CAPITAL STRUCTURE AND FINANCIAL PERFORMANCE OF DEPOSIT MONEY BANK IN NIGERIA
ABSTRACT: The study determined the empirical impact of deposit insurance on the financial performance of deposit money banks in Nigeria. The data made use of annual data ranging from the year 2006 – 2017 summing up to 11 samples observations. The data used was sourced from the Nigerian bank’s financial annual reports. The study adopted a quasi-experimental research design. Bank performance which is the dependent variable was measured by return on assets and return on equity of banks in Nigeria, while the independent variable was proxied by Total debt ratio and debt to equity ratio. The study adopted and specified a multiple regression model and the model was estimated by the ordinary least square technique of regression. Data analysis was carried out by E- views 8.0 statistical package. The study found that there is a negative and non-significant relationship between total debt ratio, debt to equity ratio and return on assets of Nigeria banks, there is also positive and significant relationship between total debt ratio and return on equity of Nigeria banks, there is negative and non-significant relationship between debt to equity ratio and return on equity. The study recommends Each Deposit Money Banks should determine and chose an optimal level of debt and equity combination based on the tradeoff between the cost and benefits of debt.
CHAPTER ONE
INTRODUCTION
Background of the Study
The capital structure being one of the principal decisions made by corporate financial managers refers to the way a corporation finances its assets through some combination of equity and debt (Pandey 2004). Equity in a company’s capital structure consists of common stock and retained earnings, which is summed up in the shareholder’s account on a balance sheet (Okwoli & Kpelai, 2008). Debt, on the other hand, includes all interest-bearing stocks repayable over a fixed period, such as a capital bond, bearer bonds r syndicated loans and unsecured loan stocks (corporate debentures) (Bello & Yunisa, 2010). The combination of equity and debt facilitates the company’s growth through the acquisition of profitable assets.
Capital structure is one of the fundamental decisions by finance managers. Pandey (2010) defined capital structure as the various means of financing a firm, that is, the proportional relationship between equity and debt. Pandey (2010) further stated that capital structure is a remarkable managerial decision because its impact on the shareholder’s return and risk as the market value of the share may be affected by the capital structure decisions. In making capital structure decisions, to Pandey (2010) corporate managers are expected to seek answers to the following questions: how should the investment project be financed; does how the investment projects are financed matter; how does financing affect the shareholders’ risk, return and value; does there exist an optimum financing mix in terms of the maximum value to the firm’s shareholders; can the optimum financing mix be determined in practice for a company; and what factors in practice should a company consider in designing its financing policy?
Capital structure is the combination of long term sources of a fund such as a debenture, long term debt, preference share capital and equity share capital including reserve and surpluses and retained earnings (Pandey 2005). It is a way firm finances its assets across the blend of debt, equity or hybrid securities (Saad 2010). Capital structure decision is important for any business organization because of the need to maximize return to the various stakeholders and also because such decision has a great impact on the firms’ ability to deal with the competitive environment. (Awunyo and Badu 2012).
Financial Performance
Financial performance is a subjective measure of how well management uses firms’ assets to generate revenue. The company’s performance indicators include the financial and non-financial indicators. Financial indicators have been widely adopted because a company’s long-term goal is almost always purely financial (Wang & Song, 2013). Financial performance evaluation indicators directly link up the company’s financial goals. Thus, they are metrics used to help organizations define and measure progress towards their goals (Mostafa, et. al., 2011). According to the CBN Banking Supervision Annual Report (2014, p. 89) performance indicators used by the CBN include Bank deposit & liquidity, Asset quality, Capital adequacy, Earnings & Profitability, Market share, and Bank operational (Cost) efficiency. However, this paper used earnings as a proxy for bank financial performance. The dynamics of capital structure are such that capital structure is so important because it affects a bank’s financial strength rating which is largely controlled by the universal bank regulators such as Basel 1 and 11.
Financial performance
The concept of corporate performance has some multidimensional meanings in the field of finance. Corporate performance is measured either from financial perspectives or organizational viewpoints (Zeituna & Tian, 2007). Financial performance refers to the benchmark employed in determining the general well-being of a given entity. Bhunia et al. (2011), defined financial performance as firm’s overall financial health over a given period. They added that an analysis of financial performance is aimed at assessing the feasibility, solidity, and fertility of a business. Similarly, Nyor and Yunusa (2016) see financial performance as the level of performance of a firm over a specified time, expressed in terms of overall profit or losses during that time. It is measuring the results of a firm’s policies and operation in monetary terms.
Financial managers use ratios from company financial statements to assess their financial performance (Watson & Head, 2007; Bhunia et al., 2011). One of the key factors used in measuring the financial performance of an entity is its profitability which according to Dalhat (2014) is the firm’s ability to make a profit from its operations. Profitability is the crucial objective of all business ventures; this is because the long run existences of these ventures depend upon profitable operations. Its measurement is the most remarkable indicator of business success (Khan, Sajid, Waseem&Shehzad, 2016). Financial performance, for instance, maximizing profit on assets, and maximizing shareholders’ benefits are at the core of the firm’s value (Chakravarthy, 1986). Moreover, it shows how efficiently the management can make a profit by using all the resources available in the market. In conformity with the foregoing, Banerjee and De (2014) buttressed that profitability is central to the existence of a corporate entity. Moreover, if the profitability of a firm is high creditors and equity investors would show interest in the going concern. Return on Assets (ROA) was used as a proxy of corporate financial performance in their study.
The front runner of this debate and studies on capital structure theory is Modigiliani and Miller (1958). Several empirical and theoretical types of research (see Jensen and Meckling, 1976; Myers and Majluf, 1984; Brander and Lewis, 1986; Harris and Raviv, 1990) have been carried out in this pioneering effort of Modigiliani and Miller (1958). The general direction of the opinion of researchers is that a firm should determine and chose an optimal level of debt and equity combination based on the tradeoff between the cost and benefits of debt. Some companies according to Pandey (2010), do not plan their capital structure but rather progress from financial decisions taken by the financial managers without formal policy and planning. Thus, their capital structure is reactive because they are products of previous operating decisions rather than planned decisions. A company that does not plan its capital structure may face challenges in raising funds to finance its operations in the future and may not be able to manage its use of funds. It is the general opinion among researchers that each firm should plan its capital structure in such a way that it will maximize its use of funds and be able to adapt to changing situations. Therefore, the financial manager should plan a conducive capital structure for the company to maximize the market value of the firm.
Statement of the Problem
There have been several series of studies on the effect of capital structure on firm performance in developed countries. However, empirical studies on capital structure and its connection on firm performance in developing countries, especially in Nigeria, are very scanty. Also, after the bank consolidation exercise in Nigeria, there has not been any serious research on how the emerging capital structure has affected bank performance. Most banks in Nigerians have not been taken the advantage of debt in their capital structure mix as reflected in their financial statements.
Also, most empirical studies that analyze the relationship between capital structure and firm performance have been done for individual countries, thus limiting the generalizability of the results of such studies. The purpose of this study is to fill the gap related to capital structure and bank performance in Nigeria. Studies into the capital structure and firm performance have ignored possible endogeneity of capital structure and bank performance. The capital structure may be correlated with bank performance. Ignoring possible endogeneity may lead to inconsistent estimates (see Wooldridge, 2002 and Cameron and Trivedi, 2005).
Due to inadequacy in capital structure, the banking sector affected. To determined effectors such as tangibility, liquidity, interest rate, profitability, size and growth rate that measure the performance of banks in Nigeria.
Purpose of the Study
The general objective of the study is to examine the impact of capital structure on the financial performance of the banking industry listed in Nigeria stock Exchange. The specific objectives are to:
- Explore the effect of debt ratio on the financial performance of deposit money banks
- Explore the effect of capital structure on return on asset
- Determine the leverage risk of banking institutions listed at the Nigeria Stock Exchange
- Examine the effect of debt to equity ratio on performance of banking institutions listed in the Nigeria Stock Exchange
Research Questions
The following is aimed at finding answer to the questions
- What is the relationship between total debt ratio and Return on Assets of Banks in Nigeria?
- To what extent does debt to equity ratio influences Return on Assets of Banks in Nigeria?
- How does the total debt ratio effect Return on Equity of Banks in Nigeria?
- What effect does debt to equity ratio have on Return on Equity of Banks in Nigeria?
Research Hypotheses
The following null hypotheses shall be tested in this research work:
Ho1: There is no relationship between total debt ratio and Return on Assets of Banks in Nigeria.
Ho2: There is no significant relationship between debt to equity and Return on Assets of Banks in Nigeria.
Ho3: Debt to equity has no significant Return on Equity of Banks in Nigeria.
Ho4: There is no significant between total debt ratio and Return on Equity of Banks in Nigeria
Significance of the Study
- The Government: The study is beneficial to the government in its policy formulation and review of existing laws, regulations and bye-laws for achieving maximum efficiency and productivity.
- Future researchers: it will provide an objective view of the effectiveness of Capital structure and financial performance of deposit money banks.
- The General Public: Details of the Capital structure and financial performance of deposit banks are usually kept from the public and as such, this study will inform the general public on what Capital structure have on banks financial performance.
- Financial Analysts: The study will provide a financial basis and working effectiveness upon which to examine the effects of Capital structures with the level of Bank performances in the Nations.
In addition to the aforementioned, this study will also be used by investors and students at any level who may have vested interest in issues of the Banking sector integrations through its Capital Structure and financial performance.
Scope of the Study
The research work at hand deals on the effects of Capital structure on Bank performance in Nigeria. This study will focus on integration practices and variables with a key focus on capital Structure. Bank financial performance, return on equity, return on Asset, Total debt ratio. Total deposit base, which is a vital part of the integration process. The period cover by the research is eleven (11) years period 2006-2017. Based on the availability of uniform data on the variables informed the researcher’s choice of the period of analysis. The scope of this research work is also limited to the geographical boundary of the Nigerian economy and as such will concentrate on the Bank varying annual performance which includes the Return on Asset and Equity, over the thirteen years’ time frame.
Limitations of the Study
Factors that affect the smooth execution of the project include inadequate finance and time constraint affecting the collection and sourcing of relevant materials and resources that will be needed to guide the research work analysis.
It will be quite tasking to fully analyze and explain the overall impact of monetary policy as regards capital structure because it will be difficult to cover all possible variables and their effect on bank financial performance because of the time and non-quantitative nature of some variables such as moral suasion.
Errors from data collected due to the state and nature of the banks may also add to the limitations, the inability of the researcher to authenticate his data would be a limitation. However, this will not limit this study.
Definition of Terms
Capital structure: The capital structure is how a firm finances its overall operations and growth by using different sources of funds. Also, The capital structure is how a firm finances its overall operations and growth by using different sources of funds.
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. This term is also used as a general measure of a firm’s overall financial health over a given period and can be used to compare similar firms across the same industry or to compare industries or sectors in aggregation.
Return on Assets (ROA): Return on assets shows the percentage of how profitable a company’s assets are in generating revenue. ROA= Net Income / Total Assets multiplied by 100. This number tells you what the company can do with what it has.
Return on Equity (ROE): Return on Equity measures the rate of return for ownership interest shareholders’ equity of common stock owners. It measures the efficiency of a firm at generating profits from each unit of shareholder equity, also known as net assets or assets minus liabilities.
Total Debt Ratio: The debt ratio is a financial ratio that measures the extent of a company’s leverage. The debt ratio is defined as the ratio of total debt to total assets.
Debt to Equity Ratio: Debt to Equity ratio a financial liquidity ratio that compares a company’s total debt to total equity. The debt to equity ratio also shows the percentage of company finance that comes from creditors and investors.
Banks: A bank is a financial intermediary that creates credit by lending money to a borrower, thereby creating a corresponding deposit on the bank’s balance sheet.
Bank Deposit: Bank deposits are made to deposit accounts at a banking institution, such as saving accounts, checking accounts and money market accounts. The account holder has the right to withdraw any deposited funds, as outlined in the terms and conditions of the account.
Bank Assets: The asset portion of a bank’s capital includes cash, government securities and interest-earning loans like mortgages, latter’s of credit and inter-banks loans.
Organization of the study
This study comprises of five chapters. Chapter one concerns itself with the introductory aspect of the study which gives an insight into the subject matter of the study. This chapter provides the intended direction of the study and under it are such issues as the overview, statement of the problem, objectives, hypotheses, significance, scope, limitations, Organization and definition of terms. Chapter two reviews related literature on capital structure and financial performance of deposit money banks in Nigeria. Chapter three describes the methodology; chapter four forms the core part of the study which deals with the presentation and analysis of data collected from the study. Chapter five is devoted to the discussion of findings, conclusions, and recommendations of the research.
Table of Contents
Title Page i
Declaration ii
Certification iii
Dedication iv
Acknowledgments v
Table of Content vi
Abstract…………………………………………………………………………….,x
1 CHAPTER ONE: INTRODUCTION
1.1 Background to Study…………………………………………………………..1
1.2 Statement of the Problem……………….……………………………………..5
1.3 Aims and objectives of the Study……………………………………………..7
1.4 Research Question…………………………………………………………….7
1.5 Research Hypotheses…………………………………………………………8
1.6 Significance of Study…………………………………………………………8
1.7 Scope of the Study……………………………………………………………10
1.8 Limitations……………………………………………………………………11
1.9 Definitions of Terms………………………………………………….……..12
1.10 Organization of Terms…………………………………………….…………13
2 CHAPTER TWO: LITERATURE REVIEW
2.1 Conceptual Framework
2.1.1 Debt Financing ………….………………………………………………..16
2.1.2 Capital Structure ……………………………………………..……………16
2.1.3 Equity Financing …………………………………………………………19
2.1.4 Leverage and Bank Financial Performance …………………………………20
2.2 Theoretical Framework
2.2.1 Modigliani and Miller Approach ………………….…………………….47
2.2.2 The Trade-off Theory ………..…………………………………………..49
2.2.3 Agency Theory of Capital Structure …………………………………….52
2.2.4 Pecking Order Theory of Capital Structure ………………………………54
2.3 Empirical Framework………………………………….…………………64
2.4 Gap in Literature…………………………………………………………71
3 CHAPTER THREE: RESEARCH METHODOLOGY
3.1 Introduction……………………………………………………………….73
3.2 Research Design……………………………………………………………73
3.3 Population of the Study……………………………………………………74
3.4 Sample Size………………………………………………………………..74
3.5 Operational measures of Variables
3.5.1 Dependent Variable……………………………………………………….75
3.5.2 Independent Variable……………………………………………………..75
3.6 Model Specification………………………………………………………76
3.7 Data Analysis………………………………………………………….….78
4 CHAPTER FOUR: DATA PRESENTATION AND ANALYSIS
4.1 Introduction…………………………………………………………………80
4.2 Descriptive Statistics………………………………………………………..82
4.3 Regression Analysis…………………………………………………………86
4.4 Result Analysis………………………………………………………………87
4.4.1 Relative Statistics…………………………………………………………88
4.4.2 Global utility of Model……………………………………………………90
5 CHAPTER FIVE: SUMMARY, CONCLUSION, AND RECOMMENDATIONS
5.1 Summary………………………………………………………………………….93
5.2 Conclusion……………………………………………………………….….94
5.3 Recommendations…………………………………………………………..95
5.4 Suggestions for further Study……………………………………………….96
Appendix A………………………………………………………………………97
Appendix B……………………………………………………………………… 99
References……………………………………………………………………….100
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