ABSTRACT
The purpose of this study is to empirically analyze the impact of capital structure on firm’s performance in Nigeria; A sector by sector analysis. The annual financial statements of 15 firms listed on the Nigerian Stock Exchange from Four (4) sectors of the Nigerian economy were used for this study which covered the period between 1997-2012. Multiple regression analysis was applied on performance indicators such as Return on Asset (ROA) as well as Short-term debt to Total assets (STDTA), Long term debt to Total assets (LTDTA) and Total debt to Equity (TDE) as capital structure variables. The hypotheses were tested with ordinary least square regression estimation technique and analyzed. Generally, the results showed a negative and non-significant impact of capital structure on firm’s performance. The study therefore, concludes that statistically, capital structure is not a major determinant of firm performance. It recommends that managers of firms should exercise caution while choosing the amount of debt to use in their capital structure as it affects their performance negatively. That firms should try to finance their activities with retained earnings and use debt as a last option as this is consistent with the pecking order theory. Finally, the study strongly recommends that firms should use more of equity than debt in financing their business activities, this is because in spite of the fact that the value of a business can be enhanced with debt capital, it gets to a point that it becomes detrimental (negative) or unfavorable to the business.
SYNOPSIS
INTRODUCTION
Capital structure is one of the finance topics among the studies of researchers and scholars. It could be defined as the way a company finance itself by combining long-term debt, short-term debt, and equity. Capital structure shows how a company finances its overall operations and growth by using different sources of funds. Capital structure represents the major claims to firm’s assets. This includes the different types of both equities and liabilities. Capital structure of a firm is such a vital factor that it enhances its performance. A firm’s capital structure refers to the mix of its financial liabilities. That is the mix of equity to debt. It has been an important issue from the strategic management standpoint since it is linked with a firm’s ability to meet the demands of various stakeholders. Capital structure is the most significant discipline of company’s operations. Capital structure decision is a vital decision with great implication for the firm's sustainability. The ability of the organization to carry out their stakeholders need is closely related to the capital structure. The determination of a company’s capital structure is a difficult task to achieve. After over half a century of studies on this great topic, economists and financial experts have not reached an agreement on how and to which extent firms’ capital structure impacts on their performance. The actual impact of capital structure on firm performance in Nigeria has been a major problem among researchers that has not been resolved. There is still no conclusive empirical evidence in the literature about how capital structure impacts on firm performance in Nigeria. The aim of the study was to examine the impact of capital structure on firm performance in Nigeria. The specific objective were to: (i) examine the impact of short-term debt to total assets on firm Return on Asset (ROA), (ii) examine the impact of long-term debt to total assets on firm Return on Asset (ROA) , and (iii) examine the impact of total debt to equity on firm Return on Asset (ROA).
METHODOLOGY
This study adopted an ex-post facto design. The study used secondary data collected from the annual report of fifteen (15) firms listed on the Nigerian Stock Exchange which was extracted from four (4) sectors of the economy. The period covered ‘between’ 1997 - 2012. The sectors are: Consumer goods, Industrial goods, Healthcare and Conglomerates sector(s). Capital structure represents the ‘independent variable’ while firm’s performance represents the ‘dependent variable’. This implies that, performance of firms in Nigeria depends on their capital structure. Return on Asset (ROA) is used as the proxy for performance; while Short Term Debt to Total Assets (STDTA), Long Term Debt to Total Assets (LTDTA), and Total Debt to Equity (TDE) were used as proxy for capital structure. Three (3) hypotheses were formulated, tested and analyzed in this study with Ordinary Least Square (OLS) regression estimation technique/method of analysis on the dependent variable performance proxied by Return on Asset (ROA) and the independent variable capital structure proxied by Short Term Debt to Total Assets (STDTA), Long Term Debt to Total Assets (LTDTA), and Total Debt to Equity (TDE). Probability level of acceptance of p is when the p-value of the coefficient estimate is greater than 0.05.
RESULTS
On the consumer goods sector the objectives were properly captured and the results showed negative and non-significant impact of capital structure on firm Return on Asset (ROA). The coefficients of LTDTA, STDTA and TDE = (0.17), (0.30), (0.15), t-values = (0.12), (0.51), (0.31), r2 = 0.73, Adj r2 = 0. 64, p = 0.3 >0.05, F-statistic = 1.24, D.W= 1.10.
On the industrial goods sector the objectives were properly captured and the results showed positive and non-significant impact of capital structure on firm Return on Asset (ROA). The coefficients of LTDTA, STDTA and TDE respectively are 0.057, 0.072, (0.008), t-values = (0.72), (0.70), (1.77), r2 = 0.46, Adj r2 = 0.32, p = 0.52 >0.05, F-statistic = 3.42, D.W= 0.5.
On the healthcare sector the objectives were properly captured and the results showed negative and non-significant impact of capital structure on firm Return on Asset (ROA). The coefficient of LTDTA, and TDE = (0.21), (0.003), t-values = (2.12), (0.54); while STDTA has positive but non-significant impact on firm Return on Asset (ROA). The coefficient = 0.022, t-value = 0.23), r2 = 0.64, Adj r2 = 0.52, p = 0.23 >0.05, F-statistic =1.62, D.W= 1.3.
On the conglomerate sector the objectives were properly captured and the results showed negative and non-significant impact of capital structure on firm Return on Asset (ROA). The coefficient of LTDTA, STDTA and TDE = (0.75), (0.02), (0.003); t-values = (1.45), (0.15), (1.07), r2 = 0. 53, Adj r2 = 0. 44, F-statistic = 1.22, p = 0. 34 > 0.05, D. W = 1.1.
CHAPTER ONE
INTRODUCTION
1.1 Background to the Study
Capital structure is one of the finance topics among the studies of researchers and scholars. Its importance derives from the fact that capital structure is closely related to the ability of firms to fulfil the needs of various stakeholders. Capital structure represents the major claims to firm’s assets. This includes the different types of both equities and liabilities. Capital structure of a firm is such a vital factor that it enhances its performance (Uremadu and Efobi, 2012). A firm’s capital structure refers to the mix of its financial liabilities. It has been an important issue from the strategic management standpoint since it is linked with a firm’s ability to meet the demands of various stakeholders. Capital structure is the most significant discipline of company’s operations. Capital structure decision is a vital decision with great implication for the firm's sustainability. The ability of the organization to carry out their stakeholders need is closely related to the capital structure. The determination of a company’s capital structure is a difficult task to achieve. According to Uremadu (2004) capital structure of a firm includes retained earnings, debt and equity. This is in agreement with Pandey (2010) which states that the term capital structure is used to represent the proportionate relationship between debt and equity. Equity includes paid-up share capital, share premium and reserve and surplus (retained earnings).
Capital structure has been a major issue in financial economics ever since Modigliani and Miller showed in 1958 that given frictionless markets, homogeneous expectations; capital structure decision of the firm is irrelevant. By relaxing the assumptions and analyzing their effects, theories seek to determine whether an optimal capital structure exists or not, and if so what could possibly be its determinants. The relationship between capital structure decisions and firm value has been extensively investigated in the past few decades. Capital structure could have two effects; according to Desai (2007) firms of the same risk class could possibly have higher cost of capital with higher leverage. Also, that capital structure may affect the valuation of the firm, with more leveraged firms, being riskier and consequently valued lower than the less leveraged firms. If the manager of a firm has the shareholders' wealth maximization as his objective, then capital structure is an important decision, for it could lead to an optimal financing mix which maximizes the market price per share of the firm.
Every business whether newly born or an ongoing, requires fund to carry out its activities as no success is achievable in the absence of fund. The needed fund may be for daily running of a firm or for business expansion. This tells how important fund is in the life of every business. This fund is referred to as capital. Capital therefore refers to the means of funding a business. Firms that are willing to raise capital for their activities normally source their funds through two major sources. These sources are internal and external sources. The internal source refers to the funds generated from within an enterprise which is mostly retained earnings. It results from success enterprises earn from their activities. Firms may in the same vein look outside to source for their needed funds to enhance their activities. Any fund sourced not from within the earnings of their activities is termed external financing. The external funding may be by increasing the number of co-owners of a business or outright borrowing in form of loan. Financing and investment are two major decision areas in a firm. In the financing decision the manager is concerned with determining the best financing mix or capital structure for his firm. Capital structure decision is the mix of debt and equity that a company uses to finance its business (Damodaran, 2001). Capital structure theory is an essential reference theory in firm’s performance. The capital structure refers to firms’ mixture of debt and equity financing. To pursue a policy of an optimal capital structure, is one of the most important and complex issues to resolve in an organization. Most firms’ capital especially during the beginning of their businesses comes from combinations of various debt and equity proportions. This is gotten from shareholders funds to finance their company’s needs and balance their leverage which signifies good standing of the firm. Debts can be acquired in form of bonds, short and long term credit while equity can be acquired through participation of stakeholders or common stocks and retained earnings. Following the work of Modigliani and Miller (1958), a substantial amount of effort has been put forward in corporate finance theory to determine the factors that influence a firm’s choice of capital structure. The issue of finance has been identified as the major reason for firms failing to start or grow. It is pertinent for firms in Nigeria to make the best choice in financing their activities and grow over time.
After over half a century of studies on this great topic, economists and financial experts have not reached an agreement on how and to which extent firms’ capital structure impacts on their performance. However, this study contributes to the empirical studies on how capital structure impact on firm performance in the Nigerian context.
1.2 Statement of the Problem
The actual impact of capital structure on firm performance in Nigeria has been a major problem among researchers that has not been resolved. There is still no conclusive empirical evidence in the literature about how capital structure impacts on firm performance in Nigeria and this formed a knowledge gap that needs to be filled. Therefore, it is on this premise that the researcher embarked on this study. Meanwhile, according to Kochar (1997), poor capital structure decisions may lead to a possible reduction/loss in the value derived from strategic assets. Hence, the capability of a firm in managing its financial policies is important, if the firm is to realize gains from its resources. The raising of appropriate fund in an organization will aid the firm in its operation; hence, it is important for firms in Nigeria to know the debt-equity mix that gives effective and efficient performance, after a good analysis of business operations and obligations.
A firm’s capital structure refers to the mix of its financial liabilities. It has long been an important issue from the strategic management standpoint since it is linked with a firm’s ability to meet the demands of various stakeholders (Roy and Minfang, 2000). Debt and equity are the two major classes of liabilities, with debt holders and equity holders representing the two types of investors in the firm. Each of these is associated with different levels of risk, benefits, and control. While debt holders exert lower control, they earn a fixed rate of return and are protected by contractual obligations with respect to their investment. Equity holders are the residual claimants, bearing most of the risk and have greater control over decisions.
An appropriate capital structure is a critical decision for any business organization. The decision is important not only because of the need to maximize returns to various organizational constituencies, but also because of the impact such a decision have on an organization’s ability to deal with its competitive environment. Following the work of Modigliani and Miller (1958) much research has been carried out in corporate finance to determine the influence of a firm’s choice of capital structure on performance. The difficulty facing companies when structuring their finance is to determine its impact on performance, as the performance of the business is crucial to the value of the firm and consequently, its survival.
Managers have numerous opportunities to exercise their discretion with respect to capital structure decisions. The capital structure employed may not be meant for value maximization of the firm but for protection of the manager’s interest especially in organizations where corporate decisions are dictated by managers and shares of the company closely held (Dimitris, and Psillaki, 2008). Even where shares are not closely held, owners of equity are generally large in number and an average shareholder controls a minute proportion of the shares of the firm. This gives rise to the tendency for such a shareholder to take less interest in the monitoring of managers who pursue interest different from owners of equity.
Any investment decision taken by a firm’s manager affects the performance of the firm. What will be the appropriate percentage of the capital, debt, and equity so as to maximize profitability of the firm given that each source of finance has a cost and benefit attached to it, makes it a major and difficult decision to be taken by the managers. It is always very difficult for firms to identify or get the right combination of debt and equity (capital structure) which will ultimately satisfies them or brings favourable and profitable results for the firms. However, not all business or firm use a standardized capital structure; hence they differ in their financial decisions under various terms and conditions. It is therefore a difficult situation for these firms to determine the capital structure in which risk and costs are minimum and that can raise the value of shareholders wealth and maximize profit. Decisions as to the right source to obtain funds for investment purposes are often very difficult one. Factors such as the shareholders liability, bankruptcy cost, uncertainty and taxes complicate the decision of capital structure for firms.
Similarly, the difficulty facing firms in Nigeria has to do more with the financing – whether to raise debt or equity capital. The issue of finance is so important that it has been identified as an immediate reason for business failing to start or grow. Thus, it is necessary for firms in Nigeria to be able to finance their activities properly and grow over time, if they want to play an increasing and predominant role in creating value added, as well as income in terms of profits. From the foregoing, it is therefore important to understand how firms financing choices affects their performance.
However, many scholars over time have examined the impact between capital structure and firm’s performance. Some were of the view that capital structure has positive and significance impact on firm’s performance, others reported negative impact while others were of the view that both positive and negative relationship exist between capital structure and firm’s performance. While some authors work such as Akintoye (2008) lacked empirical analysis a study of this nature should have and the study covered ten years.....
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