CAPITAL STRUCTURE AND FINANCIAL PERFORMANCE OF LISTED MANUFACTURING FIRMS IN NIGERIA

CAPITAL STRUCTURE AND FINANCIAL PERFORMANCE OF LISTED MANUFACTURING FIRMS IN NIGERIA

ABSTRACT: There has been a variance of opinion in accounting literature on the link between capital structure the financial performance of firms. This synthesis of opinions has always caused the relationship between equity holders and debt holders to be controversial. Consequently, this research work examined the impact capital structure has on the financial performance of listed manufacturing firms in Nigeria. The study formulated six hypotheses and used generalized mean, standard deviation, and multiple regression to analyze the secondary data extracted from the annual reports and accounts of the 49 sampled firms spanning from 2006 to 2018. The study found that the components of capital have positive relationship with financial performance, Debt has an insignificant relationship with return on assets, Equity has an insignificant relationship with return on assets, Debt has an insignificant relationship with return on investment, Equity has a significant relationship with return on investment, Debt has an insignificant relationship with net profit margin, Equity has an insignificant relationship with net profit margin, Capital structure and return on assets are not significantly related, There is a significant relationship between capital and return on investment and finally there is an insignificant relationship between capital structure and net profit margin. Based on the findings and conclusions reached the following recommendation is made, Manufacturing companies should analytically determine the optimal equity – debt mix in the composition of financing options,  also Firms should leverage on the stable operational climate to make strategic plans that will enhance their financial performance,  and finally, Management of manufacturing companies should break loose from the aversion to risk to taking reasonably risky investments to have the chance of enhancing profitability.

CHAPTER ONE

INTRODUCTION

BACKGROUND TO THE STUDY

In accounting and finance studies, greater attention has been dedicated to the extent and nature of the correlation between financial performance and capital structure of firms. The capital structure decision is considered as one of the most significant resolutions any company has to take. Capital structure relates to the choice of the aggregation of the different sources of capital an entity utilizes to fund its operations and significant investments. It refers to the ratio of several kinds of securities a firm raises as long-term finance. Capital structure is measured by the long term equity capital and debt capital utilized by a company. One core aim and goal of financial managers is to improve the wealth of shareholders by determining the best composition of financial resources for an entity and maximizing the company’s value by defining where to devote their resources.  As a case of stating the fact, the capital structure of an entity ought to be ideal, i.e. following what the business enterprise requires.

The Capital structure denotes the foremost claims to a company’s assets “This consists of the various forms of equities and liabilities” (Riahi-Belkaoui, 1999). The debt-equity combination can be in any of the following forms: 100-percent (%) equity or 0-percent (%) debt funding, 0-percent (%) equity or 100percent (%) debt funding and Q-percent (%) equity or R-percent (%) debt funding. From the foregoing alternatives, option one is commonly adopted by companies that shun the benefit of leverage if any. Companies that have no equity usually favor the second alternative however in the real-life economic scenario; this option may not be possible in that no funds provider may be willing to invest resources in a company without any equity capital. Partially this describes the term “trading on equity”, i.e. it the equity portion that exists in the entity’s capital structure that reassures the debt providers to commit their limited resources to the business. The third choice is most realistic because it pools both a definite fraction of equity and debt in the capital structures thus, the benefits of leverage if any is achieved. This combination of equity and debt has long been a question of debate in accounting literature concerning its, evaluation, determination and accounting.

Financial performance is concerned with the determination of how well a company can utilize its assets from its principal course of the operation to create revenues. Erasmus in 2008 opined that financial performance parameters like profitability or liquidity among others offer a valuable mechanism to stakeholders that assist in assessing the previous financial performance and current position of a company. The evaluation of financial performance is intended to be responsible for answers to a wide range of essential questions which may include whether the entity has sufficient cash to address all its financial burdens, is it generating adequate size of sales to substantiate current investment. In 2007 Tian and Zeitun argued that capital structure is linked closely with financial performance. Financial performance can be represented by parameters that involve profitability, productivity, growth or even satisfaction for customers. These parameters are related to each other. Financial measurement is one of the apparatuses which show the financial strength or opportunities and weakness or threats. Sanford in 2009 stated that those measurements may include but not limited to return on investment (ROI), return on assets (ROA), return on equity (ROE), residual income (RI), earning per share (EPS), dividend yield, growth in sales, etc.

One key factor that may impact the company’s performance is capital structure. Since bankruptcy costs exist, weakening returns happen with further usage of debt to derive the rewards of tax deduction and interest. Hence, there is a suitable capital structure beyond which escalations in bankruptcy costs are higher than the minimum tax sheltering gains associated with the further switch from debt to equity. Firms are often willing to improve their performance and lessen their financing cost by maintaining a suitable capital structure or the optimum capital structure.

Past research works on capital structure have usually employed varying proxies to define the capital structure. The parameters regularly used in the literature in ratios forms are a total debt to total assets, short term debt to total assets, total debt to total equity and long term debt to total assets. The total debt as a ratio to total assets measures the amount of debt utilized to finance the company, assets and other capital expenditures that can advance company’s performance. Hence, it is anticipated that increasing control components of an entity’s capital structure could increase the efficiency level and in so doing increase their performance. Managers of the company who can ascertain the level of leverages as components of the company’s capital structure are compensated with reduced finance cost thus maximizing the entity’s revenue (Zeitun & Tian, 2007). Total capitals sourced from outsiders about the total assets of the firm are measured by total debt as a ratio to total assets. It indicates the extent of cover for debts of a firm’s by total assets. It defines the level to which a firm or investor is utilizing the borrowed fund. Largely, investors would favor a lower ratio for all debts, since the lesser the ratio the healthier the cushion effect against the creditor’s losses in the case of winding up of the business. Most companies utilize borrowed funds to finance their operation with the expectation of improvement in their performance. By so doing, a firm raises its leverage because it can be able to commit resources in business operations without increasing its equity. Total debt to total equity measures the level of utilization of borrowed capital.

The origin of capital structure can be traced to the renowned work of Modigliani and Miller (M & M) in 1958. In their opinion, under certain circumstances, the option between equity and debt does not impact an entity’s worth hence, the capital structure decision is immaterial; but in a world with tax-deductible interest payment, company value and capital structure are certainly related. M & M (1958) pointed out the direction that capital structure must take by describing under what circumstances the capital structure is irrelevant. Titman (2001) listed some essential issues that make the M & M submission hold as no taxes, no transaction cost, no bankruptcy cost, perfect contrasting assumptions, and complete and perfect market assumption. The M & M position became a subject of huge debate both in empirical and theoretical research. Several criticisms have greeted the work of M & M by many scholars because, in real-world scenarios, the central assumptions never hold. They maintained that in a non-perfect world, there exist factors influences the capital structure decision of a company.

Ever since the presentation of M & M’s irrelevance propositions, several issues have arisen relative to capital structure. A lot of researchers and scholars have tried to establish whether their theory is realistic and able to resolve basic financing decision difficulties regarding appropriate capital mix for an individual company and the effect of a suitable financing mix on company performance and in what circumstance is the choice of capital structure relevant (Aliu 2010). Their work, however, has provided a varying opinion on the direction of their relationship. The combined and inconclusive findings provided the impetus for further research in this area to ascertain whether the capital structure has an impact on the financial performance of companies in different subdivisions of the economy.

The fact that companies especially manufacturing in Nigeria commonly use leverage to finance their principal operation with equity or debt or both, the level of impact capital structure has on their operation has been a subject of concern. It has been debated that the fastest way in which a nation can earn viable growth and economic development is neither by the extent of its available material nor that of its enormous human resources but through technological innovation, enterprise development, and industrial capacity. In the present era, the manufacturing sector is viewed as a basis for determining whether a nation is economically efficient.

Arising from the strategic prominence of the manufacturing sector to an economy such as Nigeria’s, investors and shareholders must understand the impact of capital structure on the performance of manufacturing firms. This is because the capital structure decision on how to finance their assets by equity or debt will affect significantly the relationship with the ultimate results for any defined period since it influences the risks and returns of shareholders and as a result affects the market value of the shares. Because of this, it becomes vital to learn the link between capital structure and financial performance of manufacturing firms in Nigeria.

STATEMENT OF THE PROBLEM

There have been current questions and various views that have attracted great attention on the theory of capital structure and leverage and how they impact the company’s performance. This debate is further limited to down to the identification of suitable variables that can best determine or describe the capital structure of manufacturing companies. The decision of determining the ideal capital structure of a company poses some difficulties. A company has to issue several securities in a limitless mixt to arrive at particular combinations that can maximize its overall worth which means optimum capital structure. Optimum capital structure also describes that with the least weighted-average cost of capital by which the value of a company is fostered. According to Rahul (1997), “poor choice of capital structure may lead to a potential drop in the value derivable from strategic assets”. Hence, the ability of a firm to manage its financial programs is important if the firm is to get rewards from its particular resources. The pattern and level of correlation between company performance and capital structure have given impetus or birthed several types of research. These studies, which are mainly foreign-based, have nonetheless exposed differing findings.

In Nigeria, some of the researches fail to use other parameters on capital structure and financial performance. The studies which include Rapuluchukwu (2012) and Idode, Bello and Onyesom (2005), Salawu (2007), Olokoyo (2012), Babalola (2012), Sabastian and Adeleke, Ogunlowo and Ashogbon (2014) Yinusa and Babalola (2012), have created a vacuum that needs to be filled. For example, Salawu (2007), who researched the “effect of capital structure on the financial performance of selected quoted companies in Nigeria” between 1990 and 2004 focused on short term debt. His work failed cover to other arrangements of financing; hence the result could only be useable from the perspective of short term debt financing. This contravenes a realistic study on capital structure which ought to spread to both types of debt financing.

Babalola (2012) whose work focused on the “effect of optimal capital structure on firm’s performance in Nigeria” between, 2000-2009 used a sample of 10 companies, concerning the study to only total debt to total assets. This study jettisoned the characteristic of ’’total debt to equity, short term debt to total assets and long term debt to total assets financing’’ even though both equity and debt financing were utilized by the sampled firms. Furthermore, his work and those of Bello and Onyesom (2005) and Olokoyo (2012) employed the Chi-square technique in analyzing their data. Chi-square technique is perceived to be weak in terms of reflecting time difference and specific distinctive issues. Studies on capital structure and performance of companies are ordinarily expected to employ parametric techniques that reflect both time differences and specific characteristic issues.

Likewise, the work of Yinusa and Babalola (2012) studied the ’’impact of corporate governance on capital structure decision of ten (10) firms in the food and beverage sector’’ between 2000 -2009. They measured capital structure using total debt to total assets ratio. The work did not spread other forms of debt financing such as ’’total debt to total equity, short- term debt and long-term debt’’ Additionally, Sebastian and Rapuluchukwu (2012) who examined the ’’impact of capital structure and liquidity on corporate returns of manufacturing firms’’ between 2002 to 2006, dwelt on short-term debt, long-term debt and total debt without incorporating total debt to total equity financing. The study lacks the use of total debt to total equity as an index of debt financing. Idode, Adeleke, Ogunlowore and Ashogbon (2014) in their study ’’the influence of capital structure on profitability of banks in Nigeria’’ span between 2008 through 2012 extended to both equity financing and debt financing. However, they overlooked a short-term debt and long-term debt which represent other significant forms of financing for manufacturing firms in Nigeria.

Owed to these recognized gaps, the fundamental research problem will concern in finding out an ideal level of capital structure which a company can adopt to foster its financial performance more effectively and efficiently. Debt financing affects an entity’s performance for the reason that firms will commonly accept fixed repayments for a specific period. These payments occur irrespective of the company’s performance. Although equity financing naturally avoids these repayments, it needs companies to give an ownership stake in the company to venture capitalists or investors. Also, using too much external funding can cause in the over‐leveraging of a company, which means the business has extensive burdens to individual and institutional investors who can interrupt the firm’s operations and financial returns.

 AIMS AND OBJECTIVES OF THE STUDY

The overall objective of this study is to examine the impact of capital structure on the financial performance of listed manufacturing firms in Nigeria. Specifically, the study sought:

1. To evaluate the impact of Debt funding on the Return on Asset of listed manufacturing companies in Nigeria
2. To determine the effect of Equity funding on Return on Asset of listed manufacturing companies in Nigeria
3. To examine the influence Debt funding has on The Return On Investment of manufacturing companies in Nigeria
4. To Assess the impact of Equity funding on the Net Profit Return on Investment of listed manufacturing companies in Nigeria
5. To survey the effect of Debt funding on Net profit of listed manufacturing companies in Nigeria
6. To investigate the influence Equity funding has on the Net profit of manufacturing companies in Nigeria

RESEARCH QUESTIONS

To reveal the nuance and perspective of the study, the following research questions would be employed.

1. Does Debt Funding exert any influence on Return on Assets of listed manufacturing companies in Nigeria?
2. Does Equity Funding impact the Return on Assets of listed manufacturing companies in Nigeria?
3. Does Debt Funding influence the Return on Investment of listed manufacturing companies in Nigeria?
4. Is there any significant relationship Equity funding and Return on Investment of listed manufacturing companies in Nigeria?
5. Is there any significant relationship between Debt Funding and Net Profit of listed manufacturing companies in Nigeria?
6. Is there any significant relationship between Equity Funding and Net Profit of listed manufacturing companies in Nigeria?

RESEARCH HYPOTHESIS

1. There is no significant relationship between Debt Funding and Return on Assets of listed manufacturing companies in Nigeria.
2. There is no significant relationship between Equity Funding and return on Assets of listed manufacturing companies in Nigeria.
3. There is no significant relationship between Debt Funding and Return on Investment of listed manufacturing companies in Nigeria.
4. No significant relationship exists between Equity Funding and Return on Investment of listed manufacturing companies in Nigeria.
5. No significant relationship exists between Debt Funding and Net Profit of listed manufacturing companies in Nigeria.
6. No significant relationship exists between Equity Funding and Net Profit of listed manufacturing companies in Nigeria.

SIGNIFICANCE OF THE STUDY

The consequence of this study would advance the merit to the already existing body of knowledge because, though there have been several studies on capital structure and financial performance around the globe, there have been noticeable deficits of evidence using data on listed manufacturing companies in Nigeria. The aftermath of the study would, therefore, assist as reference material or a means for subsequent researchers and would serve as a basis for further studies in this area.  It is expected that the results of this study will be advantageous to both internal and external parties such as managers in improving investors worth, placing them on a sound grip to understanding the effect of several financing mix on the operations of their entities, owners in making an informed decision, creditors in determining credit capability of a firm, Shareholders were able to make an informed decision with relative to their equity interest in regards to the debt financing alternatives available to their firms and Government in making satisfactory financing policies, etc. to improve on the GDP input by the manufacturing sector and also advance the employment rate once the sector is sustainable since the stakeholders are interested in knowing the effect of such decisions on a firms performance.

Also, government and its agencies will necessarily gain from the conclusions of the study, the study will point out the need for the government to convey more favorable financial and economic guidelines as the sector requires and this will sustain the operations of Nigerian Manufacturing companies, especially the prospective firms yet to be listed in the stock market and as a result contributing to GDP of the economy which has been on the deterioration hitherto.

SCOPE OF THE STUDY

The scope of this study is made up of content, geographical and time dimensional examination.

• Content Scope: This is to investigate the relationship between capital structure and the financial performance of listed manufacturing in Nigeria.
• Geographical Scope: This study will be focused on the Agriculture sector, Conglomerates sector, communication & telecom sector, industrial goods sector, Nigeria Breweries,  and natural resources as these industries are the main streams of Nigeria diversified economy as suggested by records displayed by the NSE.
• Time dimension: The study will be span for a period of twelve (12) years between 2006 –  2018.

 LIMITATIONS OF THE STUDY

Any event or circumstance that will pose a drawback or lessen the success or the practice of the findings and conclusion should be discussed. This study identifies some of the following limitations.

1. The study will use only the firms in the industrial sector out of the numerous firms in Thus, the findings may not be generalized.
2. Timing of the research study limited to 2006 – 2018.

• Limitations associated with the statistical tools used.

1. Respondents’ reluctant attitude to provide relevant information.
2. Financial constraints.

Despite these forgoing identified limitations, the researcher still believes that the accuracy and findings of this study will not be affected significantly.

ORGANIZATION OF THE STUDY

This research work is organized into five (5) chapters.  The background to the study, the statement of problem of the study aims and objectives of the study, research questions highlights of the research hypothesis to be tested, scope of the study, significance, limitations and operational definition of terms are all captured by chapter one (1), chapter two (2) defines the theoretical studies and conceptual reviews concepts. It further spells out empirical studies that relate to past studies of other scholars, findings, and gaps related to their works. Chapter three (3) on the other hand describes the research design, population, sources of data and the model of specification while Chapter four (4) and five addresses the issue of data analysis and testing of hypothesis, discussions of findings, conclusion, and recommendations for further studies respectively.

OPERATIONAL DEFINITION OF TERMS

• Capital Structure: a firm’s capital structure refers to the combination of its financial liabilities and its equities. It is the way a corporation finances its assets through some mix of equity and debt.
• Financial Performance: Financial performance is a subjective measure of how well a firm can use assets from its primary mode of business and generate revenues.
• Listed Manufacturing Company: this is a company whose shares are traded on the floor of the official Nigeria stock exchange. It must necessarily adhere to the listed requirements of the exchange which may include how many shares are listed and a minimum level.
• Net profit Margin: Net Profit Margin (NPM) also known as “Profit Margin” is a financial ratio used to compute the percentage of profit a firm to its total revenue. It measures the amount of net profit a company obtains per naira of revenue gained. The net profit margin is equal to net profit (also known as net income) divided by total revenue, expressed as a percentage.
• Return on Asset: Return on Assets (ROA) is an indicator of how profitable a company is relative to its total assets. ROA gives an idea as to how efficient management is at using its assets to generate earnings. Calculated by dividing a company’s annual earnings by its total assets, ROA is displayed as a percentage.
• Return on Investment: Return on investment (ROI) is a measure that investigates the number of additional profits produced due to a certain investment.

Table of contents

Title page

Declaration

Certification

AcknowledgmentsDedication

Abstract

Table of Contents

List of Tables

List of Appendices

CHAPTER ONE: INTRODUCTION

1.1 Background to the Study

1.2 Statement of the Problem

1.3 Aims and Objectives of the Study

1.4 Research questions

1.5 Research Hypotheses

1.6 Significance of the Study

1.7 Scope of the Study

1.8 Limitations of the study

1.9 Organization of the study

1.10 Operational definition of terms

CHAPTER TWO: LITERATURE REVIEW

2.1 Theoretical Framework

2.1.1    Efficiency-Risk Hypothesis

2.1.2    Franchise-Value Hypothesis

2.1.3    Modigliani-Miller Theory

2.1.4 Trade-off Theory

2.1.5 Pecking Order Theory

2.1.6 Agency Theory

2.1.7 Financial Distress and Bankruptcy Costs Theory

2.1.8 The Bargaining Based Theory

2.1.9 The Organizational Theory

2.2 Conceptual Review

2.2.1.   Capital structure

2.2.2.   Debt

2.2.2.1. Short term Debt

2.2.2.2. Long term Debt

2.2.2.3. Long Term Debt on the Balance Sheet

2.2.3.   Equity

2.2.4.   Capital Structure and Firm performance

2.2.5.   Relationship of Financial Statement with Investment Decision

2.2.6.   Ownership structure and capital structure

2.2.7.   Financial Performance

2.2.7.1. Net profit margin

2.2.7.2. Return on asset

2.2.7.3. Return on Investment (ROI)

2.2.8.   PROFITABILITY

2.2.9.   MANUFACTURING COMPANIES IN NIGERIA

2.2.9.1. Opportunities

2.2.9.2. Challenges

2.2.9.3. Government initiatives

2.3 Conceptual Framework

2.4 Empirical Reviews

CHAPTER THREE: RESEARCH METHODOLOGY

3.1 Research Design

3.2 Population and Sampling procedure of the study

3.3 Sources and Method of Data Collection

3.4 Technique of Data Analysis

3.5 Operational Measurement of variables

3.6 Models Specification

CHAPTER FOUR: DATA PRESENTATION, ANALYSIS, AND DISCUSSION OF FINDINGS

4.1 Data Presentation

4.2 Data Analysis

4.3 Hypothesis Testing

4.4 Discussion of Findings

CHAPTER FIVE: SUMMARY, CONCLUSIONS, and RECOMMENDATIONS

5.1 Summary of Findings

5.2 Conclusions

5.3 Recommendations

5.4 Limitations of the Study

5.5 Areas for Further Research

References

Appendices

LIST OF TABLES

Table 3.1 Listed companies in Nigeria stock exchange

Table 4.1 Return on Asset, Return on Investment, Net Profit margin, Debt-Capital Ratio and Equity Capital Ratio

Table 4.2 Descriptive Statistics for the Data

Table 4.3 Summary of Parameters

LIST OF APPENDICES

Appendix A Results for Model 1

ApendixA(1) Model summary

Appendix A(II) ANOVA

Appendix A(III) Coefficients

Appendix B Results for model 2

ApendixB (I) Model summary

Appendix B (II) ANOVA

Appendix C Results for model 3

Apendix C (I) Coefficients

Appendix C (II)Model  summary

Appendix C (III) ANOVA

Appendix (IV) Coefficients