ABSTRACT
The study assessed the effect of capital structure on financial performance of building material firms in Nigeria. An ex-post facto research design was employed and data gotten from 8 out of 9 listed building material firms on the Nigerian stock exchange using a judgmental sampling technique. The specific objectives to this study is to examine the effect of capital structure (EQT, LTD & STD) on return on assets of building material firms in Nigeria. Secondly to determine the effect of capital structure (EQT, LTD & STD) on return on equity of building material firms in Nigeria. Again is to examine the effect of capital structure (EQT, LTD & STD) on earnings per share of listed building material firms in Nigeria. The study employed the use of panel regression (OLS) for analysis of data. Findings revealed that equity capital structure has a significant effect on the return on assets, return on equity and earnings per share of listed building material firms in Nigeria. Also, long term debt capital structure has no significant effect on the return on assets, return on equity and earnings per share of listed building material firms in Nigeria. Finally, short term debt capital structure has no significant effect on return on assets, return on equity and earnings per share of listed building material firms in Nigeria. It was recommended that listed building material firms should consider the need to ensure more equity capital combination on their financing decision. This should be done with due consideration of the cost of capital so as to reduce the negative effect of equity capital on the financial performance of firms which is believed to be as a result of high agency cost. More long term debt should be used for financing building material firms’ investments. By so doing, the firms can spread the interest on debt liabilities over a period that will not be of burden to the firms in turn bring about a positive significant effect on the firms’ financial performance. Furthermore, firms should go for short term debts with low repayment interest. This will enable them have enough reserves for reinvestment which will burst the firms’ financial performance.
TABLE
OF CONTENTS
Title
page i
Declaration ii
Certification iii
Dedication iv
Acknowledgements v
Table
of Content vi
List
of Tables ix
Abstract
x
CHAPTER 1: INTROUCTION
1.1.
Background
to the Study 1
1.2.
Statement
of the Problem 5
1.3.
Objectives
of the Study 7
1.4.
Research
Questions 7
1.5.
Research
Hypotheses 8
1.6.
Scope
of the Study 8
1.7.
Significance
of the Study 9
1.8.
Operational
Definition of Terms 10
CHAPTER 2: REVIEW OF
RELATED LITERATURE 12
2.1
Conceptual Framework 12
2.1.1
Capital structure 12
2.1.2
Measurement of capital structure 13
2.1.2.1
Equity capital 15
2.1.2.2
Debt capital 17
2.1.2.3 Total Debt to total assets 17
2.1.2.4
Total debt to total equity 18
2.1.2.5
Short term debt to total assets 19
2.1.2.6
Long term debt to total assets 20
2.1.3
Concept of financial performance 20
2.1.4
Capital structure and financial performance 27
2.1.5 Optimal capital structure 28
2.1.6
Factors determining capital structure 28
2.1.6.1
Size 29
2.1.6.2Growth
rate 29
2.1.6.3Profitability 29
2.1.6.4
Dividend payout 31
2.1.6.5Business
risk 32
2.1.6.6
Tax charge 32
2.1.6.7Tangibility 34
2.2
Theoretical Framework 34
2.2.1
Irrelevance and relevance theory 33
2.2.2
Agency cost theory 35
2.3
Empirical Review 36
2.4
Summary of Reviewed Empirical Literature 53
2.5
Research Gap 56
CHAPTER 3: METHODOLOGY 57
3.1.
Research Design 57
3.2.
Population of the Study 57
3.3.
Sample Size and Sampling Technique 57
3.4
Source and Method of Data Collection 57
3.5
Model Specification 58
3.6
Description of Variables 59
3.6.1
Dependent variables 58
3.6.2
Independent variables 60
3.7
Techniques of Data Analysis 63
3.8
Decision Rule 63
3.9
Diagnostic and Robustness Test 63
CHAPTER 4: DATA
PRESENTATION AND ANALYSIS 64
4.1
Data Presentation 64
4.2
Data Analysis 64
4.2.1
Descriptive statistics 64
4.2.2
Data validity test 65
4.2.2.1 Stationarity/unit root test 66
4.2.2.3 Co-integration test 67
4.2.3
Regression of the estimated model summary 68
4.2.3.1
Effect of capital structure (EQT LTD STD) on return on assets of listed
building material firm in Nigeria 69
4.2.3.2Effect
of capital structure (EQT LTD STD) on return on equity of listed
building material firm in Nigeria 71
4.3
Discussion and Interpretation of Result 76
CHAPTER 5: SUMMARY OF
FINDINGS, CONCLUSION AND RECOMMENDATIONS 78
5.1
Summary of Findings 78
5.2
Conclusion 78
5.3
Recommendation 79
5.4
Contribution to Knowledge 80
5.5
Areas for Further Research 80
5.6
References 81
APPENDICES 88
LIST OF TABLES
2.1 Summary of reviewed empirical literature 53
3.1: Operational Mean of Variables Measurement and
Definitions 62
4.1: Descriptive Statistic Table 64
4.2: Unit Root Test Table 66
4.3: Table for co-integration Test 67
4.4: Model
Summary 1 69
4.5: Model Summary 2 71
4.6: Vector
Autoregressive Model for EQT LTD STD & EPS 73
4.7: Error
Correction Model for EQT LTD STD and EPS 74
CHAPTER 1
INTRODUCTION
1.1 BACKGROUND TO THE STUDY
Capital structure refers to the planning process directed at
satisfactorily balancing the array of possible types of finance available to
the company (Anyafo,2002). Interest in this area of finance has been
accentuated in recent times as a result of mixed conclusions regarding the
effect of capital structure on firm value and performance. Modigliani and
Miller (1958), in a seminal article propounded the now famous irrelevance
theory. The Modigliani and Miller (M and M) theory posits that the capital
structure of a firm has no effect on the firm value.
Capital structure has been viewed by firms
when considering financial performance. Considering that a firm’s capital
structure is imperative not just to boost earnings but also its effect on
organization’s capability to manage competitive environments, the aim of a firm’s
capital structure may not only be focused on wealth maximization but also to
safeguard management’s interest mostly in firms where control is dictated by
directors and shares of the corporation carefully held (Dimitris and Psillaki,
2014).
A
firm’s capital structure refers to the mix of its financial liabilities, Capital structure
decision making depicts systems in which equity as well as debt are employed
for funding the firm’s activities to yield optimum returns for the stakeholders
to maximize firm’s returns given a level of risk (Dada and Ghazali, 2016). 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 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.
Consequently, firms should with the right
capital structure be able to improve their market share, finance operations and
grow in the long run to improve value added and profits. Firms going through
financial distress often also have issues with its operational functions, high
labor turnover and organization dysfunction. This is because financial distress
shifts from wealth creation to funding debt instruments. A no leverage position
depicts that a business forgoes low-cost sources of financing and depends on
equity, a costly source of capital.
In the manufacturing sector it is observed
that the association between capital structure and performance has for long
been a subject of deliberations for scholars and practitioners. The performance
of management is often measured in relation to profitability which reflects
managers’ ability to earn optimum returns on assets at their disposal over a
period. Profitability according to Owolabi and Obida (2012) is the ability of a
business to make returns higher than the cost of financing their core
operations to ensure the continued survival of the company. This implies that
profitability entails the capability of a company to make profits from its
operating, investing and financing activities to maximize the values and wealth
of the shareholders. Often, listed companies in Nigeria do find it difficult to
make profits, this affects their performance which may be attributed to
inadequate finance or where the finance is available at a cost too expensive
(Akintoye, 2016; Lambe, 2014; Akinyomi and Olagunju, 2013; Salawu, 2009). The
problem of capital structure, therefore, arises from determining the quantum of
each source of finance that will yield optimum return with little risks
(Akintoye, 2016; Dada and Ghazali, 2016; Gambo Ahmad and Musa 2016).
In spite of these, a school of thought has argued that
capital structure is not relevant. Then there is also another thing to
consider: the interaction between financing and investment. In order to try to
distinguish the effects of various determinants of capital structure, it is
assumed that the investment decision is held constant. The choice of capital
structure of a firm is determined by a number of factors which include the
market forces, type of industry, internal policies of the firm, size of the firm,
profitability, corporate tax and bankruptcy costs. There have been various
schools of thoughts on the relevance of capital structure to a firm’s
performance and this study intends to examine the impact on building material firms
in Nigeria.
In Nigeria, like in other climes most
corporate decisions are dictated by managers. Equity issues are often favored
over debt in spite of debt being a cheaper source of fund; even where debts are
employed, it is usually on the short-term basis. This could be as a result of the manager’s
tendency to protect his undiversified human capital and avoid the performance
pressure associated with debt commitment.
More often, when debts are issued voluntarily, particularly long-term
debt, it is used as an anti-takeover device against the challenge of potential
corporate riders. The corporate sector in the country is characterized by a
large number of firms operating in a largely deregulated and increasingly
competitive environment. Since 1987, financial liberalization resulting from
the Structural Adjustment Programme changed the operating environment of
firms. The macroeconomic environment has
not been conducive for business while both monetary and fiscal policies of
government have not been stable. Following the Structural Adjustment Programme,
lending rate rose to a high side from 17.59 percent in 2010 but it declined to 14
percent as at fourth quarter (4Q) in 2018 (Investopedia).
The high interest rate implies that costs of
borrowing went up in the organized financial market, thus increasing the cost
of operations. The Structural Adjustment Programme (SAP) came with its
conditions, policies that liberalized and opened up the Nigerian economy to the
outside world even when the gross domestic product cannot stand in equal comparison
to international commodities, causing unfavorable balance of payment as
domestic demand for foreign goods increased also led to the high volatility of
the exchange rate system thereby rendering business in Nigeria uncompetitive,
especially given high cost of borrowing and massive depreciation of Naira,
which culminated to increasing rate of Inflation in Nigeria. In this light, it
is essential to comprehend how organization’s financing methods impact their
performance.
The capital structure theory originated from
the famous work of Modigliani and Miller (M & M) (1958). They argued that,
under certain conditions, the choice between debt and equity does not affect a
firm’s value and hence, the capital structure decision is irrelevant; but in a
world with tax-deductible interest payment, firm value and capital structure
are positively related. M & M (1958) pointed out the direction that capital
structure must take by showing under what conditions the capital structure is
irrelevant.
Titman (2001) lists some fundamental issues
that make the M & M proposition hold as: no taxes, no transaction cost, no
bankruptcy cost, perfect contracting assumptions and complete and perfect
market assumption. The M & M presentation has since become a subject of considerable
debate both in theoretical and empirical research. The work of M & M has
been criticized by many scholars in view of the fact that in the real-world
situation, the main assumptions never hold. They argued that in
anon-perfectworld, there are factors influencing capital structure decision of
a firm.
Since
the presentation of M & M’s irrelevance propositions, a lot of issues have
been raised with respect to capital structure. Many researchers have attempted
to establish whether their theory is realistic and capable of resolving basic
financing decision problems regarding optimal capital structure for individual
firms and the effect of an appropriate financing mix on firm performance and in
what condition is the choice of capital structure relevant (Aliu, 2010). These
studies however, have provided different opinions on the direction of their
association. The mixed and inconclusive findings provided motivation for
further studies in this area to determine whether capital structure has an
influence on financial performance of firms in different sectors of the
economy. With particular reference to building material firms in Nigeria.
1.2 STATEMENT OF THE PROBLEM
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 has on an organization’s ability to deal with its competitive
environment. The vital
issue confronting managers today is how to choose the mix of debt and equity to
achieve optimum capital structure that would minimize the
firm’s cost of capital and improve return to owners of the business. Financial managers make efforts to ascertain
a particular combination that will maximize profitability and the firm’s
market value. According to Abdul (2012), it is generally believed that the
value of a firm is maximized when its cost of capital is minimized. The kind of combination of debt
and equity that will minimize the firms cost
of capital and hence maximizes the firm’s profitability and market value is the
optimal capital structure. Unfortunately, financial managers do not have a well-defined formula for
taking decision on optimal capital structure.
A number of theories have been advanced to
explain the capital structure of firms. However, there is lack of consensus
among researchers of financial management about the optimal capital structure.
The variations in the various theories necessitate further studies on capital
structure decisions and make it more compelling. Thus, capital structure
decision is very critical, particularly in relation to performance of a firm in
terms of profitability and value of the equity.
Following the work of Modigliani and Miller
(1958) substantial 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
company 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 left themselves pursue interest different from owners of equity.
The
issue of finance is so important that it has been identified as an immediate
reason for business failing to start in the first place or to progress. From
the foregoing, it is therefore important to understand how firm’s
financing choice affects their performance. It is evidently clear that both
internal (firm specific) factors and external (macroeconomic) factors could be very important in
explaining the performance of firms in an economy.
In Nigeria, investors and stakeholders appear
not to look in detail the effect of capital structure in measuring
their firm’s performance as they may assume that attributions of capital structure are
not related to their firms’ value. Indeed, a properly engineered capital
structure could lead to the success of firms. Hence, the issues of capital
structure, which may influence the corporate performance of Nigerian firms,
have to be resolved. In addition, the capital structure choice of a firm can
lead to bankruptcy and have an adverse effect on the performance of the firm if
not properly utilized. The research problem therefore revolves the need to determine
an appropriate mix of debts and equity through which a firm can increase its
financial performance more efficiently and effectively. However, most of these
studies do not pay much attention on long term debt to total asset and
short-term debt to total asset. Hence this study intends to fill the gap by
including these variables (long term debt to total asset and short-term debt to
total asset) as proxies for capital structure. Thus, the central focus of this
study is to assess the effect of capital structure on financial performance of listed
building material firms in Nigeria.
1.3 OBJECTIVES OF THE STUDY
The main objective of the study is to assess
the effect of capital structure on financial performance of building material firms
in Nigeria. The specific objectives include:
i.
To examine the effect of capital structure (EQT,
LTD & STD)on return
on asset of building material firms in Nigeria.
ii.
To determine the effect of capital structure (EQT,
LTD & STD)on return
on equity of building material firms in Nigeria.
iii.
To examine the effect of capital structure (EQT,
LTD & STD)on earnings
per share of building material firms in Nigeria.
1.4. RESEARCH QUESTIONS
This study addressed the following questions.
i.
What is the effect of capital structure (EQT,
LTD & STD)on return
on asset of building material firms in Nigeria?
ii.
What is the effect of capital structure (EQT,
LTD & STD)on return
on equity of building material firms in Nigeria?
iii.
What is the effect of capital structure (EQT,
LTD & STD) on
earnings per share of building material firms in Nigeria?
1.5 RESEARCH HYPOTHESES
This study tested the following null
hypotheses
HO1: Capital
structure (EQT, LTD & STD) has no significant effect on return on assets
of
listed building material firms in Nigeria.
HO2: Capital
structure (EQT, LTD & STD) has no significant effect on return on equity
of
listed building material firms in Nigeria.
HO3: Capital
structure (EQT, LTD & STD) has no significant effect on earnings per
share
of listed building material firms in Nigeria.
1.6. SIGNIFICANCE OF THE STUDY
The beneficiaries from this study includes
Companies, Investors, Government, Students and Researchers.
Companies and firms
The study will enable companies in their
financing decision, whether to finance using debt or equity or both. The
findings and recommendations of this study will also enable companies to know
the effect of capital structure on company’s performance. Also educate firms on
the type of debt (whether long term debt, short term debt, total debt or debt
to equity) that will be appropriate for financing a business and enhancing
firms’ performance.
Investors
The study will also be significant to
investors on the basis that investors are those that invest in companies and as
such would want the performance of the company to increase. The findings and
recommendations of this study will enable investors to know the effect of
capital structure on firm’s performance. The findings and recommendations of
this study will also enable investors to know the type of financing that will
enhance the performance of the firm which will also guide them in decision
making.
Government
The findings of this study will also help
government in policy setting. The findings and recommendations of the study
will enable government set policy(s) that will help firms finance their
business effectively for increase in performance. It is known that government
charge tax base on performance. However, the performance of business firms is
important to government.
Students
The findings of this study will enlighten
students of this noble institution and other institutions on the effect of
capital structure on the performance of firms in Nigeria.
Researchers
Finally, the study will also serve as a
reference material to researchers who would want to research on a similar topic
in future.
1.7. SCOPE OF THE STUDY
The
study is designed to examine the effect of capital structure and financial
performance of listed building material firms in Nigeria. The study covered a
period of five (5) years from 2015 to 2019. The researcher chose the building
material firms as its domain. The independent variables of the study are
capital structure proxied by equity, long term debt and short term debt, and
the dependent variable is represented by financial performance proxied by
return on assets, return on equity and earnings per share. The study covered
from 2015 to 2019. The choice of this period by researcher is based on the
availability of the data as other building material firms do not have complete
data within the period covered.
1.8 OPERATIONAL DEFINITION OF TERMS
Return on asset (ROA)
Return
on Asset: This refers to the
amount of income generated on the employment of each assets by the firm.
ROA is calculated by dividing a company’s net
income by total assets. it would be expressed by
Return on Assets = Net Income
Total Assets
Return equity
This refers to the amount of income generated and attributed
to the ownership stake of each investor in the business.
ROE is calculated by dividing a company’s net
income by shareholders fund.it would be expressed by
Return on Equity = Net Income
SHF
Earnings
Per Share:
This is used to measure the earnings of the business other
than the trading activities. It is attributed to the number of shares owned by
investors in order to ascertain the return on shares owned by each investor.
EPS is calculated thus:
EPS
= Profit
before interest and tax
Total assets –Current liabilities
Debt to total
assets ratio
The debt to total assets ratio is an
indicator of a company's financial leverage. It tells you the percentage of a
company's total assets that were financed by creditors. Debt is the total amount
of all liabilities (current liabilities and long-term liabilities). It is calculated thus:
TOTAL DEBTS
TOTAL ASSETS
Long-term debt-to-total-assets ratio
The long-term
debt-to-total-assets ratio is a measurement representing the percentage of a
corporation's assets financed with long-term debt, which encompasses loans or
other debt obligations lasting more than one year. This ratio
provides a general measure of the long-term financial position of a company,
including its ability to meet its financial obligations for outstanding
loans. It is calculated thus:
Long Term Debt
Total assets
Short -term debt-to-total-assets ratio
The short -term
debt-to-total-assets ratio is a measurement representing the percentage of a
corporation's assets financed with short -term debt, which encompasses debt obligations lasting less more than one year. This ratio
provides a general measure of the long-term financial position of a company,
including its ability to meet its financial obligations for outstanding
loans. It is calculated thus:
Short Term Debt
Total Assets
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