structure which maximizes the value
of the firm (optional capital structure) are brought to bear. The firm’s
optional capital structure should represent a balance between debt and equity.
Such advantage that comes from using cheaper debt is just matched by the
increase in the financial risk that comes form debt.
1.2 Statement of Problem
The capital structure mix that a company
decision will definitely have an effect on its market value. A cursory look
will be taken on the extent to which capital structure relates to the market
values, there is need to seek answers to the following questions:
There is relationship between capital
structure and market value of companies.
There is optimal capital structure
improvement on market value for existing and potential shareholders.
The shareholders fund has impact on the
market value of the firm.
There are factors that influence the
decision of management as regards to capital structure.
1.3 Research Questions
What is the relationship between capital
structure and market value of companies?
Does optimal capital structure improve
on market value for existing and potential shareholders?
Does the shareholders fund have a
significant impact on the market value of the firm?
What are the factors that influence
decision of management as regard capital structure?
1.4 Objectives of the Study
The hallmark of business enterprises are
probability and accountability which enables the organization to gain public
confidence on which the organization thrives. The research work seeks to
achieve the following objectives:
To establish the relationship between
capital structure and the market value of company.
To determine the factors that influences
the decision of management as regards capital structure.
To determine if shareholders fund has a
significant impact on the market value of the firm.
To ascertain the optimal capital
structure that improves on market value for existing and potential
1.5 Statement of Hypothesis
Null Hypothesis (Ho): Capital structure does not have impact
on the market value of the firm.
Hypothesis (Hi): Capital structure
has impact on the market value of the firm.
Null Hypothesis (Ho): Shareholders fund does not have
significant impact on market value of the firm.
Hypothesis (Hi): Shareholders fund
has a significant impact on market value of the firm.
1.6 Significance of the Study
This study attempts to produce
information to bridge the information needs of the potential and actual
investors as well as for the management of companies.
Therefore the following categories will
benefit immensely from the findings of this research work.
Potential Investor: It could serve as a guide in determining the value of the company
that would finally have an influence on their investment decision.
Management: It would expose them to improve practice as well as help control
Shareholders: It would help them to estimate and evaluate the returns suitable
from their investments.
Government: It would be beneficial to government in the area of policy
formulation and implementation towards sustaining the capital structure
policies already in place.
The Public: It will enlighten the public
on the need to invest in a well capital structured company with effective
policies. It will also benefit the public in the area of providing relevant
information for the future researchers own research work.
Customers: It would expose them to knowing the company better, thereby
making the demand for the companies product increase. It would also make them
evaluate the returns suitable from investment.
1.7 Scope of the Study
This research work encompasses a
comprehensive survey of companies in Nigeria. The fundamental aim
of this study is to analyze the
relationship that subsist between capital structure and market value or share
price. The data is obtained using a cross section of quoted companies in the
Nigerian stock exchange for the period of 2010.
1.8 Limitation of Study
The research study is associated with
the problem of data collection principally how to obtain information required
for the study is a Herculean task.
The smallness of the sample size is also
as constraints to this research project.
It is also possible the wrong
information has been given intentionally or otherwise, during the data
Some of the data generated and analyze
were based on fact and figures reported by journals, magazines, newspapers,
textbooks, etc. There is the livelihood that historical errors reported by them
might be included.
1.9 Definition of Terms
Capital: Capital relates to the proportion of different types of
securities both debt and equity issued by a company.
Capital Structure: Capital structure relates to the mix of the long-term sources of
funds by the company.
Liquidity: It is the ability of the company to meet short term maturing
obligation as they fall due.
Dividend: This is the payment made by a quoted company to its shareholders.
It could be either in cash or stock dividends.
Stock: Stock refers to a fixed interest security issued by companies and
it’s also part of the equity capital of the company.
Stock Exchange: This is a place where
stocks, security and share are constantly traded.
Capital Gains: It occurs when stock
exchanged securities are sold at a higher price than it was paid for. Hence, it
could be seen as a situation where the share of a company appreciates in value
because the earnings power of the company is appreciating.
Share: A share is the smallest individual unit of capital of a limited
liability company which gives its holders the opportunity to receive an amount
Share Price: Share price is the market
price of share of a company as stated on the daily listings of activities in
the stock exchange.
Leverage: This is the amount of debt that a firm utilizes in financing its
activities. A company is said to be highly leveraged when it has a high
proportion of debt stock in its capital structure.
Shareholders: This is a part owner of a limited liability company and he or she
is entitled to vote in annual general meetings of the company and to receive
dividends and to obtain a chare in the net assets of the company on its
Quoted Company: This is a company whose
share is listed on the stock exchange.
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