ABSTRACT
The broad objective of this research is to evaluate the impact of capital structure on profitability of commercial banks in Nigeria, 2008-2017. The specific objectives are to: evaluate the impact of shareholders’ fund on profitability of commercial banks in Nigeria, evaluate the impact of total asset on profitability of commercial banks in Nigeria. Investigate the impact of financial leverage on profitability of commercial banks in Nigeria. Ex-post-facto research design was adopted. The traditional panel least square regression (PLSR) was used in the model. The study applied panel data models on annual data of the commercial banks within the scope. In order to circumvent endogeneity problems, panel estimation techniques of fixed and random effects was adopted in this study, Panel data estimation allows for the control of individual-specific effects usually unobservable which may be correlated with other explanatory variables included in the specification of the relationship between dependent and explanatory variables using Haussmann test. Result from the Haussmann test statistics reveals that Shareholders’ fund had a negative and significant impact on profitability of commercial banks in Nigeria. Debt/total asset had a positive and significant impact on profitability of commercial banks in Nigeria. Financial leverage had a positive and significant impact on profitability of commercial banks in Nigeria. The study concluded that financial leverage and total assets were positively and significant in impacting profitability of commercial banks in Nigeria while shareholder fund was negative significant in impacting profitability of commercial banks in Nigeria. The study also recommended that commercial banks should imbibe trade off capital structure theory in financing its operations by either substituting gearing for shareholders’ fund or shareholders’ fund for gearing until an optimal and desired capital structure is arrived at.
TABLE OF CONTENTS
Title
Page i
Declaration ii
Certification iii
Dedication iv
Acknowledgements
v
Table
of Contents vi
List of
Tables x
List of
Figures xi
List of
Appendices xii
Abstract xiii
CHAPTER
1: INTRODUCTION
1.1
Background to the study 1
1.2
Statement of the problem 3
1.3
Objectives of the study 5
1.4
Research questions 5
1.5
Statement of hypotheses 5
1.6
Significance of the study 6
1.7
Scope of the study 7
1.8
Limitations of the study 7
CHAPTER
2: LITERATURE REVIEW
2
.1 Conceptual Review 8
2.1.1
Capital structure 8
2.1.2 Capital
Structure, Firm Value and Performance 10
2.1.3 Optimal
Capital Structure 11
2.1.4 Factors Determining Capital Structure 12
2.1.4.1
Determinants of Banks Capital Structures 12
2.1.4.2
Size 13
2.1.4.3
Growth Rate 13
2.1.4.4
Profitability 14
2.1.4.5
Dividend Payout 15
2.1.4.6
Business Risk 16
2.1.4.7
Tax Charge 16
2.1.4.8
Tangibility 17
2.1.5.1 Measurement of Capital Structure 18
2.1.6 Financial Ratios 20
2.1.6.1 Liquidity Ratios 21
2.1.6.2 Asset Management
Ratios 22
2.1.6.3 Leverage Ratios 25
2.1.6.4 Profitability
Ratios 25
2.1.6.5 Valuation Ratios 29
2.1.7 Capital Structure Ratios 31
2.1.7.1 Total Debt to Total Assets 32
2.1.7.2 Total Debt to Total Equity 33
2.1.7.3
Short Term Debt to Total Assets 34
2.1.7.4 Long Term Debt to Total Assets 35
2.1.7.5 Equity 36
2.1.8 Concept of Financial Performance 37
2.1.8.1 Capital Structure and financial performance 39
2.2
Theoretical Review of Literature 40
2.2.1
Modigliani and Miller Theory 40
2.2.2
Trade-Off Theory 41
2.2.3
Agency Cost Theory 41
2.2.4
Signaling Theory 43
2.2.5
Pecking Order Theory 43
2.2.6
Bankruptcy Cost Theory 44
2.3
Empirical Literature Review 45
2.3.1
Capital Structure and Firm Performance: A Negative Relationship 46
2.3.2
Positive Relationship between Capital Structure and Firm Performance 50
2.3.3
Capital Structure and Firm Performance: A Review of Mixed Findings 56
2.4
Summary of Reviewed Literature 60
2.5 Research Gaps 62
CHAPTER 3: METHODOLOGY
3.1
Research Design 64
3.2
Population of the Study 64
3.3 Sampling Technique 64
3.4
Sources of Data Collection 64
3.5 Model Specification 65
3.5.1 Pooled Panel
Regression Model 67
3.5.2
Fixed Panel Regression Model 67
3.5.3 Random Effect Model 67
3.6
Apriori Expectation 69
3.7 Data Estimation Technique 69
3.8 Description of Model Variables 70
3.8.1
Return on equity 71
3.8.2
Debt/Total asset 71
3.8.3
Shareholders’ fund 71
3.8.4
Financial leverage 72
3.8.1
Measure of Variables 72
CHAPTER 4:
DATA PRESENTATION AND INTERPRETATION
4.1 Data Presentation 73
4.2 Data Analysis 76
4.2.1
Tests of Unit root using Philip and Peron 76
4.2.2Tests
of autocorrelation using correlogram Q-statistics 77
4.2.3
Tests of autocorrelation using panel cross sectional heteroscedasticity
variance 78
4.2.4
Tests of autocorrelation using residual cross sectional Dependent 79
4.2.5
Tests of normality distribution of the cross sectional and idiosyncratic
identifiers 79
4.2.6
Tests of covariance distribution cross sectional and idiosyncratic identifiers 81
4.3
Test of Hypotheses 82
4.3.1
Correlated Random Effects - Hausman Test for Hypothesis 1 83
4.3.2 Correlated Random Effects - Hausman Test for
Hypothesis 2 85
4.3.3 Correlated Random Effects - Hausman Test for
Hypothesis 3 87
4.4
Discussion of Findings 88
CHAPTER 5: SUMMARY, CONCLUSION AND
RECOMMENDATIONS
5.1
Summary 93
5.2
Conclusion 93
5.3 Policy Recommendation 94
5.4
Contributions to Knowledge 95
5.5 Recommendation for Further
Studies 95
References 96
Appendices 100
LIST
OF TABLES
Table 2.4 Summary of Reviewed literature 60
Table 3.8.1 Measure of Variables 72
4.2.1
Tests of Unit root using Philip and Peron 77
4.2.2Tests
of autocorrelation using correlogram Q-statistics 78
4.2.3
Tests of autocorrelation using panel cross sectional heteroscedasticity
variance 79
4.2.4
Tests of autocorrelation using residual cross sectional Dependent 79
4.2.5
Tests of normality distribution of the cross sectional and idiosyncratic
identifiers 79
4.2.6
Tests of covariance distribution cross sectional and idiosyncratic identifiers 81
4.3.1
Correlated Random Effects - Hausman Test for Hypothesis 1 83
4.3.2 Correlated Random
Effects - Hausman Test for Hypothesis 2 85
4.3.3 Correlated Random
Effects - Hausman Test for Hypothesis 3 87
LIST OF FIGURES
Figure
4.1 Cross Sectional Level Using Categorical Variable 74
Figure 4.2 Plot of the Residual of the
Estimated Graph 75
Figure 4.3 Actual, Fitted and Residual Model 76
LIST
OF APPENDICES
Appendix1 Data Extracted from the Accounts of Selected
Commercial Banks in Nigeria 100
Appendix 2 Panel Unit Root Test of Return on Equity 103
Appendix 3 Panel Unit Root Test of Shareholders’ Fund 104
Appendix 4 Panel Unit Root Test of Debt/Total Asset 105
Appendix
5 Panel Unit
Root Test of Financial Leverage 106
Appendix 6 Tests of Autocorrelation Using
Correlogram Q-Statistics 107
Appendix 7 Tests of Autocorrelation Using Panel Cross Sectional
Heteroscedasticity
Variance 108
Appendix 8 Tests of
Autocorrelation Using Residual Cross Sectional Dependent 109
Appendix 9 Tests of normality
distribution of the cross sectional and idiosyncratic
Identifiers 110
Appendix 10 Table of Panel least
square showing ROE and SF in Nigeria 111
Appendix 11 Table of Panel least square showing ROE and D/TA in Nigeria 112
Appendix
12
Table of Panel least square showing ROE and LEV in Nigeria 113
CHAPTER 1
INTRODUCTION
1.1 BACKGROUND TO THE STUDY:
The best combination of
capital structure (optimal mix of debt and equity) is one of the most critical
financial decisions for any firm because of its impact on shareholders risk and
return. Such decisions are taken not only to maximize shareholders wealth, but
also to make certain the firm’s capacity to cope with the uncertain, volatile,
competitive and versatile environment of business. The singular most important
function of capital structure is that it aids in striking a balance between the
risks and returns in the operations of the firm if properly managed (Zeitun &Tian,
2007).
The asset of a company
can be financed either by increasing the owner claims or the creditor claims.
The owner claims increases when the firm raises funds by issuing ordinary
shares or by retaining the earnings; the creditors’ claims increase by
borrowing. The various means of financing represents the financial structure of
an enterprise. The left-hand side of the balance sheet (liabilities plus
equity) represents the financial structure of a company (Pandey, 2010).
The term capital
structure is used to represent the proportionate relationship between debt and
equity. Equity includes paid-up capital, share capital, share premium, reserves
and surplus (retained earnings), while debt includes public deposits, bonds or
debentures (Pandey, 2010).
The financing or capital
structure decision is a significant managerial decision. It influences the
shareholders’ return and risk. Conversely, the market value of the shares may
be affected by the capital structure decision of the firm.
To this effect, analysts
and policy makers have expressed diverse opinions as to which of the components
of capital structure available to commercial banks would enhance their profitability.
In literature, three differing views have been put forward by scholars of
corporate finance. First, a positive relationship between high equity-to-debt
ratio and firm’s profitability such that firms depend more on owners funds than
borrowed funds. The second is a relationship between high debt-to-equity ratio
and firm profitability such that firms rely heavily on borrowed funds
relatively to owners funds. The last scenario depicts a middle position between
owner’s funds and borrowed funds. The applicability of any given scenario at
any particular point in time however, depends largely on the cost of financing,
particularly of the borrowed funds. (Yakubu & Baba, Yaaba, 2013).
Financing decisions in
commercial banks are not very similar to other business firms due to the nature
of operations of these financial institutions. Although commercial banks are
able to raise finance using equity and debt, the fact that they mobilize
deposits which make up their short term liabilities and is a source of finance,
makes their capital structure unique as compared to other business firms
(Abdabi & Abu-Rub, 2012, Taani, 2013).
Performance is a
controversial issue in finance; this is as a result of its multi-dimensional
meanings. Many experts define financial performance in different ways. According
to Metcalf and Titard (1976), financial performance refers to the degree to
which financial objectives are being or has been accomplished or it is used as
a general measure of a firm’s overall financial health over a given period of
time, and can be used to compare similar firms across the same industry or to
compare industries or sectors in aggregation.
This research therefore
is carried out to investigate the impact of capital structure on profitability
of commercial banks in Nigeria.
1.2 STATEMENT OF THE PROBLEM
As mentioned earlier the
capital structure of commercial banks differ from that of firms and non-bank financial
institutions in the sense that commercial banks primary responsibility is the
acceptance of deposits, these deposits accepted become short term liabilities
of those banks and those deposits also make up part of the debt component of
the capital structure of commercial banks, which means that banks now use those
deposits as loans given to borrowers seeking for loan facilities from the bank;
this action accounts for the major reason why commercial banks’ capital
structure seems to be highly geared i.e (more of debt financing than equity).
In an event of repayment of loans default, or bad debt, how do commercial banks
cope in this scenario knowing fully well that these monies are depositors’
money and also form part of their capital structure?
Different studies have
attempted to examine the application of different capital structure theories in
banking sector and other financial institutions and their results are diverse. Many
researchers have written on the impact of capital structure on commercial
banks’ profitability, using different variables as proxies for commercial
bank’s profitability over time and arrived at different results and findings,
some researchers such as Adeslan and Nwidobie (2015) and Adeleke, Ashogbon,
Idode and Ogunlowore (2014) reported a positive relationship between capital
structure and commercial banks’ profitability in Nigeria, while some
researchers such as Opoku, Audu and Anarfi (2013) and Akeen, Terer, Kiyanjui
and Kayode (2014) reported negative
relationship, while some other researchers such as Olokoyo (2012) and Addae,
Nyarko-Baasi and Hughes (2013) reported mixed findings.
The banking sector reform
of 2006 (bank consolidation) changed the capital structure of commercial banks
in Nigeria; banks were required to increase their capital base to N25 billion
and as such, banks that could not meet up with the new capital base either had
to merge with other banks or got acquired by bigger banks which could afford
the new capital base, this reduced the numbers of commercial banks in Nigeria
to 21 till date. The problem this research seeks to solve is to investigate if
bank consolidation of 2006 with regard to capital structure has significant
impact on the profitability of commercial banks in Nigeria. Also, this research
is set out to compare past studies on this subject matter using various
variables and estimation techniques different from past work to investigate the
impact capital structure has on profitability of commercial banks in Nigeria and
see if there would be differences in findings elicited from past studies
compared to recent studies. With passage of time, new banking reforms have been
implemented such as the Basel III accord and new Central Bank of Nigeria
prudential guidelines which further affects the capital structure of commercial
banks in Nigeria and also widen the gap not filled by past works. This research
work aims to close the gaps left by others since this study was done in more
recent time in relation to past research works.
1.3 OBJECTIVES
OF THE STUDY
The broad objective of
this research is to evaluate the impact of capital structure on profitability
of commercial banks in Nigeria, 2008-2017. The specific objectives are to:
1. Evaluate the impact of shareholders’
fund on profitability of commercial banks in Nigeria.
2. Evaluate the impact of debt/total asset
on profitability of commercial banks in Nigeria.
3.
Investigate the impact of
financial leverage on profitability of commercial banks in Nigeria.
1.4
RESEARCH QUESTIONS
1. What is the extent of the impact of
shareholders’ fund on profitability of commercial banks in Nigeria?
2. How did debt/total asset impact on
profitability of commercial banks in Nigeria?
3. To what extent does financial leverage
impact on profitability of commercial banks in Nigeria?
1.5 HYPOTHESES
The hypotheses of this
study will be presented in null.
HO1: Shareholders’ fund has no
significant impact on the profitability of commercial banks in Nigeria.
HO2: Debt/total asset has no significant
impact on the profitability of commercial banks in Nigeria.
HO3: Financial leverage has significant
impact on the profitability of commercial banks in Nigeria.
1.6 SIGNIFICANCE OF THE STUDY
Although this work is an
academic research work, it will be useful and be of great importance to the
under listed groups:
Management:
This study would aid managers and finance
decision makers for firms, banks and other organizations in determining the
optimal capital structure to be employed in financing the operations of their
firms.
Bank
customers: This research will go a long way in
creating awareness to bank customers operating one account or the other with
the bank, enlightening them on the financial position and health of the bank
they are banking with.
Investors:
This work will provide investors and potential investors with adequate
information on the interplay of the component of capital structure and the
gearing position of the bank and how capital structure should be employed in
their organizations.
Body
of Academics: This study will serve as a guide for
further research on the impact of capital structure on commercial banks’
profitability in Nigeria and must have closed a gap which previous studies
could not cover.
1.7 SCOPE
OF THE STUDY
The impact
of capital structure on profitability of commercial banks in Nigeria is the
focal point of this research. This research work covered the period 2008-2017, a period of 10 years. The rationale for commencement of this
study in 2008 was as a result of banking reforms of the Central Bank of Nigeria
in 2006 (bank consolidation) which demanded commercial banks to update their
capital base to N25 billion, this culminated in banks merging with other banks,
while some acquired others so as to meet up the new capital base. Commercial
bank’s capital structure began to take shape from 2008; hence the reason why
this study started from 2008. The study
comprises of sample of 14 commercial banks between 2008 and 2017 as only banks
that were present on the Nigerian Stock Exchange (NSE) throughout the study period
and have available data for selection.
1.8 LIMITATIONS
OF THE STUDY
It is uncommon in a research study not have
certain factors that may militate against its accuracy. The major militating factor that would have challenged this study
is the short period of observation running from 2008-2017. However, this short period of study has been
remedied by the use of panel data. Despite these challenges, the
findings of this study remain valid and reliable.
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