DETERMINANTS OF FINANCIAL STRUCTURE: EVIDENCE FROM NIGERIAN QUOTED FIRMS
ABSTRACT
The study sought to examine the
determinants of financial structure of Nigeria quoted firms during the
period spanning 1999 – 2014. The 15- year period accommodated several
time periods and data points. The study adopted ex-post facto research
design. The research work also adopted two theoretical frameworks:
Pecking Order and Static Trade – off theories captured in a panel
regression model. A sample of 24 firms was selected based on data
quality and availability to address the requirements of the variables in
the model. Five hypotheses were formulated and tested using Pooled
Ordinary Least Squares (OLS) multiple regression. Results show that
profitability (PRT) had a positive and significant impact on financial
structure; tangible fixed asset (TAN) has a positive and significant
impact on financial structure of quoted firms; growth opportunities
(GRW) had a positive and significant impact on financial structure of
Nigerian quoted firms. Results of panel regression also indicate that
operating risk (volatility), (OPR) had a positive and statistically
significant impact on financial structure of listed firms in Nigeria.
Finally, firm size (FST) which is the natural logarithm of total assets
had a positive and significant impact on financial structure. Firm size
was used to control possible non-linearity and prevent problem of
heteroskedasticity. These findings are corroborative of theoretical and
empirical predictions. For instance, employing a high proportion of a
long term debt in the financial structure results in low profitability
because short-term debts are less expensive, but accessible to many
firms. On the basis of the entire findings, useful recommendations for
optimal financial mix by managers as well as measures to enhance the
management of the Nigerian Stock Exchange were made. For instance,
reducing floatation costs insider abuses will enable firms to access
funds easily and increase investors’ confidence respectively.
CHAPTER ONE
1.0 INTRODUCTION
1.1 Background of the study
In some countries, governments often give
financial assistance to business firms to enable them to kick-start and
sustain their operations and overcome some teething problems. Such
assistance takes preeminence during economic recession which is often
characterized by low demand for goods and services occasioned by low
level of income, falling Gross Domestic Product (GDP), business failure
and loss of jobs.
The rationale for governments’ action in
this direction are legion: to prevent corporate failure and its
contagious effects; increase the Gross Domestic Product by producing
goods and services for local and international consumption; maintain a
desired level of employment and above all, encourage entrepreneurial
development.
Financial and economic crises are known
to have effects on financial structure decision of firms. For instance,
Deesomak, Paudyal and Pescetto (2004) investigated the determinants of
capital structure of Asia Pacific region after the financial crisis that
engulfed Thailand, Malaysia and Singapore. The crisis which originated
in Thailand, had a snowball effect on the region’s capital markets
severely, with outflows of foreign investments as international
investors become concerned with higher risk in the affected countries.
Raising capital in these countries became more costly because of high
risk premia, compounded by the high level of interest rates needed to
support local currencies (Deesomark, et al 2004). Grenville
(1999) and Chou and Ho (2002), reported that the Asian countries were
hit in different degrees by the crisis. This prompted researchers to
conduct research on determinants of capital structure across the
affected countries between the pre and post- crisis period to provide
insights into firms’ financial decision making. In the same vein Zoppa
and McMahon (2009) compared Pecking Order Theory with the financial
structure of manufacturing SMEs in Australia.
Financing decisions have also been
identified to have direct impact on financial structure and performance
of companies. See for instance, Gupta, Srivastava and Sharma (2010),
Chou and lee (2007), Schwarts and Aronsou (1979), Booth, et al (2001), Pratheepkpanth (2001), Bas, Muradoglu and Phylaktis (2009) and Booth, Alvazian and Demirguc – Kunt (2001).
Economic and financial crises are not
alien to Nigeria especially during the period spanning 1990 – 2008. See
for instance, Dagogo and Ollor (2009), Olo (1991), Uche (2000), Sanusi
(2003) and Soludo (2004). In every economy, the real and financial
sectors complement each other in order to maintain a progressive balance
(Dagogo and Ollor, 2009).
A deficiency in one sector hampers growth
and development in the other. For instance, Sharpe, Alexander and
Bailey (1995) argued that there exists a strong relationship between
highly developed financial sector and real sector investment. In
Nigeria, however, evidence shows that both sectors are not so symbiotic
such that the financial sector milk – dries the real sector. Thus, funds
meant for real sector development are channeled to non-productive
sectors. Soludo (2004) and Sanusi (2003) observed that banks declare
huge profits even as factories close down, simply because Nigeria banks
were less responsible to long-term financing than they were to
short–term trade financing and foreign on exchange deals. Dagogo and
Ollor (2009), have observed that the failure of previous financial
policies of government to achieve desirable economic growth was a
concern that demands restructuring of the Nigerian system, especially in
the glare of an ailing economy. Thus, the introduction of the
Structural Adjustment Programme (SAP) in 1986 and the privatisation
programme in 1989 were in response to failed institutional measures to
promote growth in the industrial sector. Uche (2000) is of the view that
SAP was designed to achieve balance of payment viability by altering
and restructuring the production and consumption patterns of the
economy, eliminating price distortions, reducing the heavy dependence on
consumer goods, imports and crude oil exports, enhancing the non-oil
export base, rationalising the role of the public sector, accelerating
the growth potential of the private sector and achieving sustainable
growth. To achieve these objectives, the main strategies of the
programme were the adoption of a market exchange rate for the Naira, the
deregulation of external trade and balance of payment arrangements,
reduction in the price and administrative control and more reliance on
market forces as a major determinant of economic activity. In the same
vein, Ojo (1991) pointed out that government’s reasons for deregulation
of the economy were legion: stagnant growth, rising inflation,
unemployment, food shortage and mounting external debt.
The corporate sector remains the engine
room of growth and development of all economies. Abor (2008) observed
that corporate sector growth is vital to economic development.
While acknowledging the role of small and
medium scale enterprises in the Nigerian economy, Yerima and Danjuma
(2007) pointed out that these enterprises have been identified as the
means through which rapid industrialization, job creation, poverty
alleviation, and other developmental goals are realized. Again, Abor
(2008) asserts that it is imperative for firms in developing countries
to be able to finance their activities and grow overtime if they are
ever to play an increasing and predominant role in providing employment
as well as income in terms of profits, dividends and wages to
households. Firms earn economic gains or rents from strategic assets
which are financed by debt or equality.
Kochhar (1997) affirms that strategic
assets provide a firm with a source of steady stream of rents so that it
gains a sustained competitive advantage over its rivals. Thus, it is
the stock of strategic assets that is important in determining a firm’s
profitability level.
Increasingly, business people are seeking
to manage companies in a strategic manner. The strategic model of the
firm argues that improved firm performance occurs when the firm’s
managers select strategic goals and all of the activities of the firm
are directed towards meeting those goals. Therefore, the financial
strategy of the firm should be consistent with the firm’s strategic
objectives (Prasad, et al, 1997). Again, Kochhar (1997) asserts
that the nature of the firm’s assets predicts efficient ways of
organising transactions. Varying characteristics of assets imply
different levels of optimal capital mix of debt and equity.
If the transactions with suppliers of
finance are not organised as per these predictions, the ability of firms
to obtain a competitive advantage over their rivals maybe impaired
(Hennart, 1994).
It suggests, therefore that the
capabilities in managing financial policies are important if a firm is
to realise gains from its specialized resources; poor capital structure
decisions lead to a possible reduction/loss in the value derived from
strategic assets (Kochhar, 1997).
In the presence of uncertainty, bounded
rationality and opportunism, contracts that completely safeguard an
investment cannot be designed. This leads to organising costs for the
firm, as is the case for other economic activities. These organising
costs are a function of the institutional and environmental constraints
(Williamson, 1991). It is important to note that different countries
have different institutional arrangements, mainly with respect to their
tax and bankruptcy codes, the existing market for corporate control and
the roles banks and securities markets play (Pratheepkpanth, 2011).
The choice between two governance
structures depends on the comparative costs for organising a particular
transaction, for instance, financing a particular investment (Kochhar,
1997). As Williamson (1991) argued, it is the characteristics of assets
under consideration that affect costs under alternative governance
structures. Alternative governance structures are referred to debt and
equity. The variation in the benefits of the two instruments and their
ability to monitor and evaluate managerial actions according to Berglof
(1990) and Williamson (1988) imply that debt and equity can be
considered as alternative governance structures. A firm has the option
to choose either one when financing a new investment. The
debt-to-equality ratio therefore is the result of transactions with
potential debt-holders and equality holders. These transactions come
about with the formation of explicit or implicitcontracts that delineate
the benefits and resource available to the suppliers of finance (Jensen
and Meckling, 1976). The benefits available represent the property
rights due to their claims over the return streams (from the assets).
This recourse available is in the form of their control rights over
management actions (Kochhar, 1997).
There are two basic concepts involved in
financing firms’ assets – capital structure and financial structure.
Capital structure is most applicable to developed economies because the
financial markets are efficient and near perfection. Whereas financial
structure is applicable to less developed financial markets typical of
developing economies. Firms have choices to raise their capital by
various means including internally generated funds equity issues and
various types of debts. The decision to select sources of finances is
referred to as financial structure decision. Financial structure
decision is very critical decision with great implications for the
firm’s performance. Theories proposed by the researchers to explain the
financing decisions have been subject of considerable debate (Amjed,
2010). Internal funds allow companies to utilize gained profit for
financing. It means that instead of dividends distribution, they use
profit for the company’s operation in order to have higher return. In
contrast, external financing companies use debt and issue securities
(Titman and Gronblati, 1998).
A process which leads to final decision
of combining equity and debt (short and long – term) is called financial
structure determining method.
Methods of determining financial
structure should be chosen with particular attention to the main
features of securities influenced by internal factors within the firm or
other external factors (Esfaheni, 2006). Financial managers chose
policies related to the financial structure of firms for increasing
stockholders’ wealth; they also consider solutions such as debtor equity
increase for financing their projects (Asghari 2009).
The aim of determining financial
structure is to distinguish structure of financial fund in order to
minimize shareholders’ wealth (Akparpour and Aghabeygzadeh, 2011). The
more bonds a firm issues, the higher will be its breakdown point and
leverage. Otherwise, the profit per share will decline, therefore,
financial managers’ measure different impacts on different financial
structures on shareholders’ wealth (Reynor, 2006.
According to William (1991), the
financing structures of debt and equity can be compared with respect to
the characteristics of control and property rights. The debt instrument
carries with it fixed rules and covenants that usually monitor the
lending process. The repayment schedule of the principal loan amount and
the interest payment are stipulated in the contract, with debt holders
having primary claim over the firm’s cash flows from the assets. The
firm is often required to meet liquidity tests to ensure that lender’s
investment is not jeopardized.
Equity owners, on the other hand, have a
residual claimant status over the cash flows from asset earnings and
assets liquidation. That is, they obtain the cash flows from asset
earnings and assets liquidation. That is, they obtain the cash flows
that are left after paying off more senior claims such as debt. Thus,
equity holders have weaker property rights, similar to hierarchical
control (Williamson, 1991).
Therefore, debt increases creditors’
claims and equity increases owners’ claims on the organisation. The
owners’ claim increases when a firm issues shares to raise capital or
pay dividends in form of bonus shares. On the other hand, the creditors’
claims increase when a firm borrows on both short and long-terms.
Hovakimian, Opler and Titman (2001)
tested the hypothesis that firms tend to a target ratio when they either
raise new capital or retire or repurchase existing capital. They argued
that firms should use relatively more debt to finance assets in place
and relatively equity to finance growth opportunities. Booth, Alvanzian,
Demirguc-Kurt and Maksimovic (2001) noted, in general, highly
profitable slow-growing firm should generate more cash, but less
profitable fast-growing firms will need significant external financing.
They averred that there maybe link with the agency cost argument if the
existence of strong investment opportunities is correlated with current
levels of profitability. Prasad, et al (2001) argued that
growing SMEs will contribute in expanding the size of the direct
productive sector in the economy; generating tax revenue for the
government; and in facilitating poverty reduction through fiscal
transfers and income from employment and firm ownership.
Firms must accumulate capital for growth
and survival. To understand how firms in developing countries such as
Nigeria finance their activities, it is necessary to examine the
composition of their capital, hence the focus on financial structure in
this study.
The capital of any business firm is the
foundation upon which the business operates. Capital absorbs losses,
multiplies fixed assets, and in all, enhances growth through mergers and
acquisitions.
The decision to combine equity, long-term
and short-term debts as the mcapital mix is called financial structure.
When financing their activities, firms, especially those with limited
liabilities, combine debt and equity.
Equity capital includes common and
preference shares while debt includes such instruments as long-term loan
stock, mortgage and debenture bonds. The combination of long-term
interest bearing obligations and equity is referred to as capital
structure. This work is not centered on capital structure decision.
However, attempts have been made to explain the concept – capital
structure. It refers to the mix of long-term sources of funds, such as
debentures, long-term debts, preference share capital and equity share
capital including reserves and surpluses (i.e. retained earnings)
(Pandey, 2000). Teker, et al (2009) explained that the capital
structure of a company consists of a particular combination of debt and
equity issues to relieve potential pressures on its long-term financing.
To examine such issues, many theories have been developed in the
literature and they generally focus upon what determinants are likely to
influence the so-called leverage decisions of the firms. Among these,
the Modigliani and Miller (MM) theory, trade-off theory, pecking order
theory or signally theory have been said to mainly play a crucial role
in identifying and testing the various properties of the leverage
decisions (Teker, et al 2009). Dagogo and Ollor (2009)
explained that the capital structure of a firm involves decisions about
debt and/or equity financing, and the implication that higher leverage
increases value seems to be more applicable to large corporations than
to fledglings. Usually, at the early stage preference is given to
survival and sustainability, in which case the first rule is to employ
the structure that does not expose the enterprise to overbearing
financial obligation during period of low cash flow and low return on
assets. They argued that debt financing is cheaper only with mature
businesses or businesses with high initial cash inflow.
Longenecker, Moore and Petty (1997)
argued that financial structure decision depends on the type of
business, the firm’s financial strength, and the current economic
environment. It also involves tradeoffs about potential profitability,
financial risk and voting control. Debt financing involves fixed
interest bearing instruments or obligations, the payment of which takes
precedence over other financial claims to the enterprise.
See for instance, Price and Allen (1998)
and Hiscrich and Peters (1998). Financial structure decision is a very
strategic managerial decision. This is because it influences the
shareholders’ risk and return, consequently the market value of the
firm. Inability to plan firms’ financial structure develops as a result
of the financial decisions taken by the financial managers. Such
companies with unplanned capital structure may flourish in the short
run, but ultimately they may encounter severe financial crises. The
adage, “he who fails to plan, plans to fail” is a pointer to this
argument. Failing to plan implies that these companies may not be able
to utilise the accounting principle of conservatism in the management of
their funds. Pandey (2000) argued that it is being increasingly
realized that a company should plan its capital structure to minimize
the use of the funds in order to adapt more easily to the changing
macroeconomic conditions surrounding businesses.
Most empirical studies on the
determinants of capital structure have been based on data from developed
economies. For instance, Devan and Danbolt (2000 and 2002) utilized
data from the UK. Similarly, Antoniou, Guney and Paudyal (2002) analysed
data from the UK, Germany and France while Hall, Hutchinson and
Michaelas (2004) obtained data from European SMEs. There are a few
studies which have provided evidence from developing economies. In this
category are, Booth, Aivazian, Demirguc-Kunt and Maksimovic (2001) who
utilized data from ten developing countries, viz: Brazil, Mexico, India,
South Korea, Jordan, Malaysia, Pakistan, Thailand, Turkey and Zimbabwe;
Abor (2008) combined data from Ghanaian quoted firms and SMEs; Pandey
(2001) used data from Malaysia, Chen (2004) utilised data from China;
Al-Sakran (2001) analysed data from Saudi Arabia while Buferna, Bangassa
and Hodgkinson (2005) concentrated on data obtained from Libya. The
present study is restricted to the Nigerian business environment which
is typical of a developing economy. Booth, Aivazian, Demirguc-Kunt and
Maksimovic (2001) identified unique factors that affect leverage ratios
in developed and developingcountries, thus;
In general, debt ratios in developing
countries seem to be affected in the same way and by the same types of
variables that are significant in developed countries. However, there
are systematic differences in the way these ratios are affected by
country factors, such as GDP growth rates, inflation rates, and
development of capital markets.
In the developing economies such as
Nigeria, financial structure decisions are taken based on the level of
development of the domestic markets. Amjed (2008) observed that
financial markets are complete almost perfect in developed counties.
Therefore, parameters for making financial structure decisions are
mainly the cost benefits of a particular source of financing these
countries. Whereas in developing countries, financial markets are not
fully capable of meeting the financial needs of the corporate sector.
Non conventional securities particularly debt securities are not warmly
welcomed by the markets. Therefore, firms rely on the commercial bank
loans and lease financing as source of debt. With this challenge, the
firms in developing economies have to balance their capital structure in
such a way that short term sources of financing are inclusive.
In Nigeria, there is little or no
empirical work on the determinants of financial structure among quoted
firms. Available empirical works are on the determinants of capital
structure. However, Odedokun (1995) showed the influence of dividend
policy and investment spending on financing decisions of non-financial
firms in Nigeria. In the same vein, Adesola (2009) tested static
trade-off theory against Pecking order models of capital structure among
quoted firms in Nigeria. See also for example, Olatundun (2002), Abel
(2010) and Abel and Okafor (2011).
In each case, the researchers utilised
familiar determinants such as firm size, non-debt tax shield, growth
opportunities, profitability (return on assets) and tangibility of
assets. Additionally, Olowoniyi, Akinleye and Afolabi (2012), and
Owolabi(2012) attempted an analysis of the determinants of capital
structure of listed Nigerian firms. Although, capital structure
describes the appropriate relationship between debt and equity, Equity
includes paid-up-share capital, share premium and reserves and surplus
(retained earnings) while long-term debts include debenture, fixed
income securities, mortgage and debenture bonds.
Because of absence of long-term debts in
financial markets of developing economies, some authors and scholars
alike attempt to include short-term debts in their analysis of capital
structure. If this is the case, it is better to analyze the determinants
of financial structure.
Therefore, this work will include short-term debts or liabilities hence, the title financial structure.
1.2 Statement of the Problem
Financial structure decisions are one of
the most contentious areas in corporate finance. The issue in contention
revolves around the optimal financial mix. There are two schools of
thought in this regard. One school of thought called the traditional
theory advocates for optimal financial structure and the other opposes
it. The former school argues that judicious use of debt and equity
capital can maximise the value of the firm. The latter school of thought
led by Modigliani and Miller (1958) contended that financing decision
does not affect the value of the firm because the value of the firm
depends on the underlying profitability and investment risk. That is,
under the perfect capital market assumption of no bankruptcy cost and
frictionless capital markets; if no taxes, the firm’s value is
independent of the financial structure.
In developing countries such as Nigeria,
financing decisions are taken based on the level of development of the
domestic markets. Firms in developing countries rely on commercial bank
loans and lease financing as major sources of debt. It behaves on
researchers in such countries to analyse the determinant of financial
structure of firms instead of capital structure because of the
limitations of the domestic markets. In view of the peculiarity of the
Nigerian financial market and the necessity to split the financial mix
of debt and equity in order to support a company’s operations, hence to
maximise its market value, what are the critical factors determining the
financial structure of a given company in Nigeria? Therefore, what is
the impact of profitability, tangibility, volatility, growth
opportunities and firm size on the financial structure of listed firms
in Nigeria?
1.3 Research Objectives
The broad objective of the work was to
analyze the determinants of financial structure of listed firms in
Nigeria. The specific objectives of the research were:
- To examine the impact of profitability on the financial structure of quoted firms in Nigeria.
- To assess the effect of tangible fixed assets (tangibility) on the financial structure of quoted firms in Nigeria.
- To examine the impact of growth opportunities on the financial structure of quoted firms in Nigeria.
- To evaluate the impact of operating risk (volatility) of Nigerian quoted firms on financial structure.
- To appraise the effect of firm size on the financial structure of quoted firms in Nigeria.
1.4 Research Questions
In line with the specific objectives, the following questions were raised:
- To what extent does profitability impact on the financial structure of Nigerian quoted firms?
- To what extent do tangible fixed assets impact on the financial structure of Nigerian quoted firms?
- How far do growth opportunities influence the financial structure of Nigerian quoted firms?
- To what extent does operating risk impact on the financial structure of quoted firms in Nigeria?
- To what extent does firm size impact on the financial structure of quoted firms in Nigeria?
1.5 Research Hypotheses
To reaffirm or refute the relationship
between variables in the previous researches, the following null
hypotheses were formulated to guide the study;
- Ho: profitability of quoted firms in Nigeria has no significant positive effect on financial structure.
- Ho: Tangible fixed assets (tangibility) of quoted firms in Nigeria have no significant positive impact on firms’ financial structure.
- Ho: Financial structure is not positively and significantly influenced by growth opportunities of Nigerian quoted firms.
- Ho: Operating risk (volatility) does not have a significant positive impact on the financial structure of Nigerian quoted firms.
- Ho: Firm size does not have a significant positive impact on the financial structure of Nigerian quoted firms
1.6 Scope of Research
In terms of scope, this study will adopt a
single-country survey as evident in Turkey, Ghana, Australia, Sweden
and Greece etc. The study focuses on the period spanning 1999 – 2014.
This period is significant in respect of the government multiple
economic reforms and programmes.
The study collated and analyzed data from quoted firms on the Nigerian Stock Exchange (NSE).
1.7 Significance of the Study
Firms, whether small, medium or large,
contribute immensely to economic growth and development. Considering the
strategic role played by these manufacturing firms, this work is
significant in many respects. The work will have impact on the following
stakeholders:
- Scholars, researchers and students: basically, the work provides empirical evidence to support popular capital structure theories propounded by scholars and researchers alike. This is because the work is a test of the workability of existing theories such as Pecking Order and Static Trade-off theories. It would form a basis for further research because there exists knowledge gap in every piece of research. Since the research will conform to the standard procedure called research methodology, it would enable other research students to evaluate their works or researches.
- Academics: it would contribute to the endless academic debate on the determinants of capital structure, hence optimal capital mix of debt and equity. This is the most critical area in corporate financial management.
- Managers of business firms: the work would become a working paper for managers who seek solution to their leverage decisions and the factors that should influence such decisions.
- Monetary policy and development agents of the government: it would aid the government in the formulation of policies and programmes that will enable firms to accumulate capital and sustain their operations. The national economic management team will also benefit from this work as it will contribute to the actualization of government macroeconomic objectives of economic growth, price stability and employment creation. Guided by the recommendations, corporate failure and its attendant consequences on the economy will be prevented.
- Professionals: these include economists, bankers, accountants, stockbrokers and lawyers. This work will enable them to guide their clients who beseech them daily on financial management issues.
REQUEST FOR PROJECT MATERIAL
Good Day Sir/Ma,
WARNINGS!
PLEASE make
sure your project topic or related topic is found on this website and
that you have preview the abstract or chapter one before making payment.
Thanks for your interest in the research
topic. The complete research work will cost you N2000 and we will send
the material to you within 24hours after confirming your payment.
Make the payment of N2000 into any of the account
number below and we will send the complete material to you within
24hours after confirming your payment.
Account Name: Agada Leonard E
Account No: 2070537235
Bank: UBA
Or
Account Name: Agada Leonard E
Account No: 3049262877
Bank: First Bank
Or
Account Name: Agada Leonard
Account No: 0081241151
Bank: Diamond Bank
After payment, send the following information to us through this email
address: enemsly@gmail.com
Topic paid for:
Amount Paid:
Date of Payment:
Teller No or Transaction ID:
Name of Depositor:
Depositor Phone Number:
Email address:
NOTE: The material will be forwarded to the email address you provided
within 24hrs after confirmation of the payment.
Thanks.
Agada Leonard E.
For: Enems Project.
For more information visit our contact page @ CONTACT US
No comments:
Post a Comment