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THE IMPACT
OF FINANCIAL STRUCTURE ON PERFORMANCE OF QUOTED FIRMS IN NIGERIA
ABSTRACT
Financial
structure is financing decision undertaken by a firm in the course of funding
its corporate investment. It entails the mixture of debt and equity capital to
finance firm’s assets. The impact of financial structure has been inconclusive
in literature. It is on the premise of the foregoing that the study sought to
examine the impact of financial structure surrogated as short-term debt ratio,
long-term debt ratio, stock/shareholders’ fund on performance of quoted firms
in Nigeria (measured by return on asset). Panel data were collated from the
published financial reports of ten firms over a six-year period ranging between
2011 and 2016. The data were subjected to pooled ordinary least square
technique and Hausman tests. The Hausman tests indicated that random-effect
model is more appropriate to estimate the four specified models. The results
revealed that financial structure represented by short-term debt ratio
(β=-0.21; p<0.05); long-term debt ratio (β=-0.33; p<0.05);
stock/shareholders’ funds (β=-0.42; p<0.05) and short-term liabilities
(β=-0.40; p<0.05) had significant negative impact on the performance of
selected quoted firms in Nigeria. The study suggested amongst others that it is
important for government to pursue genuine policy measures targeted at
developing the security market to ensure high volume of corporate debt issue,
liquidity of market and market efficiency in order to ensure smooth allocation
and mobilization of funds to quoted firms in Nigeria.
CHAPTER ONE
INTRODUCTION
1.1 Background to the
Study
Financial
structure involves financing decision undertaken by a firm in the pursuit of
financing its corporate investment. Financial structure involves the mix of
debt and equity to finance the assets of a firm. The inherent risks in business
environment have contributed to every corporate organization to structure its
financing decision towards achieving the objectives of profitability and wealth
maximization. According to Itiri (2014), the financing decision of a firm
varies according to the rate of risk related to each financing options as well
as the relationship between risk and return. Firm seek to adopt a mixed
financial structure that guarantees minimum cost to achieve the goal of profit
maximization. The effect of financial structure on performance of a firm is
controversial due to broadened debate from various perceptions. The core
argument among scholars in two dimensions namely irrelevance and relevance
theories of financial structure. The irrelevance theories of financial
structure contends that under the restrictive assumptions of perfect capital
markets, homogenous expectations of investors, symmetric information and
absence of bankruptcy cost, financial structure has no effect on performance of
firms (Onaolapo&Kajola, 2010). On the other hand, relevant theories with
imperfect market assumptions maintained that financial structure has either
positive or negative significant effect on performance of firms
(Zeitun&Tian, 2007).
Financial
structure relates to the combination of sources from which long-term funds are
raised for the firm. Financial structure is equally the composition of a firm’s
long-term funds consisting of common equity, preference equity and debt
(Nwolisa & Chijundu, 2016). The financial structure of a firm consists of
various sources, which are presented in the equity and liability side of the
balance sheet. Financial structure indicates the ratio between owned and
borrowed capital. While planning the financial structure of a firm, there
should be proper balance between debt and equity. Although, there are no hard
and fast rules as regard the optimal financial structure, a firm may opt for
equity financing or may adopt the mix of equity and debt financing.
The
financial structure decision of a firm is imperative for it to effectively
compete in the corporate environment. The decision is equally important because
of the need to maximize returns to various constituencies of a firm. The desire
of most firms is to have a mix of debt, preferred stock and common stock which
will maximize the wealth of shareholders (Modugu, 2013; Njagi, 2013). The
average weighted cost capital depends on the combination of different
securities in the financial structure. A change in different securities in the
financial structure will change the financial structure. Thus, there will be a
combination of different securities in the financial structure at which
weighted average cost capital will be the least (Dare& Sola, 2010; Itiri,
2014).Nwolisa&Chijundu (2016) aver that a world without corporate taxes
financial structure is useless. The value of the firm is independent of the
financial structure decision as the value of a firm equals operating income
divided by operating cost of capital. Thus, the mix between debt and equity is
not important. Any benefit of low cost debt is completely offset by an increase
in cost of equity due to use of borrowing.
In an
attempt to explain the impact of financial structure decision on firm
performance, several theories such as pecking order theory, trade-off theory
and agency cost theory have been developed by scholars. The perking order
theory maintains that equity is a less preferred means to raise capital because
managers issue new equity (Njagi, 2013). Investors believe that managers
overvalue the firms and are taking advantage of this overvaluation and they
places a lower value to the issuance of new equities. The perking order theory
preserves that businesses adhere to a hierarchy of financing sources and prefer
internal financing when available and debt is preferred to equity. The agency
cost theory championed by Jensen (1976) states that the relationship between
managers, shareholders and debt holders influence the financial structure of a
firm. The agency cost theory believes that the optimal financial structure of
the capital emanates from a concession between sources of financing through
common equity, preference equity and debts such that conflict of interest
between suppliers of funds (equity and debt holders) and managers is appeased.
Ebaid (2009) argues that the indebtedness allows shareholders and managers to
align have similar objectives, but causes conflict between managers and
shareholders on one hand, and creditors on the other-hand. The optimal level of
indebtedness is the one that minimizes the total agency costs. Test of the
agency theory regress measures of financial structure on performance indicators
of firms and some control variables. The study attempts to examine the impact
of financial structure on performance of quoted firms in Nigeria using recent data
of quoted firms to cover gap in literature.
1.2 Statement of Problem
The impact
of financial structure decision on performance of firms is inconclusive due to
arguments from various points of view. The subsisting empirical studies to
prove the impact of debt and equity mix on firm performance in Nigeria is
streamlined to capital structure measures with established conflicting views
deduced from the inconsistencies among their findings. Thus, the conclusions
and results of past studies may be misleading. For instance, Adelegan (2007)
report a negative and insignificant effect of financial structure on firm
performance and leverage. Also, the
findings of Itiri (2014); Nwaolisa & Chijundi (2016) indicate a negative
and significant effect of financial structure on firm performance. In addition to these, Dare & Sola (2010)
found a positive and significant effect of financial leverage on corporate
performance of oil firms in Nigeria.
Financial
structure variables have a better chance to produce unbiased result, because of
different empirical implications as regard different types of debt instrument.
However, in underdeveloped financial system in less developed countries likes
Nigeria, the external debt finance of most firms is majorly short term finance,
imposing extra burdens at very high costs on the firm. For example, Modugu
(2013) argues that significant results are good reason for adopting different
measures of leverage ratios because some of the theories of financial structure
have different implications for not adopting the narrow definition of leverage
ratios. Furthermore, it is worthwhile to differentiate short-term debt,
long-term debt and total debt effects since they have different risk and return
profiles (Zuraidah, et al, 2012). This disclosure pops an important research
question on the effectiveness of financial structure in fostering the
performance of quoted firms in Nigeria. To this end, the study sought to
investigate the effect of different measures of financial structure on the
performance of quoted firms in Nigeria.
1.3 Objectives of the Study
The main
objective of the study is to examine the impact of financial structure on the
performance of quoted firms in Nigeria. The specific objectives of the study
are:
To investigate the effect of short-term
debt ratio on the performance of quoted firms in Nigeria.
To explore the impact of long-term debt
ratio on the performance of quoted firms in Nigeria.
To assess the effect of Stock holders
(share holders) on the performance of quoted firms in Nigeria.
To evaluate the effect of short term
liabilities on the performance of quoted firms in Nigeria.
1.4 Research Questions
Based on the
objectives of the study, the questions that necessitated the study are:
To what extent do short-term debt ratio
impacts on the performance of quoted firms in Nigeria?
To what extent do long-term debt ratio
affects the performance of quoted firms in Nigeria?
To what extent do Stock holders (share holders)
affects the performance of quoted firms in Nigeria?
To what extent do short term liabilities
has effects on the performance of quoted firms in Nigeria?
1.5 Research Hypotheses
The research
hypotheses guiding the study are stated as follows:
H01:
Short-term debt ratio has no significant effect on the performance of
quoted firms in Nigeria.
H02:
Long-term debt ratio has no significant effect on the performance of
quoted firms in Nigeria.
H03:
Stock holders (share holders) have no significant effect on the
performance of quoted firms in Nigeria.
H04:
Short term liabilities have no significant effect on the performance of
quoted firms in Nigeria.
1.6 Significance of the Study
The study
has immense benefits to financial analysts, investors and firms, regulators and
future researchers. The study helps financial analysts to infer the nature of
equity and debt position of sampled firms and also reveals the risk of interest
bearing assets. The study equally enables decision makers to restrain from
unwholesome practices in financing pattern of most firms when analysts can
establish the real class of firm’s assets.
The study
enables investors and firms to ascertain the risk nature of their investment in
financial instruments. It also provides an in-depth knowledge to firms on the
way to reduce the price of their floating assets relatively to inherent risk of
the assets, in reducing the volatility of their earnings.
The study is
also important to regulators and other participants in financial and real
sector as it enlightens them on the need to enhance development in the sectors.
The study
serves as a veritable material that can be consulted by students, researchers
and academic on the subject matter in their future research undertakings.
1.7 Scope of the Study
The study
examines the effect of financial structure on performance of firms with respect
to non-financial firms in Nigeria. Firms in the financial sector such as
commercial banks, merchant banks, insurance firms, mortgage banks and other
specialized financial institutions are excluded in the study because their
financial structure are excessively regulated as a result of the restrictions placed on them by regulatory authorities,
which consequently influences their financial structure relative to
performance.
Firms
operating in the ICT, cement, food & beverage, pharmaceutical and
agriculture industries are considered in the study. The study covers a six (6)
year period ranging from 2011 to 2016.
1.8 Definition of Key Terms
The terms
important to the study are defined as follows:
Capital:
This refers to financial assets or the financial value of assets, such as funds
held in deposit accounts, as well as the tangible machinery and production
equipment used in the firm such as factories and other manufacturing
facilities.
Financial Structure:
This refers to the balance between all of the liabilities and equities of a
firm. It covers the entire liabilities and equities side of a balance side of
the balance sheet.
Equity: This
refers to the ownership interest or claim of a holder of common stock (ordinary
shares) and some types of preferred stock (preference shares) of a company. On
a balance sheet, equity represents funds contributed by shareholders plus
retained earnings and minus accumulated losses.
Debt: This
refers to a duty or obligation to pay money, deliver goods or render service
under an express or implied agreement. The use of debt in the financial
structure of a firm creates financial leverage that can multiple yield on
investment provided returns generated by debt exceed its cost.
Firm
Performance: There is no consensus about the definition, dimensionality and
measurement of firm performance. The concept is explained via ratio analysis.
Ratio analysis helps managers and shareholders to analyze the financial health
of a company. The performance of a firm can be captured from the angle of
profitability, liquidity, leverage and wealth maximization.
Quoted
Firms: These are public joint stock companies whose shares are traded either on
the main stock exchange or related secondary market such as unlisted securities
markets.
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