CORPORATE PERFORMANCE EVIDENCE AND CAPITAL STRUCTURE  FROM NIGERIA’S MANUFACTURING SECTOR

CORPORATE PERFORMANCE EVIDENCE AND CAPITAL STRUCTURE  FROM NIGERIA’S MANUFACTURING SECTOR

The main purpose of this study is to examine the relationship between capital structure and corporate performance of the manufacturing sector in Nigeria, draw conclusions and make relevant recommendations on matters concerning capital structure for profit maximization of the manufacturing sector in Nigeria.

CHAPTER ONE

INTRODUCTION

• Overview of the Study

Capital structure is a major topic of debate in finance among scholars and researchers. Its importance derives from the fact that capital structure is closely related to the ability of firms to fulfill the needs of various stakeholders (i.e. making a profit and maximizing shareholders wealth). The capital structure represents the major claims to the firm’s assets. This includes the different types of both equities and liabilities. The capital structure of a firm is such a vital factor that 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 decision is an important and vital decision with great implications for the firm’s sustainability and continuity. The ability of the organization to carry out its 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. Also in alignment 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).

In the financing decision, the manager is concerned with determining the best and most appropriate source of funds to attain an optimal 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).  However, every debt acquired has a corresponding price which is referred to as interest, interest which is the sum of money which the borrower pays for the privilege of using the lender’s money (Ezirim, 2005). Therefore, interest expenses increases as a higher amount of debt are incurred.  A firm can be either highly levered (having more debt than equity in its capital structure) or lowly leveraged (having more equity than debt in its capital structure). Furthermore, having debt in a firm’s capital structure is beneficial to a firm; this is because a firm with debt in its capital structure enjoys tax savings as interest is paid before tax is deducted from the firm’s income. However, debt irrespective of its benefit to a firm also creates financial risk, if a highly levered firm is unable to make sufficient EBIT, such a firm might go into liquidation as it may not be able to meet its interest obligations and also finance other expenses of the firm. Most companies use debt to finance operations. By doing so, a company increases its leverage because it can invest in business operations without increasing its equity.

Capital structure has been a major issue in financial economics ever since Modigliani and Miller (M & M) showed in 1958 that given frictionless markets, homogeneous expectations; capital structure decision of the firm is irrelevant. More theories seek to determine whether an optimal capital structure exists or not and if so what could be its determinants. The relationship between capital structure and firm value has been critically investigated in the past few decades. The capital structure could have two effects; according to Desai (2007) firms of the same risk, class could have a 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 the 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.

Corporate performance is the measurement of what has been achieved by the firm within a given period. The aims of measuring performance are to obtain very useful information about the uses of firm finances, the flow of funds, efficiency and effectiveness. Besides, the managers can make the best decisions from the information on firm’s performance (Almajali et al, 2012).

Nigeria’s manufacturing industry is entering a phase of major change, as producers expand capacity to cope with the country’s critical economic growth and sustainable development.

Due to the strong correlation between GDP growth and manufacturing consumption, manufacturing production growth has also been helped by Nigeria’s strong economic performance in recent years. The magnificent importance of the manufacturing industry to the Nigerian economy as a whole is a key motivator to conducting this analysis of the various factors that determine the financial mix of this noble sector in Nigeria.

Looking inward to the manufacturing sector it is observed that the association amid capital structure and performance is for long a matter of substantial deliberations for equally scholars and practitioners. Strategic management looks towards capital structure because it is related to a corporation’s capability to satisfy numerous stakeholders demands (Roy and Minfang, 2000). The performance of management is often measured regarding profitability which reflects managers’ ability to earn optimum returns on assets at their disposal over a period.

However, the theoretical position as regards to capital structure and firm performance are inconclusive. For instance, Modigliani and Miller’s capital structure irrelevance theorem in the determination of optimal capital structure has stirred up many controversies in Finance. 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. According to the trade-off theory, an optimal ratio of debt and equity is to be determined after accessing the costs of both debt and equity. While the pecking order theory ranks the capital sources but does not suggest an optimal ratio between debt and equity. The signaling theory has been known for information asymmetry, adverse selection, and moral hazards. This research contributes to the existing empirical studies and also to check the extent of the relationship existing between capital structure and corporate performance of the manufacturing sector in Nigeria from 1988 -2018.

Statement of the Problem

Optimal capital structure is a puzzle to every manager and board of directors, failure to put considerations on capital structure might lead to low profitability, bankruptcy, failure to invest in high returns project and ultimately decrease in the value and shareholders wealth (in a nutshell poor company performance). The popular and first capital structure theory of Modigliani and Miller states that firm’s value/profitability is not affected by its capital structure decision, therefore equity and debt choice becomes irrelevant, this claim was upheld by Velnampy & Anojan (2014) discovering that capital structure measured by leverage does not have any effect on profitability of firms.

Semiu and Collins (2011) did not agree with the above M & M theory in their findings, stating that the market value of a firm is determined by its capital structure decisions, Ogebe et al (2011) in their research ‘The impact of capital structure on firms’ performance in Nigeria’ also found out that capital structure is important in determining firms performance and this is in line with the static trade off theory by Myers (1984) opposing the M & M theory, they support the relevance of capital structure, stating that there is an optimal ratio of debt and equity a firm can use in financing its operations and they move towards that target (that is optimal capital structure) and this makes capital structure decisions relevant, more so it affects a firms profitability, they further mentioned that owners and managers must choose between debt and equity in respect to the cost of acquiring them, that is a mix of debt equity should depend on the cost of getting them, the most cost efficient method should be used to maximize profit and firm performance.

Aliu (2010) found out that there has been neglect by investors/stakeholders to ascertain the effect of capital structure in measuring firm’s performance and they assume capital structure is not tied to firm performance, as this brings the need for more research, furthermore, the determination of optimal capital structure has been very controversial and the relationship existing between capital structure and firm performance has been a huge problem to determine, since, after several researches are done on the subject matter, researchers have not agreed on the extent of relationship, in light of all these differences in the findings, this researcher finds the need for this research as to determine or know the extent of relationship existing between Capital structure and corporate performance of manufacturing sector in Nigeria from 1988 – 2018

Purpose of the Study

The main purpose of this study is to examine the relationship between capital structure and corporate performance of the manufacturing sector in Nigeria, draw conclusions and make relevant recommendations on matters concerning capital structure for profit maximization of the manufacturing sector in Nigeria. And more specifically, it seeks to;

1. Determine the relationship between debt to assets ratio and return on assets of the manufacturing sector in Nigeria.
2. Find out the relationship between debt to equity ratio and return on assets of the manufacturing sector in Nigeria

• Research questions

What is the relationship between capital structure and corporate performance of the manufacturing sector in Nigeria?

1. What are the relationship between debt to asset ratio and return on assets of the manufacturing sector in Nigeria?
2. What is the extent of the relationship that exists between the debt to equity ratio and returns on assets of the manufacturing sector in Nigeria?

• Hypotheses

In line with the objective of the study, the following hypotheses have been formulated in null form:

HO.₁ There is no significant relationship between debt to asset ratio and return on assets of the manufacturing sector in Nigeria.

HO.₂ There is no significant relationship between debt to equity ratio and return on assets of the manufacturing sector in Nigeria.

Significance of the Study

This study contributes to existing literature in several ways as the study will be of significant benefit to several individuals including the investors to recognize the link between capital structure and corporate performance of manufacturing sector in Nigeria thereby choosing appropriate ways to evaluate companies’ (manufacturing sector) financial status while committing their hard-earned funds for an expected return. This research will make some significant contribution to the existing body of finance in the area of corporate financing and consequently accounting knowledge in Nigeria, hoping that the result of this study will be beneficial to both internal and external parties (i.e managers in maximizing investors return, owners in making an informed decision, creditors in ascertaining creditworthiness of a firm (manufacturing sector), Government in making favorable finance policies, etc). Students and researchers who will want to develop a future research on this subject will also benefit from this study and it will contribute in filling the gap of existing body of knowledge in finance and accounting as regards capital structure decisions which have been a long debate, therefore, creating an opportunity for future research to be conducted on the subject matter.

Definition of Terms

Capital Structure: The particular distribution of debt and equity that makes up the finances of a company. It is how a firm finances its overall operations and growth by using different sources of funds (debt and equity). Debt comes in the form of bond issues or long-term notes payable, while equity is classified as common stock, preferred stock or retained earnings. Short-term debt such as working capital requirements is also considered to be part of the capital structure.

Leverage: Leverage is the use of various financial instruments or borrowed capital to increase the potential return of an investment. It is also referred to as the use of debt to acquire additional assets therefore the amount of debt used to finance a firm’s assets. A firm with significantly more debt than equity is considered to be highly levered/highly geared.

Debt: Debt is an amount of money borrowed by one party from another. Debt is used by many corporations and individuals as a method of making large purchases that they could not afford under normal circumstances. A debt arrangement gives the borrowing party permission to borrow money under the condition that it is to be paid back at a later date, usually with interest. Debt is one of the two main ways companies can raise capital in the capital markets. Companies like to issue debt because of tax advantages. Interest payments are tax-deductible. Debt also allows a company or business to retain ownership, unlike equity. Additionally, in times of low-interest rates, debt is abundant and easy to access.

Equity: In finance in general, you can think of equity as one’s degree ownership in any asset after all debts associated with that asset are paid off. For example, a car or house with no outstanding debt is considered entirely the owner’s equity because he or she can readily sell the item for cash, and pocket the resultant sum. Stocks are equity because they represent ownership in a firm, though ownership of shares in a public company generally does not come with accompanying liabilities. Equity is more expensive than debt, especially when interest rates are low. However, unlike debt, equity does not need to be paid back if earnings decline. On the other hand, equity represents a claim on the future earnings of the company as a part-owner.

What is Corporate performance? : Corporate performance is a subjective measure of how well a firm can use assets from its primary mode of business and generate revenues. It is also the measurement of what has been achieved or attained by the firm within a given period.

Company (manufacturing firm) profitability: This is defined as the degree to which a business or company’s (manufacturing firm) activities yield financial gain. A company also can use its resources to generate revenues over its expenses.

Manufacturing Sector: It refers to those industries which are involved in the manufacturing and processing of items and indulge in either the creation of new commodities or in value addition. Agglomeration of industries engaged in the chemical, mechanical or physical transformation of materials, substances or components into consumer or industrial goods.

Return on Assets (ROA): ROA is the ratio of net profit to total assets of the company, measuring the return on total investments in the company, high ROA means the investment gains compare favorably to investment cost. As a performance measure, ROA is used to evaluate the efficiency of an investment or to compare the efficiency of several different investments. ROA = Net profit/Total assets

Debt ratio (DR): Debt ratio is defined as the ratio of total long-term and short-term debt to total assets, expressed as a decimal or percentage. It can be interpreted as the proportion of a company’s assets that are financed by debt. It measures the proportion of funds provided by creditors who are regarded as external fund providers for the company. The debt includes all current liabilities and all long term obligations including bonds, mortgages, etc. (Nnamdi & Nwakanma, 2013). Debt ratio = Total debt/Total assets.

Debt to equity ratio (DER): Nwude (2003) defines debt to equity ratio as a measure of the proportion of debt to shareholders funds (i.e Net Worth) in the total financing of a business. Items such as accumulated losses and deferred expenditures are eliminated from the shareholders’ funds before using it as the denominator. The ratio indicates how much naira was raised as debt for N1 of equity. Enekwe (2012) continues that debt to equity ratio is a financial ratio indicating the relative proportion of equity and debt used to finance a company’s assets which is an indicator of the capital structure. It is equal to total debt divided by shareholders’ equity. A high debt to equity ratio generally means that a company has been aggressive in financing its growth with debt. Debt to equity ratio = Total debt / Shareholder’s Funds or Total equity (capital)

Limitations of the Study

In the course of the study, certain challenges may act as restrictions on the interpretation of the findings; the proxies/variables used to measure or represent the subject matter are limited, therefore, more research should be carried out on this subject matter using a mix of both proxies and variables which are used in this study and also the ones not used in this study to represent the subject matter for more conclusive results. The number firms/companies (manufacturing sector) used in this research are not certain as the sources of data were all secondary sources showing data for total manufacturing firms (i.e. cumulative financial statement for all manufacturing firms)  each year from 1988 to 2018 and not individual data for each company that existed within this period understudy making it difficult for the researcher to pick selected manufacturing company as sample to represent the Manufacturing Sector, Furthermore, due to the use of secondary source of data, there could be some errors in data collected as it was not collected primarily by the researcher and as such data may not be readily available to the researcher. The researcher also experienced difficulty due to poor electric power supply, as the inconsistencies in power supply made it harder for the researcher to use gadgets and phones to search for data as their batteries were always low, adding to this, the slow internet data services in the country of the researcher made it also difficult for the researcher to use the internet with ease and get data needed for the research.

Organization of the Study

This study focuses on the capital structure and corporate performance of the manufacturing sector in Nigeria. Covering a period from 1988 to 2018, the remainder of the study paper is organized as follows: Chapter two is about literature review discussing both theoretical and empirical review. Chapter three discusses the methodology used in carrying out this research and Chapter four presents and discusses the data results. Finally its chapter five with conclusion and recommendations based on the findings.

Measures of Corporate performance.