ABSTRACT
Previous empirical literature demonstrates conflicting
results on the effect of capital structure on firm value. Building on extant
literature on the effect of capital structure on firm value, this study was
undertaken to examine the effect of capital structure on the firm value of
manufacturing companies listed on the Ghana Stock Exchange (GSE). In
particular, the study analyzed the effect of Equity and Long Term Debt as
components of capital structure on the firm value of listed manufacturing
companies in Ghana.
To achieve the research objectives, a panel data of firms
spanning the period 2008 to 2012 were collected from the annual published
financial statements of 8 sampled firms. The study employed a multiple
regression technique to estimate the impact of capital structure on firm value.
The outcome of the study shows that both Equity and Long Term Debt have
positive impact on the value of listed manufacturing firms. However, the study
found that the effect of debt capital on firm value is pronounced relative to
equity.
From the financial management perspective, the findings of
the study provide enough grounds for the utilization of both equity and debt
capital in the financing activities of listed manufacturing firms. But it is
recommended from the findings of the study that firms employ more debt capital
than equity capital to finance business activities because of its greater
impact on firm value vis-a –vis equity. The study culminates by outlining
suggestions for further research. It is suggested that future research studies
conduct longitudinal studies to measure the stability or otherwise in research
findings.
CHAPTER ONE
INTRODUCTION
For most firms, forming an optimal
capital structure (equity and debt) is key to business survival and continuity.
Previous studies on the effect of these two components of capital structure
have produced mix findings. For some studies, the effect of capital structure
on firm value have been found negative whereas in other studies, the effect of
capital structure on firm value has been found positive. Also, other empirical
literature on the effect of capital structure on firm value suggests that the
effect is felt beyond and below certain thresholds. This study extends this line
of research by testing the effect of capital structure on the firm value of
listed manufacturing firms in Ghana. Given the contentious nature of the
relationship between capital structure and firm value in the finance
literature, the research problem was primarily on how capital structure affects
firm value of listed manufacturing companies in Ghana. The outcome of the study
would contribute to both theory and practice of knowledge. The findings of the
study contribute to the extant literature on the effect of capital structure on
firm value and future studies may find it useful. The practical implication of
the study consists in the fact that firms would find knowledge of the effect of
capital structure on the value of firm beneficial which ultimately will help in
the financing decision of firms.
Background to Study
In their seminal works, Modigliani
and Miller (1958 & 1963) as cited in Ogbulu and Emeni (2012), demonstrate
that in a frictionless world, financial leverage is unrelated to firm value
but in a world with tax-deductible interest payments, firm value and capital
structure are positively related. Miller (1997) extended this line of thinking
by incorporating personal taxes in the analysis and consequently demonstrates
that optimal debt usage occurs on a macro level but does not exist at the firm
level. Interest deductibility at the firm level is offset at the investor
level. Modigliani and Miller (1963) as cited in Ogbulu and Emeni (2012) in
addition made two propositions under a perfect capital market condition. The
first proposition is that the value of a firm is independent of its capital
structure. Their second proposition states that the cost of equity for a
leverage firm is analogous to the cost of equity for an unleveraged firm plus
an added premium for financial risk.
Yet, other theories such as the
trade-off theory (Myers, 1984), pecking order theory (Myers & Majluf, 1984)
and agency cost theory (Jensen & Meckling, 1976) argue that if capital structure
decision is irrelevant in a perfect market, then imperfection which exists in
the real world may be adduced for its relevance. Such imperfections include
bankruptcy costs (Kim, 1998), agency cost (Jensen & Meckling, 1976), gains
from leverage-induced tax shields (De Angelo & Masulis, 1980) and
information asymmetry (Myers, 1984). Consistent with this line of argument,
Pandey (2004) contends that the capital structure decision of a firm influences
its shareholders, return and risk. As a result, the market value of its shares
may be affected by the capital structure decision. Obviously, the objective of
a firm should therefore be directed towards the maximization of its value by examining its capital structure or
financial leverage decision from the point of its impact on the firm value.
Against this background, the
proposed research study will seek to examine how the various components of
capital structure namely the amount of equity and the amount of debt used by a
firm affects its market value drawing on the case study of listed manufacturing
companies in Ghana.
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