ABSTRACT
This study focuses on the effect of capital structure on the financial performance of Banks in Nigeria. The greatest issue striving against the management of any firm in Nigeria and the world over is how to minimize cost of capital and maximize shareholders wealth. The study made used of an ex-post facto research design. The data collected were then tabulated and analyzed using the simple regression analysis. The study revealed that The intercepts of the bank is negative meaning that without debt financing (D), equity financing (E) and debt to equity ratio (D/E), the profitability of the bank considered in this study will be negative. Debt financing (D) is negatively related to profitability of the bank as it was assumed that the slope coefficient is constant for the bank. When debts become relatively high, further increasing generate significant agency of bankruptcy of financial distress between bondholders and shareholders. This is then reflected as a negative relationship. The value of debt financing is -0.040657, meaning that a unit increase in debt financing will pull down the profit of the shareholders by 4%. Equity financing exist a positive coefficient of 0.389768 for the bank that is, equity financing is positively related to profitability of the bank considered in the study. It then implies that an increase on equity financing of the bank, the profitability of the bank will increase by about 40%. It therefore, explained that shareholders of the banks tend to maximize more profit through equity financing. It is therefore, perfectly significant. The financial ratio which is debt to equity ratio is positive with a value of 407776.6; it explained that there is a positive relationship between debt to equity ratio and profitability of the bank under investigation. An increase on debt-equity financing will bring about 407776.6 units increase in profit of the bank. Conclusively, Debt/equity ratio significantly influences financial performance, with most investors preferring to invest in companies with a smaller debt/equity ratio. Also, it could be concluded from the above findings that the performance of First bank Nigeria Plc is significantly related to the capital structure ratios. It is recommended that In improving banks’ performance, share of equity financing in the capital structure should be increased. To avoid conflict of managers with shareholders interest, managers should go for long run value maximization of the firm which satisfies both managers and shareholders interest.
TABLE
OF CONTENT
Title
page i
Declaration ii
Certification iii
Dedication iv
Acknowledgement
v
Table
of content vi
List
of table ix
Abstract x
CHAPTER ONE
INTRODUCTION
1.1 Background
to the Study 1
1.2 Statement
of the problem 5
1.3 Objectives
of the study 6
1.4 Research
Questions 7
1.5 Research
Hypotheses 7
1.6 Significance
of the Study 8
1.7 Scope
and Limitation of the Study 9
1.8 Definition
9
CHAPTER TWO
REVIEW OF RELATED
LITERATURE
2.1
Conceptual Framework 12
2.1.1
Strategies management research and capital structure 12
2.1.2
Determinants of capital structure 31
2.1.3
Capital structure and cost of capital 40
2.1.4
Financial leverage and the shareholders’ return 43
2.1.5
Financial innovations for improving capital structure 44
2.1.6
Concept of performance measure in a capital structured firm 49
2.1.7
Equity financing and firm performance 50
2.1.8
Value and corporate performance of firms 51
2.2
Theoretical framework 52
2.2.1
The trade-off theory 53
2.2.2
Agency theory 55
CHAPTER THREE
RESEARCH
METHODOLOGY
3.1
Research design 59
3.2
Data sources and method of data collection 59
3.2.1
Data sources 59
3.2.2
Methods of data collection 59
3.3
Model specification 60
3.4
Techniques of data treatment 61
CHAPTER FOUR
DATA PRESENTATION,
ANALYSIS AND DISCUSSION OF FINDINGS
4.1
Data presentation 63
4.2
Analysis of data 64
4.3
Test of hypotheses 65
4.4
discussion of findings 68
CHAPTER FIVE
SUMMARY,
CONCLUSION AND RECOMMENDATIONS
5.1
summary of findings 70
5.2
conclusion 70
5.3
recommendations 71
REFERENCES
List
of Table
Tables pages
4.1 Indices of capital
structure and financial performance of first
bank Nigeria PLC from 2010-2014 63
4.2 Regression
result of the relationship between capital structure and profitability (PROF) 64
CHAPTER ONE
INTRODUCTION
1.1 Background to the
study
Investment is the commitment of funds by an individual
or a group of persons with the aim of receiving profit (Holfer, 2001). Most
often investor(s) start a business with their personal capital which they must
have generated through savings. In view of expanding the business and the
current business fund is unable to finance the expansion, investors then have
two options to finance the business. These two options are usually made up of
debt and equity.
The debt
instruments are long-term external sources of funds for financing a firm's
assets. However, before a firm can raise debt, it is mandatory that there
should be equity capital which represents shareholders’ contribution to the
financing of business (Laverty, 1996). The composition of debt, equity and retained
earnings depends on certain factors which could be either internal or/and
external affecting the operations of the firm (Holfer, 2001).
Equity capital represents ownership; equity owners
have a residual claimant status over the cash flow from asset earnings and
asset liquidation. That is, they obtain the cash flows that are left after
paying off more senior claims such as debt. Thus, equity holders have weaker
property rights, similar to hierarchical control (Franco, 1995). The equity
contract is not for a fixed period but runs for the life of the firm. The board
of directors is present to closely monitor and evaluate managerial actions,
ensuring that the investment of equity holders is protected. The board has the
authority to monitor internal performance, approve significant decisions,
decide on managerial compensation, and replace managers if it deems so
necessary (Foulks, 2000). The instrument of equity emphasizes continuous
behavioural control providing equity holders with stronger control rights.
The second option for financing a venture is through
debt. The debt instrument carries with it fixed rules and covenants that
usually monitor the lending process. The repayment schedule of the principal
loan amount and the interest payments are stipulated in the contract, with debt
holders having primary claim over the firm's cash flows from the assets. The
firm is often required to meet liquidity tests to ensure that the lenders'
investment is not jeopardized. These characteristics imply that debt has strong
property rights, making it similar to the market exchange mechanism (Mittra,
2001).
The third option for firms to finance their growth is
by ploughing back a portion of earnings available for shareholders. This method
of acquiring fund is known as retained earnings. Financing policy by firms require financial
managers to identify ways of funding new investment. The manager may exercise
three main choices: use retained earnings, borrow through debt instruments, or
issue new shares. Hence, the standard capital structure of a firm includes
retained earnings, debt and equity. These three components of capital structure
reflects a firm's ownership structure in the sense that the first and third
components are shareholders’ ownership while the second component represents
ownership by creditors. This is the pattern found in developing and developed
countries alike (Shleifer, 1999)
The choice of appropriate capital structure is seen as
a viable option to increase and maximize shareholders’ wealth. With the recent
development in the Security and Exchange Commission (SEC), Nigerian Stock
Exchange (NSE), and the entire financial system, with firms being listed and
quoted on the Nigerian Stock Exchange (NSE), one issue that has received great
attention is the capital structure decision. This follows because the market
value of the firm may be affected by the capital structure decision. The
debt-equity mix has implications for the shareholder earning and risk, which in
turn will affect the cost of capital and the value of the firm (Prasad, 1997).
According to Solomon (2003), to acquire equity funds,
a firm can sell shares. The shareholders invest their money in the shares of a
company with the expectation of returns on their invested capital. Equity fund
can equally be obtained by ploughing back a portion of the earnings available
for shareholders. This method of acquiring funds internally is known as
retained earnings. For quite a long time no body has tried to explain how and
why firms choose their capital structure. If an optimal capital structure can
be identified, a firm could maximize its value by reaching and maintaining that
financial mix (Modigliani, 2001). A wide variety of explanations have been
offered to explain why firms choose the capital structure that they maintain,
for example information asymmetries between firms’ managers and the financial
market. The tax shield of debt and non-debt expenses and the use of debt to
maintain managerial discipline have all been offered explanations (Grossman
& Hart, 2001). This confusing mixture of answers leads Mayer (2003) to
conclude that, "no clear solution exists as to why firms make certain
choices concerning their debt/equity mix. To date, there is still no
consistently accepted answer to this puzzle (Norton, 1999)
Increasingly, business organizations in Nigeria and
beyond are seeking to manage companies in a strategic manner. The strategic
model of the firm argues that improved firm performance occurs when the firm's
managers select strategic activities of the firm which are directed towards the
goals of the firm (Holfer, 2001). In order to appreciate any discussion
relating to the influence of capital structure on investment decision, one
should be familiar with fundamental tenets of modern finance. Thus the financial
strategy of the firm should be consistent with the firm’s strategic objectives.
1 .2 Statement of the
problem
The greatest issue striving against the management of
any firm in Nigeria and the world over is how to minimize cost of capital and
maximize shareholders wealth. To achieve this major objective, financial
managers of firms need to understand the source of capital to finance the
growth of the firm and also the efficient use of the available capital.
A cursory look at quoted companies in Nigeria reveals
large differences in capital structure; that is the proportion of debt: equity:
retained earnings differ from one firm to the other. There is also growing
predictions of bankruptcy, financial distress and restructuring. This is
usually caused by wrong combinations and mismanagement of debt, equity and
retained earnings among others. The instability of the economic environment
seems to be another major factor to consider. Some firms therefore become
riskier than others and as a result rational and informed investors purchase
the securities of one firm more than the other (Holfer, 2001 ),
Consequently, this research work is aimed at finding
out the effect of capital structure on corporate financial performance and
shareholders’ investment decisions in Nigeria.
1.3
Objectives of the study
The main objective
of the study is to examine the relationship between capital structure and
financial performance of Banks in Nigeria.
The specific
objectives of this study are as follows:
1.
To examine
the relationship between debt financing and profitability.
2.
To examine
the relationship between equity financing and profitability
3.
To examine
the relationship between debt/equity ratio and profitability
1.4 Research
questions
The research questions for the study are as follows:
1.
What is the
relationship between debt financing and profitability?
2.
What is the
relationship between equity financing and profitability?
3.
What is the
relationship between debt/equity ratio and profitability?
1.5 Research
hypotheses
The following null hypotheses are formulated and
would be tested in order to authenticate the objectives of the study.
1.
There is no
significant relationship between debt financing and profitability.
2. There is no significant relationship between equity financing and
profitability.
3. There is no significant relationship between debt/equity ratio and
profitability.
1.6 Significance
of the Study
The study x-rays some of
the importance factor that should be taken into consideration in detaining
financing choices of a firm.
Also, since capital structure is regarded as a major branch of financing, it is
a truism that an empirical work on the subject attracts considerable attention.
It is in the light of the foregoing that one takes a look at the importance of
capital structure with a view to determining its effects on financial
performance.
Moreover,
from an academic point of view, the study could be of immense benefit to
university students who may be interested in examining capital structure.
Indeed, a
discovery of knowledge of the protracted problems of capital structure and the
policy recommendations of this study would enable financial regulatory bodies
to make adjustment where necessary in order to achieve macroeconomic objectives.
Furthermore, the results of the study could help in no small way to
assist financial experts, management, government and the general public to
organize, plan and restructure their capital mix machineries for optimality.
1.7 Scope and Limitation of the study
This study focuses
on the effect of capital structure on the financial performance of banks in
Nigeria. The study period is from 2014 -
2018
The scope of the study is not limited to the case studies
in questions, but considers every other organization that employs capital
structure (financing choices) to enhance profitability.
1.8 Definition of concepts
Capital: Capital is wealth that
is used to produce more wealth like buildings, machines, goods and others.
Capital investment:
This refers to the situation where firms make current cash outlay and use of
sophisticated machines for the benefits to be realized in the future.
Capital structure:
This represents the proportionate relationship between equity and debt i.e. the
firm's mix of different securities.
Corporate finance:
This refers to the procedures and activities that deal with rising of funds for
financing corporate activities.
Cost of capital:It
is a price for obtaining capital.
Debt: Refers to the amount of
money borrowed to finance the purchase of assets or expansion of a company.
Equity:
This refers to the shareholders stake in any business organization.
Equity fund:
This is the contribution of shareholders (owners) to the financing of the
business.
Financial assets:
This refers to stocks and bonds that aid in income generation of any business
organization.
Financial leverage:
It is the use of fixed cost sources of finance, such as debt and preference
share capital to finance the asset of
the company.
Financial performance:
This refers to results of carrying out business activities when measured
against plans and targets of the
company (i.e. return on equity and asset).
Financial risk:
The variability of earnings per share caused by the use of financial leverage.
Issued capital:
This refers to the share capital actually issued by any business organization,
which can not exceed authorized share capital.
Market structure:
The characteristics of a group of firms producing the same or related
product.
Optimum capital structure:A
capital structure that has the best possible mix of debt, preferred stock, and
common equity with the weighted average cost of capital at its lowest .
Preference shares:This
refers to those shares having preferences over/advantages over ordinary shares
in the payment of dividend and recoupment
of capital in case of liquidation of the company.
Preference share capital:
Preference shares may be issued with or
without a period. The holders get dividend at fixed rate and have a preference
over ordinary shareholders.
Retained earnings
(profitability): Retained earnings represent that
portion of shareholders’ earning ploughed back into the business.
Securities:
This refers to documents of title to investments, such as shares,
certification, and bonds.
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