ABSTRACT
This study analyzed the impact of corporate diversification and financial structure on the performance of Commercial Banks in Nigeria. A sample of ten (10) Commercial Banks ranking most based on their asset base was selected through judgmental sampling technique and the relevant secondary data was obtained from the annual reports of the selected Commercial Banks in Nigeria over a twenty-year period (2001-2020). The data obtained were analyzed using panel data analysis on Eviews 9. The findings of this study show that service diversification, geographical diversification and financial structure positively affect the performance of Commercial Banks in Nigeria. This study recommends that bank management should ensure that the modifications arising from environmental forces and the need to remain relevant to their stakeholders do not pressurize them into expanding their financial services into areas where it faces a high degree of competition or lacks prior lending experience as this can lead to a fall in bank returns.
TABLE
OF CONTENTS
Title
Page ii
Declaration
iii
Certification
iv
Dedication
v
Acknowledgments
vi
Table of
Contents ` vii
List of
Tables viii
Abstract
ix
CHAPTER 1: INTRODUCTION 1
1.1 Background
to the Study 1
1.2 Statement
of Problem 6
1.3 Objectives
of the Study 8
1.4 Research
Questions 8
1.5 Research
Hypotheses 9
1.6 Significance of the Study 9
1.7 Scope of the Study 10
1.8 Limitations of the Study 10
CHAPTER 2: LITERATURE REVIEW 11
2.1 Conceptual
Review 11
2.1.1
Corporate diversification 11
2.1.2 Benefits of diversification 12
2.1.3 Disadvantages of diversification 14
2.1.4 Types
of Diversification 15
2.1.5
Financial structure 17
2.1.6 Factors
to be considered when designing the financial structure of a firm 19
2.1.7 Firm's performance 20
2.1.8 Conceptual framework of hypotheses and
independent variables 23
2.2 Theoretical
Framework 23
2.2.1 Modern portfolio theory 24
2.2.2 Resource
Based View (RBV) 25
2.2.3 Signalling theory 26
2.3 Empirical
Review of related Literature 27
2.3.1 Summary
of Literature 39
2.3.2 Research
Gap 59
CHAPTER 3: METHODOLOGY 60
3.1 Research
Design 60
3.2 Type and Method of Data Collection 60
3.3 Population of Study 60
3.4 Sampling
Technique 61
3.5 Method of Data analysis 61
3.6 Model Specification 61
3.7 Description of Research Variables 62
3.7.1 Dependent variable 62
3.7.2 Independent variables 63
CHAPTER 4:
DATA PRESENTATION, ANALYSIS AND INTERPRETATION OF RESULT 65
4.1 Data
Presentation 65
4.2 Analysis
of Data 73
4.3 Test of Hypotheses 75
4.4 Discussion
on Findings 77
CHAPTER 5: SUMMARY
OF FINDINGS, CONCLUSION AND RECOMMENDATIONS 78
5.1
Summary of Findings 78
5.2 Conclusion 78
5.3 Recommendations 79
5.4 Suggestions for
Further Studies 79
5.5 Contributions to Knowledge 80
References 81
Appendix 93
LIST OF TABLES
2.1: Summary of Empirical review 42
4.1: Selected
corporate diversification, financial structure and performance variables 65
4.2: Extracted
probability from Hausman Test 74
4.3 Output for analyzed data using dependent variable ROA 74
CHAPTER
1
INTRODUCTION
1.1
BACKGROUND OF THE STUDY
Changes arising from
environmental forces coupled with the necessity for firms to survive in today’s
fiercely competitive market are causing many firms to have a rethink on how to
be more efficient and productive so as to retain their investors in future
times. These influences pose serious tasks as well as new opportunities for the
growth and development of firms (Ojo, 2011).
As profit-oriented
organizations that seek to minimize costs and maximize returns in every venture
undertaken, commercial banks are adopting various strategies to respond to
these forces in order to be sustained in their business. They render financial
services with the aim of making profit, offer services that encompass a broad
range of monetary transactions required to obtain a financial good (something
tangible that lasts, whether for a long or short time). Such transactions
include real estate, consumer finance, banking, insurance, investment funding,
issuing securities, asset management inter alia (Irena, 2020).
In every geographical
location where economic activities takes place, commercial banks are always
present and can be seen in both or either local, national, regional and
international financial centers. Being among the major financial services
providers in any economy, commercial banks play important roles in the progress
of the said economy. They carry out financial intermediation function that the
problem associated with direct financing such as transaction costs, information
asymmetry and counter party risk are being taken care of.
Theoretically, the
financial goal of any firm is to maximize owner's economic welfare; a properly
defined and clearly stated objective is the moving force that moves the firm to
the desired position in the nearest future. Other objectives of a firm include
growth, expansion, survival, market leadership, benefit maximization and
shareholders wealth maximization (Ihemeje, 2014).
In order to achieve the aforementioned
objectives, commercial banks have to enlarge their coast - expanding their
business operations beyond their usual horizon i.e. from rendering core banking
services the normal way to better and more efficient ways. Business operations
by nature are risky ventures as a positive correlation exists amidst risk and
expected return. As commercial banks expand their business operations; they are
also being exposed to more risk.
Risk can be said to be
the unpredictability associated with future returns from an investment. Risk
and uncertainty are often used interchangeably, yet they do not mean the same
thing. Strictly, implies a scenario in which the future outcome is unknown, but
the likelihood of various possible future outcomes may be assessed with some
degree of confidence, probably based on knowledge of past or existing events.
In other words, probabilities of possible outcome can be estimated. Uncertainty
on its own connotes a condition where the future outcome cannot be predicted
with any degree of confidence from knowledge of past or existing events. Hence
with uncertainty, no probability estimates are available (Osuala, 2009). Risk
is also the probability of loss inherent in an organization's operations and
environment such as competition and adverse economic conditions (Orina, 2011).
According to Gupta (2011), having
a single investment is a risky decision; as such, it is important to
diversify investment portfolio. Scattering investments among numerous, dissimilar
investments reduce the risk of a sudden, unexpected outcome. In a diversified
portfolio, a loss (risk) in one investment is offset by gains from another
investment. Portfolio theory has it that risk cannot
be totally eliminated; rather it can be reduced to the barest minimum. One of
the ways of reducing risk in the operation of a firm is through
diversification.
Diversification is an
investment strategy that aims at reducing risk while maximizing returns. It
does this by disseminating vulnerability of a portfolio to diverse asset
classes and within each asset class. The thinking is that; if one sector or one
holding goes down, the whole portfolio will not sink and may even experience gain
elsewhere (Javier, 2020). The primary
reason for diversification is hinged on minimizing the variability of portfolio
returns without jeopardizing the expected rate of return (Osuala, 2009).
Increasing
profitability, market share, debt capacity, growth opportunity, risk reduction,
and the need to use human and financial resources efficiently are also some of
the aims of corporate diversification (Afza, Talat, Choudhary, and Mian, 2008).
Sanjay, (2019) gives
some reasons for diversification to be for growth in business operations, to
ensure maximum utilization of the existing resources and capabilities and also
to escape from unattractive industry environments
Corporate diversification
is among the fundamental strategic alternatives available to organizations to
sustain growth and search for higher profits (Nwakoby and Ihediwa, 2018). Li and Greenwood
(2004) opined that companies whose products are threatened by environmental
uncertainty or by declining phase of their life cycle curve will prefer to
engage in diversification to overcome the risk arising from current industries.
Furthermore, firms may engage in expanding its product line and activities to
different sectors where environmental uncertainty is reduced and, profitability
is higher, such that a company may confirm its survival which will make its
cash flow more reliable.
According to Phung and
Mishra (2016), changes in economic or industrial conditions can force management
to diversify their business.
Managers tend to diversify their business
to get more benefits from the current market with minimum risk. Globalization offers
firms the privilege to enlarge their trade beyond the usual boundary for profit
maximization. Thus, corporate diversification strategy becomes important for
the expansion and growth of firms in competitive and dynamic environments. The aim
for corporate diversification is increased profitability, market share, debt
capacity, growth opportunity, risk reduction, and the need to use human and
financial resources efficiently (Afza, et al., 2008). Diversification
also helps firms to explore different markets (Gomes and Livdan 2004).
With regard to the
overall influence of diversification on commercial bank performance, Boyd and
Prescott (1986) recommended that the optimal efficiency of a commercial bank is
one where it is well diversified as possible. Acharya, Hasan, and Saunders
(2004) suggested that there seems to be diseconomies of diversification for any
commercial bank that expands into industries where it faces a high amount of competition
or lacks prior lending experience. These diseconomies arise in the form of a
worsening of the credit quality of loan portfolios simultaneously with a fall
in returns (perhaps due to worse monitoring, adverse selection, higher
overheads, or some combination of these factors).
However, according to
Bernstein (1996), diversification is mainly vital for a commercial bank given
its nature as a financial intermediary. In like manner, its efficiency is
measured by how well the said commercial bank achieves an optimal risk
trade-off (the most desirable return with an increase in risk) in the mix of
its business activities. When the most desirable returns
are achieved in banking, such returns provide important sources of equity
especially if reinvested into the business (Flamini, McDonald and Schumacher,
2009).
As one of the imperative
topics in finance literature, diversification is crucial
for commercial bank as financial institution; when commercial banks diversify
their credit portfolio, it increases their performance and reduces the credit
portfolio risk (Turkmen and Yigit, 2012).
Whenever commercial banks opt
in for diversification, extra capital becomes a
necessity (Afza, et al., 2008). According to Lewellen (1971), having in
mind that a good
financial structure will maximize shareholders
value, firms that are diversified require more debt
financing than firms that are not diversified. Thus, financial
structure is a vital factor that affects the firms' financial performance. Financial
structure is how a company finances its assets and operations. It is the
amalgam of debt and equities used in financing a firm’s assets and
manage its day-to-day operations. Every firm is free to choose its own
structure; both private and public firms have access to more or less the same
type of sources of funds except for equity. However, a firm must not live with
just any haphazard blend of debt and equity.
The kind of financial composition that one deploys
affects the WACC (Weighted average cost of capital) of that company. It, in
turn, has a direct attitude on the valuation of that firm. A firm should strive
for an optimal structure if it wants to maximize its value.
A firm that depends more on the debt could have an
increased return on investment. However, having a financial
structure with more debt could prove risky if a company is unable to honor its
obligation. A financial structure with more debt can be undertaken by a firm
that is either oligopoly or monopoly as one can easily predict its sales and
cash flows. Contrariwise, it will be difficult for a
firm operating in an extremely competitive industry
to support such a financial mix. It is because the competition could result in
volatile returns and cash
flows. And, this, in turn, could result in the firm missing its debt
obligations. The way out for such a firm is to move towards a structure that
has more equity and less debt (Sanjay, 2021).
Since a firm's business activities and growth
depend largely on its financial structure, firms need to make their investment
decisions with great care as this demands the estimation of the worth of
certain projects based on timing, size, and estimation of the future cash flow of
the (Mehmood, Hunjra and Chani, 2019). As one of the major finance
firms in Nigeria, the survival of commercial banks especially; in an era where
one banking firm takes over or merges with another has become so challenging.
Looking at the complex, globalized, and challenging business environment around
the globe today, there is a great need for the survival and better financial
performance of commercial banks in Nigeria. To foster the survival and better performance
of commercial banks, corporate diversification and financial structure are some
of the important factors to be considered (Mehmood, et
al., 2019). Therefore, this study seeks to determine
the impact of corporate diversification and financial structure on the
performance of commercial banks in Nigeria.
1.2
STATEMENT OF THE PROBLEM
Over the years, one of the central themes
for research studies in finance has been corporate diversification. Factors
like saturated domestic
markets and a
quest to secure bigger
market shares globally has spurred diversification; hence
making it to become an important business growth strategy (Denis and Yost,
2002; Lee, 2013). Large number of firms across
the globe engage in
diversification through mergers,
acquisitions, development of new
product lines or
opening of new
businesses across international
borders (Martin and Sayrak,
2003).
According to Lewellen (1971), diversified
firms need more debt financing than non-diversified firms as the effective
financial structure maximizes the value for shareholders. Firms
have choices to raise their capital by various means including internally
generated fund, new equity issue or various types of debt. The decision to
select sources of finance is referred to as financing decision. Financing
decision is a very critical decision with great implications for the firm's
performance. Theories proposed by the researchers to explain the financing
decisions have always been subject of considerable debate.
In opposition to other studies, Amjed
(2011), revealed a significant negative relationship amid firm performance and
long term debt and also a significant positive relationship between profitability
and short term debt. Karimi and Kheiri (2017), opined that financial structure
statistically has no significant effect on company’s value. Ng’ang'a (2013)
revealed a negative relationship between financial structure and firm
performance. Abdallah (2014) found a clear-cut influence of financial structure
on company’s value.
Previous studies on diversification and
firm performance have shown contradictory results. In developed countries; for
instance, a positive relationship was found to exist among corporate
diversification and firm performance (Kim, Hoskisson, and Lee, 2014;
Montgomery, 1994; Park and Jang, 2013). The findings of these studies support
market views, resource-based views, internal market efficiencies, and
internationalization theories (Ali, Hashim and Mehmood, 2016). Several
researchers noted a negative correlation among corporate diversification and
firm performance (Berger and Ofek, 1995; Lang and Stulz, 1994; Lu and Beamish,
2004; Kim and Mathur, 2008; Meyer, Milgrom and Roberts, 1992; Wan and
Hoskisson, 2003).
It is worthy to note that majority of the
studies carried out on corporate diversification are focused on the U.S. and
European markets; few studies have also been done on Asian markets. In emerging
markets such as India, Hong Kong,
Indonesia, Malaysia and
South Korea the
few studies that have
been undertaken have
yielded the same puzzling results as
those in developed countries
(Lins and Servaes, 2002).
However, there is not much research on corporate
diversification in frontier markets like Nigeria. Taking cognizance of the
complex, globalized and challenging world we live in, there's a great demand
for the survival, continuity and better operation of Commercial Banks. In this
wise, this study seeks to determine what impact corporate diversification and
financial structure have on the performance of Commercial Banks in Nigeria.
1.3
OBJECTIVES OF THE STUDY
The broad objective of this study is to ascertain
the impact of corporate diversification and financial structure on the performance
of Commercial Banks in Nigeria.
The specific objectives are to;
- Evaluate
how service diversification affects the Return on assets of Commercial
Banks in Nigeria.
- Investigate
the effect of geographic diversification on the Return on assets of
Commercial Banks in Nigeria.
3. Assess
the influence of financial structure on the Return on assets of Commercial
Banks in Nigeria.
1.4
RESEARCH
QUESTIONS
1. How
does service diversification affect the Return on assets of Commercial Banks in
Nigeria?
2. What
impact does geographic diversification have on the Return on assets of
Commercial Banks in Nigeria?
3. In
what way does financial structure affect the Return on assets of Commercial
Banks in Nigeria?
1.5
RESEARCH HYPOTHESES
HO1:
Service diversification does not have a statistical
significant effect on the Return on asset of Commercial Banks in Nigeria.
HO2: Geographic diversification does not significantly
influence the Return on assets of Commercial Banks in Nigeria.
HO3:
Financial structure has a significant
impact on the Return on assets of Commercial Banks in Nigeria.
1.6
SIGNIFICANCE OF THE STUDY
The importance of this
study is to offer experimental information on the impact of corporate
diversification and financial structure on the performance of Commercial Banks in
Nigeria. This study will also be of immense value to firms,
investors/shareholders, government, academicians and other relevant stake
holders.
Firms in emerging markets
engaging or intending to engage in corporate diversification will gain more
knowledge on the influence of diversification on their institution. It will
also aid them to ascertain if the current diversification mechanism they
adopted is beneficial or detrimental to the well-being of their institution. Furthermore,
it will aid firms in choosing the appropriate mix of liabilities and equities
in their financial structure in order to ensure that shareholders receive
higher returns on their investments at a reduced rate of risk.
Investors/shareholders through this study
will have a better knowledge of the monetary health of the firms they intend to
invest their hard earned money in as a firm’s performance indicates whether the
company is worth investing or not.
Government through this
study will have more information about the operations of the firms in their jurisdiction;
it will enable them make policies that can foster the efficient operations of
firms which in turn will facilitate economic development through provision of
employment, payment of corporate tax and provision of basic amenities for its
citizens.
Academicians will find
this study to be a positive contribution to existing knowledge on corporate
finance and financial structure. It will also aid future researchers on
corporate diversification and financial structure. This study will also serve
as a basis upon which further research can be built on.
1.7
SCOPE OF THE STUDY
This
research work is undertaken to determine the impact of corporate
diversification and financial structure on the performance of Commercial Banks in
Nigeria over a twenty year period (2001 - 2020). This timeframe was selected
for easy accessibility of relevant data.
1.8 LIMITATIONS OF THE STUDY
This study is limited by sample
size. The sample size comprises of ten Commercial Banks selected out of the twenty
Commercial Banks in Nigeria.
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