ABSTRACT
This study investigated the impact of capital structure components on financial performance of quoted companies in Nigeria with specific reference to how short term debt, long term debt and equity affect financial performance in terms of Earnings per share (EPS), Dividend per share (DPS) and Net asset per share(NAS)of quoted companies in the Nigerian Stock Exchange. The research design adopted in this study was an explanatory non-experimental design. The sample size used was thirty-six (36) quoted companies; representing each sector on the Nigeria Stock Exchange as at December 2015 for a period of 11 years i.e. 2005 to 2015. Data used for the study was secondary data and were collected on short term debt, long term debt and equity and financial performance (EPS, DPS and NAS). Ordinary Least Squares method was used in analyzing the data. A positive relationship was found to exist between short term debt, long term debt, equity and firm performance. Furthermore, the finding also shows that all variables are positively related to firm performance. This relationship is statistically significant at 5% level. The study concluded that all the independent variables (STD, LTD and EQ) are positively related to firm performance (EPS, NAS and DPS); moreover, STD, LTD and EQ are significantly associated with firm performance. This study recommended that government should create an enabling business friendly environment so that businesses can thrive. This is evident in the fact that macroeconomic variables positively affect the performances of most firms in Nigeria.
TABLE OF CONTENTS
Title Page i
Declaration ii
Certification iii
Dedication iv
Acknowledgements v
List of Tables viii
Abstract ix
CHAPTER
1: INTRODUCTION 1
1.1 Background
to the Study 1
1.2 Statement
of the Problem 3
1.3 Objectives
of the Study 4
1.4 Research
Questions 5
1.5 Research
Hypotheses 5
1.6 Significance
of the Study 6
1.7 Scope
of the Study 6
1.8 Limitation
of the Study 7
1.9 Operational
Definition of Terms 7
CHAPTER
2: LITERATUREREVIEW 10
2.1 Concept
of Capital Structure 10
2.1.1 Determinant
of capital structure 12
2.1.2 Financing
structure 15
2.1.3 Financial
performance 17
2.1.4 Measures
of financial performance 18
2.1.5 Relationship
between capital structure and financial performance 22
2.5.2 Capital
structure and cost of capital 23
2.2 Theoretical
Framework 24
2.3 Empirical
Framework 34
2.4 Gap
in Literature 52
CHAPTER
3: METHODOLGY 54
3.1 Research
Design 54
3.2 Population 54
3.3 Sampling
Size and Sampling Technique 54
3.4 Sources
of Data and Data Collection Method 56
3.5 Description
of Research Variables 56
3.6 Model
Specification 57
3.7 Data
Processing and Analysis 57
3.8 Justification
of the Model 59
CHAPTER
4: DATA PRESENTATIONAND RESULTS 60
4.1 Descriptive
Statistics 60
4.2 Relationship
Between Variables 62
4.3 Test
of Hypothesis 64
4.4 Discussion 67
CHAPTER
5: SUMMARY,
CONCLUSION AND RECOMMENDATIONS 69
5.1 Summary 69
5.2 Conclusion 69
5.3 Recommendations 70
5.4 Contribution
to Knowledge 71
References 72
Appendices 82
LIST OF TABLES
Table Page
4.1: Descriptive
Statistics of independent and dependent variables 60
4.2.1: Correlation table showing the relationship
between dependent
variable and other
independent variables 62
4.2.2: Correlation table showing the relationship
between dependent
variable (DPS) and
other independent variables (STD, LTD and EQ) 62
4.2.3: Correlation table showing the relationship
between dependent
variable (NAS) and
other independent variables (STD, LTD and EQ) 63
4.3: Regression result for hypothesis 1 which
examined the
overall
effect of STD, LTD and EQ on EPS 64
4.4: Regression result for hypothesis 2 which
examined the
overall
effect of STD, LTD and EQ on DPS. 65
4.5: Regression result for hypothesis 3 which
examined the
overall effect of
STD, LTD and EQ on NAS. 66
CHAPTER
1
INTRODUCTION
1.1 BACKGROUND TO THE STUDY
Capital
Structure refer to a mixture of various sources of funds, debts, equity
(Ordinary and Preference shares), including reserves and surpluses of a company.
A firm’s capital structure simply refers to the mix of debt and equity
financing. It can also be referred to as the way a corporation finances its
assets through some combination of equity, debt or hybrid securities; that is,
the combination of both equity and debt.
Capital structure are usually represented by short term debt to capital
ratio, long term debt to capital ratio and total debt to capital ratio (Mohamad
&Abdullah, 2012). Usually, capital structure policy depends upon the
company’s size, ownership, profitability, various costs, earnings growth and
liquidity of company’s assets (Faruk &Ayub, 2012).
A
critical decision for any business organization is a decision for an
appropriate capital structure, the decision is not only critical because of the
need to maximize returns to various organizational constituencies, but also
because of the organization’s ability to deal with its competitive environment.
A finance manager is concerned with the determination of the best financing mix
and combination of debts and equity for his firm. Capital structure decision is the mix of debt
and equity that a company uses to finance its business (Damodaran, 2001).
Overall objective of companies is to reduce the cost of capital, when capital
structure decision is considered, value maximizations of the companies are
achieved. How an organization is financed is of paramount importance to both
the managers of the firms and providers of funds. This is because if a wrong
mix of finance is employed, the performance and survival of the business enterprise
may be seriously affected.
It
should be noted that there are multiple financing sources, which the firms can
depend on to finance their investments. Financing sources are categorized into
two, the internal financing which includes reserves and retained earnings.
Another source called external financing which consists of short and long term
loans and bonds issuance,common stock issuance, preferred stocks. In this case,
firms must choose the best financing sources to reach the optimal capital
structure to be in harmony with firm’s requirements to take suitable financing
decision and then reflect positively on their performance. One of the advantages
of capital structure is that it is tightly related to the ability of firms to
fulfill the needs of various stakeholders.
The
prevailing argument, originally developed by Modigliani and Miller (1958), is
that an optimal capital structure exists which balances the risk of bankruptcy
with the tax savings of debt. Once this is established, capital structure provides
greater returns to stockholders than they would receive from an all-equity
firm. In theory, modern financial
techniques would allow top managers to calculate accurately optimal trade-off
between equity and debt for each firm.
However, in practice; many studies found that most firms do not have an
optimal capital structure. This is due to the fact that the managers do not
have an incentive to maximize firm’s performance because their compensation is
not generally linked to it. Moreover, since managers do not share firm’s
profits with shareholders, they are very likely to increase company’s
expenditures by purchasing everything they like and surrounding themselves of
luxury and amenities. Hence, the main concern of shareholders is ensuring that
managers do not waste firm’s resources and run the firm in order to maximize
its value, which entails finding a way to solve the principal-agent problem.
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. Financial performance (reflecting profit
maximization, maximizing return on assets, shareholder return) is based on the
firm’s efficiency. The assessment of financial performance is based on the
return on investment, residual income, earnings per share, dividend yield, price
earnings ratio, growth in sales, market capitalization. Etc.
Firm’s
performance is significantly affected by various factors and capital structure
is one of the significant factors among them. 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 capital structure mix.
The
relationship between capital structure and financial performance is one that
received considerable attention in the financial literature. Prior studies
showed that capital structure has relationship with financial performance. How
important is the concentration of control for the company performance or the
type of investors exerting that control are questions that this study investigates. Studying
the effect of capital structure on financial performance will help us to know
the potential problems inherent in financial performance and capital structure.
1.1.
STATEMENT
OF THE PROBLEM
Several
theories have been advanced to explain the capital structure of firms. However,
there is lack of consensus about the optimal capital structure. The variations
in the various theories further make capital structure decisions crucial. Thus,
capital structure decision is very critical, particularly in relation to
financial performance of a firm in terms of the value of the equity. Given the
above background, this study attempts to examine how capital structure affects
the financial performance of quoted companies in Nigeria.
Financial
leverage refers to the proportion of debt in the capital structure. Studies
shows contradictory results about the relationship between increased use of
debt in capital structure and financial performance. Some studies (Taub, 1975),
(Roden&Lewellen 1995), (Champion, 1999), (Hadlock& James, 2002),
(Berger &Di Patti, 2006) showed positive relationship and some (Friend
& Lang, 1988), (Fama& French, 1998), (Simerly&Li, 2000), showed
negative, weak or no relationship between firms’ performance and leverage
level. In a study of listed firms in Ghana, Abor (2005) found that short- term
and total debt are positively related with firm’s ROE. Whereas long term debt
is negatively related with firm’s ROE. While examining the relationship between
capital structure and performance of Jordan firms, Zeitun& Tian (2007)
found that debt level is negatively related with performance. These
inconsistencies require the need to assess the effect of financial leverage on
the financial performance of quoted companies in Nigeria.
In
studying the effect of capital structure on financial performance of quoted companies
in Nigeria, prior studies have concentrated on one or more sectors listed on
the Nigerian Stock Exchange such as; Manufacturing, Banking, Agricultural,
among many others. This study therefore seeks to fill this gap by investigating
the impact of capital structure on financial performance of all sectors in the
Nigerian Stock Exchange.
1.2.
OBJECTIVE
OF THE STUDY
The
major aim of this study is to examine the impact of capital structure on
financial performance of quoted companies in Nigeria. The specific objectives
for the study are to:
i.
Ascertain the effect of Short
term debt, Long term debt and Equity on Earnings per Share of quoted companies
in Nigeria.
ii.
Determine the impact of Short
term debt, Long term debt and Equity on Dividend per Share of quoted companies
in Nigeria.
iii.
Examine the effect of Short
term debt, Long term debt and Equity on Net Asset per Share of quoted companies
in Nigeria.
1.3 RESEARCH
QUESTIONS
The
research questions of the study are:
i.
To what extenthaveshort
term debt, long term debt and equityimpactedon Earnings per Share of quoted
companies in Nigeria?
ii.
To what extent have short
term debt, long term debt and equity impactedon Dividend per Share of quoted companies in Nigeria?
iii.
In what way have short term debt, long term
debt and equity affected Net Asset per Share of quoted companies in Nigeria?
1.5 RESEARCH HYPOTHESES
The hypotheses are stated in the null
form. They are as follows:
Ho1: Short term debt, Long term debt and Equity have
no significant effect on Earnings per share of quoted companies in Nigeria.
Ho2: Short term debt, Long term debt and Equity have
no significant effect on Dividend per Share of quoted companies in Nigeria.
Ho3: Short term debt, Long term debt and Equity do
not have significant effect on Net Asset per Share of quoted companies in
Nigeria.
1.6. SIGNIFICANCE OF THE STUDY
The
researcher hopes that the findings from the study shall be useful to the business
community since it will throw more light on the role that capital structure
play in determining financial performance. The study will also enlighten
scholars on the importance of the capital structure to any business and will
highlight areas for further research. Scholars will have a better understanding
by getting familiarized with this trend amongst firms. It will also add value
to the academic field by complementing other researches that have been done on
capital structure in Nigeria. Scholars will use the knowledge derived from this
study as foundations to build research work upon and to make empirical findings
in their different academic areas of specialization. It will also be of
importance to company Chief Executive Officers, investors and policy makers as
it will help them to make informed choice regarding their financing decision.
The result will equally be informative to Nigerian investing public, as
findings will serve as guide for better investment decisions.
1.7 SCOPE OF THE STUDY
This
research covered thirty-six (36) quoted companies in Nigeria cutting across all
the sectors on the Nigerian Stock Exchange. To this end, eleven (11) years data
was collected to analyze the financial performance of the companies. The reason
for choosing this time horizon is to reduce estimation bias associated with
short term measurement instability.
1.8 LIMITATION OF THE STUDY
In
a developing country like Nigeria, researchers are usually faced with enormous
problems, especially during collection of data. As a result, conclusion drawn
from this research may somewhat be limited in its applicability and correctness
and thoroughness. Maximum care and conscious effort was made to minimize
errors.
Another
problem faced by the researcher was the insecurity of some materials on the
internet. Efforts were thus geared to obtaining required resources from trusted
sites and getting printed copies of the financial reports from the individual
companies.
1.9 OPERATIONAL DEFINITION OF TERMS
1.
Capital structure: Capital structure
is the arrangement of the debt and equity structure of any company. It can also
be referred to as the way a corporation finances its assets through some
combination of equity, debt or hybrid securities; that is the combination of
both equity and debt
2.
Short term debt: Short term debt is
made up of any debt incurred by a company that is due within one year. Itis
usually made up of overdraft, short-term bank loans, among other types.
3.
Long term debt: Long term debt
consists of any debt incurred by a company payable after a period exceeding 12
months from the date of the balance sheet. Examples are: bank loan, mortgage
bonds, debenture, or other obligations not due within one year.
4.
Equity: Equity is the value of
shares issued by a company. It could also be referred to as ownership interest
or claim of a holder of ordinary shares and preference shares of a company.
5.
Debt to equity ratio: It is a
financial, liquidity ratio used to measure a company’s financial leverage, it
measures the riskiness of a company’s financial structure and it indicates how much debt a company
is using to finance its assets relative to the amount
of value represented in shareholders’ equity. It is calculated by dividing a company’s Total Liability by its
Shareholders’ Equity.
6.
Debt to asset ratio: It is a leverage
ratio that defines the total amount of debt relative
to assets. It indicates the percentage of a company’s assets that are provided through debt. It is calculated by
dividing Total Liabilities by Total Assets.
7.
Debt to capital ratio: This ratio
measures a company’s capital structure, financial solvency and degree of
leverage at a point in time. It is the ratio of a firm’s total debt to its
total capital. Companies alter their debt capital ratio by issuing more shares,
buying back shares, issuing additional debt, or retiring debt.
8.
Financial leverage: It refers to the
degree to which a company uses fixed-income securities
such as debt and preferred equity to acquire additional assets. Financial leverage is also known as trading on equity.
9.
Financial performance:Financial
performance is a subjective measure of how well a firm can use assets from its
primary mode of business to generate revenues.
10.
Earnings per share:Earnings per
share (EPS) is derived bydividing the total earnings less preference dividend
by the number of ordinary shares in issue as at balance sheet date.
11.
Dividend per share: Dividends per
share (DPS) is the amount of dividends that the shareholders receive on a
per-share basis. It is calculated as the ratioof total dividends paid out to
the number of ordinary shares in issue.
12.
Net assets per share: Net asset per
share is a company's total assets minus its total liabilities, divided by its
number of ordinary shares in issue.
13.Return on equity: This term measures
the rate of return on the ownership interest (shareholders’ equity) of the
common stock owners. Its measures a firm’s efficiency at generating profits
from every units of shareholders’ equity (known as net assets - liabilities).
ROE shows how well a company uses investment funds to generate earnings growth.
14.
Return on asset: This measures shows
how profitable a company’s asset are in generating
revenue. Return on asset gives an indication of the capital intensity of the company, which will depend on the industry;
Companies that require large initial investment
will generally have lower return on assets.
15.
Inventories: Inventories are stocks
of raw materials, works in-progress and finished goods of a company engaged in manufacturing operations.
16.Agency cost theory: It is an economic
concept concerning the cost to a “principal’ (an
organization person or a group of persons), when the principal chooses or hires
an agent to act on his behalf. Example of this cost is the shareholders in
which the management can be a part of this cost.
17.Trade-off
theory: The trade-off theory refers to the idea that a company chooses how
much debt finance and how much equity finance to use by balancing the costs and
benefits. Trade-off theory allows the bankruptcy cost to exist. It states that
there is an advantage to financing with debt (namely, the tax benefit) and that
there is a cost of financing with debt (the bankruptcy costs and the financial
distress costs of debt).
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