IMPACT OF CAPITAL STRUCTURE ON FINANCIAL PERFORMANCE OF QUOTED INSURANCE FIRMS IN NIGERIA

This study examines the effect of capital structure on the financial performance of listed insurance firms in Nigerian Stock Exchange for the period of 2013-2017. Secondary data were collected and extracted from the financial reports of the 28 listed insurance firms in Nigeria for the data analysis. Data were analyze using regression analysis the results show a significant effect of capital structure on financial performance. The debt-equity ratio of the firm appears a more important factor that determines the financial performance of listed insurance firms in Nigerian Stock Exchange. The result shows that debt-equity ratio had a significant positive effect on return on equity while debt ratio found significant but negative effect on return on equity. The study recommended that top management of every insurance firm should make prudent financing decision in order to remain profitable and competitive.

Content                                                                                                           Page No.

Title page..................................................................................................................i

Declaration...............................................................................................................ii

Certification...............................................................................................................iii

Approval.................................................................................................................. iv

Dedication................................................................................................................v

Acknowledgement....................................................................................................vi

Table of contents......................................................................................................vii

List of tables.............................................................................................................xi

List of abbreviation...................................................................................................xii

Abstract....................................................................................................................xiii

1.1 Background of the Study....................................................................................1

1.2 Statement of the Research Problem.....................................................................2

1.3 Research Objective..............................................................................................3

1.4 Research Hypothesis............................................................................................3

1.5 Justification of the Study......................................................................................3

1.6 Scope and Limitation of the Study.......................................................................4

2.0 Introduction.........................................................................................................5

2.1 The Concept of Capital Structure........................................................................5

2.1.1 Financial Performance.............................................................................6

2.1.2 Relationship between Capital Structure and Financial Performance......7

2.1.3 Insurance Industry in Nigeria..................................................................8

2.1.4 Determinants of Financial Performance in Insurance Firms..................10

2.1.5 Debt Financing........................................................................................11 

2.1.6 Debt and Risk..........................................................................................12

2.1.7 Debt and Dividends.................................................................................13

2.1.8 Debt and Share Value...............................................................................14

2.1.9 Debt and Interest rates...............................................................................14

2.1.10 Factors Influencing Debt Financing........................................................14

2.1.11 Advantages of Debt Financing................................................................15

2.1.12 Disadvantages of Debt Financing.............................................................16

2.1.13 Factors affecting firm’s choice of capital structure..................................16

2.2 Theoretical Framework...........................................................................................18

2.2.1 Modigliani and Miller theory......................................................................18

2.2.2 The Pecking order theory.............................................................................20

2.2.3 Trade off Theory...........................................................................................21

2.3 Empirical Review.....................................................................................................23

2.4 Summary of Literature Review................................................................................32

3.1 Introduction.............................................................................................................33

3.2 Research Design.......................................................................................................33

3.3 Population of the Study............................................................................................33

3.4 Sources and Methods of Data Collection..................................................................34

3.5 Techniques of Data Analysis.....................................................................................34

3.6 Measurement of Variables Instrument......................................................................34

3.6.1 Indebtedness....................................................................................................35 

3.6.2 Firm Performance.............................................................................................35

4.1 Introduction..............................................................................................................36

4.2 Descriptive Statistics................................................................................................36

4.2.1 Debt Ratio.........................................................................................................36

4.2.2 Debt-Equity Ratio.............................................................................................37

4.2.3 Return on Equity..............................................................................................39

4.3 Diagnostic Test..........................................................................................................40

4.3.1 Test for Normality..............................................................................................40

4.3.2 Multicollinearity Test.........................................................................................41

4.3.3 Heteroscedasticity Test.......................................................................................41

4.4 Regression Model.......................................................................................................42

4.5 Results and Discussions............................................................................................43

5.1 Summary...................................................................................................................44

5.2 Conclusion................................................................................................................44

5.3 Recommendation......................................................................................................45

REFERENCE...............................................................................................................47

APPENDICES...............................................................................................................51

Table 2.1 Listed Insurance Firms......................................................................................9

Table 4.1 Debt Ratio.........................................................................................................36

Table 4.2 Debt-Equity Ratio.............................................................................................37

Table 4.3 Return on Equity...............................................................................................39

Table 4.4 Shapiro Wilk test...............................................................................................40

 Table 4.5 Multicollinearity Test.......................................................................................41

Table 4.6 Breusch-Pagan / Cook-Weisberg test................................................................42

Table 4.7 Regression Result...............................................................................................42

Introduction insurance company, performance is normally expressed in net premiums earned, profitability from underwriting activities, annual turnover, returns on investment and return on equity. These measures can be classified as profit performance measures and investment performance measures. The relationship between capital structure and profitability has been the subject of remarkable milestone over the past decade. Profit does not only improve upon insurers’ solvency state but it also plays an essential role in persuading policyholders and shareholders to supply funds to insurance firms In real world profitability for any business attached with the firm business performance. Profitability is seen asproxy of financial performance, which is one of the main objectives of company’s management (Burca&Batrinca, 2014). It is a crucial prerequisite for an increasing competitiveness of a company that operates in a market. To optimize economic results, a special attention should be given to the proper grounding of managerial decisions (Malik 2011). Profitability of insurance companies canbe analyzed through micro and macroeconomic level, being determined both by internal factors represented by specific characteristics of the company which is totally under the hand of the corporate management system, and external factors regarding connected industry and macroeconomicenvironment in general which also not under the hand of the corporate management but identifying and knowing its directions and magnitude was helps to develop the strategy to get the opportunity or to minimize the treat (Kripa &Ajasllari, 2016).Increasing profitability involves determining which areas of operation and a financial strategy are working and which improvement understanding the key factors and its magnitude determining profitability assists managers in developing an effective profitability strategy for their company. Malik (2011) insurers’ profitability is determined first by underwriting performance (losses and expenses, which are affected by product pricing, risk selection, claims management, and marketing andadministrative expenses) and second, by investment performance,Capital structure decision for any business organization in private and public sectors as well as economy played a prominent role. It is regularly complex for business firms to make out the right combination of debt and equity. Modern-day corporate finance managers of insurance firms in Nigeria continue to face the dual challenge of poor financial performance of their firms and finding optimum business financing options. These managers also have to tackle with the triple demands of creating wealth for investors, sustaining business operations and contributing to the growth of an economy.

However, it is important to note that, in Nigeria, various legislation have been put in place to ensure that the industry runs smoothly but these legislations have ended up constraining the insurance firms in issues relating to capital, for example a minimum paid up capital is required for the insurance firms before register a company. Then also constrain in share capital to be deposited with the central bank. These issues are very specific to insurance firms only, and they have an influence on the capital structure of the firms thus having an impact on the overall performance of these firms. This study is likely to give a practical contribution were the finding will be used by the insurance firms policy-makers in Nigeria to identify the appropriate financing mix that can go well with and overcome the constrains by examining how the capital structure affect the financial performance of insurance firms. Theoretically, the finding is also expected to contribute to validate the theories under consideration in this study.

Capital structure, according to various researchers has been a study of significance in the corporate finance field for a number of decades. Financial managers have complexity in determining the optimal or favourable capital structure. The Nigerian insurance firms have had a number of constraints in regard to how their capital ought to be structured. This is due to the legislation on minimum of paid up capital requirement and share deposit with the Nigerian central bank. These legislations have an influence in deciding what the capital structure should look like. However, other studies present different opinion about what type of fund and the optimum capital structure that will improve a firm performance. Vincent (2013) and Mahfuzah and Raj (2011), and Abdul (2012) considered debt financing as a more appropriate form of financing the business of high risk firms because of the advantage of tax shield available on interest payment, in contrary Athenia and Bongani (2015) sees equity financing as more appropriate means of financing high risk firms with a lower success probability and higher cash flow. Other researchers such as Mohammed (2013) and Serrasqueiro and Marcia, (2015), see the use of both debt and equity as a more appropriate means of financing a firm's operation.The government and the private sector have invested heavily in creating an enabling environment for doing business in Nigeria and, indeed, some companies have performed exceedingly well as a result(Raji & Abdurrahman, 2017) . Likewise, several companies, however, are experiencing declining performance and some have even been delisted from the Nigeria stock exchange(NSE) in the last decade(Raji & Abdurrahman, 2017).

Momentous efforts to revive the ailing and liquidating companies have focused onfinancial restructuring. However managers and practitioners still lack adequate guidancefor attaining optimal financing decisions (Kibet, Kibet, Tenai&Mutwo, 2011) yet manyof the problems experienced by the companies put under statutory management werelargely attributed to financing (Chebii, Kipchumba and Wasike ‚2011). This situation hasled to loss of investors' wealth and confidence in the stock market. Studies on therelationship between various financing decisions and performance have produced mixed results. It is against this background that this study is carried out to fill in this gap by investigating capital structure on firm'sperformance with specific reference to listed Insurance companies in Nigeria stock exchange.

The research questions to be answered by the study are:

To what extent does short term debt affect the financial performance of InsuranceCompanies in Nigeria?Based on these challenging views and the resulting conspicuous gap in empirical research on capital structure of insurance firms in Nigeria and the appropriate financing mix of firm’s operations, corporate managers are faced with a problem of which way of finance and at what point in terms of enormity will bring about the proficient performance of a firm and it has been observed that studies in this area OF CAPITAL STRUCTURE ON FINANCIAL PERFORMANCE OF INSURANCE COMPANY IN NIGERIA.BYSUNUSI SHUAIBUFUKD/HMSS/16/ACC/0047

The main objective of the study is to investigate the effect of capital structure of the financial performance in the insurance companies in Nigeria. Based on the above general objective, the study has the following specific objectives: 

i. To examine the effect of short term debt on the financial performance of Insurance Companies in Nigeria.

ii. To evaluate the effect of long term debt on the financial performance of Insurance Companies in Nigeria 

iii. To assess the effect of total debt on the financial performance of Insurance Companies in Nigeria.

In line with the objectives of the study, five null hypotheses are to be tested 

Hol: Short term debt has no significant effect on their financial performance of Insurance Companies in Nigeria.

Ho2: Long term debt has no significant effect on their financial performance of Insurance Companies in Nigeria.

Ho3: Total debt has no significant effect on their financial performance of InsuranceCompanies in Nigeria.

The study will be useful to academics, regulators and industry players by giving a multidimensional view to financial performance, informing policy and enhancing generalinsurance practice. It will enrich the theory of financial performance by providing insights on the underlying capital structure once evaluated by an industry in application. It will further inform regulatory policy for the insurance industry as it will provide the regulator with tools to appraise a firm's stability that is critical in the risk based supervisory framework. The study will provide input to policy formulation on performance when drafting the framework for consolidated regulation. Finally, it will assist the practice of general insurance by identifying best practice with respect to performance capital structure for adoption. The government for instance can use the research findings or conclusions, to better the reporting, performance and regulation of the insurance industry thus reequip the industry to undertake the emerging risks.The findings can help managers make more accurate reserving and reinsurance decisions that could directly benefit future financial performance. Finally, the study will contribute to the knowledge on capital structure components that affect the performance of insurance industry.

The study would be limited to capital structure components affecting insurance companies registered by NAICOM. The study would be limited to three components of capital structure which are short term debt, long term debt and total debt. The study will cover the period of 2012-2016.