Masters Project Topics in Accounting and Finance
ABSTRACT
There exists divergence of opinion in literature on the relationship between capital structure
and firms financial performance. This mix of opinions makes the direction of the
relationship between debt holders and equity holders to be controversial. Therefore, this
study investigated the impact of capital structure on financial performance of listed
manufacturing firms in Nigeria. The study formulated four hypotheses and used generalized
least square multiple regression to analyze the secondary data extracted from the annual
reports and accounts of the 31 sampled firms for the period 2009 to 2014. The study found
that total debt, long-term debt and short-term debt have significant impact on the financial
performance of listed manufacturing firms in Nigeria. The study also found that total debt to
total equity has no significant effect on the financial performance of the firms. In view of the
findings, it is recommended among others that the management of listed manufacturing
firms should work very hard to increase the short term debt to total assets component of
their capital structure, since it has positive impact on their financial performance. Also, the
firms should reduce the level of total debt to total assets and long term debt to total assets in
their capital structure components, because they affect their financial performance
negatively.
M.Sc Project Topics in Accounting and Finance
CHAPTER ONE
INTRODUCTION
1.1 Background to the
Study
The
nature and extent of relationship between capital structure and financial
performance of firms have attracted attention in the literature of finance.
Capital structure involves the decision about the combination of the various
sources of funds a firm uses to finance its operations and capital investments.
These sources include the use of long-term debt finance called debt financing,
as well as preferred stock and common stock also called equity financing. One
of the most important goals of financial managers is to maximize shareholders
wealth through determination of the best combination of financial resources for
a company and maximization of the company’s value by determining where to
invest their resources. Capital structure represents the major claims to a
corporation’s asset. This includes the different types of equities and
liabilities (Riahi-Belkaoui, 1999). The debt-equity mix can take any of the
following forms: 100% equity: 0% debt, 0% equity: 100% debt; and X% equity: Y%
debt. From these three alternatives, the first option is that of the unlevered
firm, that is, the firm shuns the advantage of leverage (if any). Option two is
that of a firm that has no equity capital. This option may not actually be
realistic or possible in the real life economic situation, because no provider
of funds will invest money in a firm without equity capital. This partially
explains the term “trading on equity”, that is, the equity element that is
present in the firm’s capital structure that encourages the debt providers to
give their scarce resources to the business. The third Option is the most
realistic one in that, it combined both a certain percentage of debt and equity
in the capital structure and thus, the advantages of leverage (if any) is
exploited. This mix of debt and equity has long been a subject of debate in
finance literature concerning its determination, evaluation and accounting.
Financial
performance is the measure of how well a firm can use its assets from its
primary business to generate revenues. Erasmus (2008) noted that financial
performance measures like profitability and liquidity among others provide a
valuable tool to stake holders which aids in evaluating the past financial
performance and current position of a firm. Financial performance evaluation
are designed to provide answers to a broad range of important questions, some
of which include whether the company has enough cash to meet all its
obligations, is it generating sufficient volume of sales to justify recent
investment. Capital structure is closely linked with financial performance
(Tian and Zeitun, 2007). Financial performance can be measured by variables
which involve productivity, profitability, growth or, even, customers‟ satisfaction.
These measures are related among each other. Financial measurement is one of
the tools which indicate the financial strengths, weaknesses, opportunities and
threats. Those measurements are return on investment (ROI), residual income
(RI), earning per share (EPS), dividend yield, return on assets (ROA),, growth
in sales, return on equity (ROE),e.t.c (Stanford, 2009).
One
of the main factors that could influence the firm's performance is capital
structure. Since bankruptcy costs exist, deteriorating returns occur with
further use of debt in order to get the benefits of tax deduction and interest.
Therefore, there is an appropriate capital structure beyond which increases in
bankruptcy costs are higher than the marginal tax-sheltering benefits associated
with the additional substitution of debt for equity. Firms are willing to
maximise their performance, and minimise their financing cost, by maintaining
the appropriate capital structure or the optimal capital structure.
Previous
studies on capital structure have used different proxies to measure capital
structure. The measures commonly used in the literature in form of ratios
include total debt to total assets, total debt to total equity, short term debt
to total assets and long term debt to total assets. Total debt to total assets
is the amount of debt used to finance firms‟ assets and other capital
expenditure that can improve firms‟ performance. Thus, it is expected that
increasing leverage components of a firm’s capital structure may increase the level
of efficiency and thereby increasing their performance. Company‟s managers who
are able to identify the level of leverages as components of firms‟ capital
structure are rewarded by reducing firm‟s cost of finance thereby maximizing
the firm’s revenue (Zeitun & Tian, 2007). Total debt to total assets
measures the amount of the total funds provided by outsiders in relation to the
total assets of the firm. It shows the extent of cover for debts of a company
by total assets. It described the extent to which a business or investor is
using the borrowed money. Generally, investors would prefer low ratio for all
debts, because the lower the ratio the better the cushion against the creditors
losses in the event of liquidation. Most firms use debt to finance their
operation with the hope of improving their performance. By doing so, a company
increases its leverage because it can invest in business operations without
increasing its equity.
Total
debt to total equity is also expected to have an influence on a firm’s
performance. Total debt to total equity assesses the extent to which a firm is
using borrowed funds. It shows the extent to which a firm is using borrowed
funds in relation to its equity. It indicates the solvency of the business and
the extent of cover for external liabilities. It also measure of a company’s
financial leverage calculated by dividing its total liability, by stockholders
equity, it indicates what proportion of equity and debt a company is using to
finance its assets (Ojo, 2012). Total debt to total equity is a measure of how
much firm uses equity and debt. Investors prefer the ratio to be lower; because
the lower ratio the higher the level of firms financing that is being provided
by shareholders and the larger the cushion (margin of protection) in the event
of shrinking asset values or outright losses. From the creditor‟s point of
view, it is possible that debt to equity helps in understanding business risk
management strategies and how firms determine the likelihood of default
associated with firms‟ financial performance (Kurfi, 2003). Semiu and Collins
(2011) see equity capital as including share-capital, share premium, reserves
and surpluses (retained earnings).
Short
term debt to total assets is another item in a firm’s capital structure that
affects its financial performance. Short term debts to total assets affect the
financial performance of a firm either negatively or positively. Short-term
debt to total asset measures the relative short-term debts to total assets of a
firm are to meet it financial obligation over the accounting period. Some
scholars argue that the shorter the debt the better the firm is in improving
its performance. Understanding the relationship between long term debt to total
assets and performance of various sectors of an economy is important to all
stakeholders. Long-term debt to total assets measures the relative weight of
long-term debt to the capital structure (long-term financing) of the firm in
long run. The level of long-term debt of a firm is also believed to be one of
the forces expected to influence the performance of a firm. A firm that has a
higher long-term debt as proposed by previous studies would have little
resources to take care of some other objectives and vice versa (Kurfi, 2013).
As
firm financial capital is an uncertain but critical resource for all firms,
providers of finance are able to exert control over firms. Debt and equity are
the major classes of capital structure, with debt holders and equity holders
representing the two types of investors in a firm. Each of them is associated
with different levels of control, benefits and risk. While debt holders exert
lower control, they earn a fixed rate of return and are protected by
contractual obligations with respect to their investment. Equity holders are
the real owners of a firm, bearing most of the risk and correspondingly, have
greater control over decisions (Aliu, 2010).
The
use of debt in an organizations capital structure has both positive and
negative effects on its financial performance. Organizations that use an
optimum amount of debt in their capital structure have enhanced firm value
which is manifested in the form of increased sales, efficiency in production
and low taxes. While firms with different cases of sub optimal use of debt in
their capital structure usually suffer from a variety of financial ailments
which Rajan and Zingales (1995) described as payment of high taxes, high
proportions of accounts payable, large deficits in the firms cash flow and in
some cases corporate dissolution. Accordingly Modigliani and Miller (1963)
suggested that firms should incorporate more debt in their capital structure in
order to maximize the firm‟s value which is manifested through high profits,
increased share prices and efficiency in management. The capital structure
theory originated from the famous work of Modigliani and Miller (M & M)
(1958). They argued that, under certain conditions, the choice between debt and
equity does not affect a firm‟s value and hence, the capital structure decision
is irrelevant; but in a world with tax-deductible interest payment, firm value
and capital structure are positively related. M & M (1958) pointed out the
direction that capital structure must take by showing under what conditions the
capital structure is irrelevant. Titman (2001) lists some fundamental issues
that make the M & M proposition hold as: no taxes, no transaction cost, no
bankruptcy cost, perfect contracting assumptions and complete and perfect
market assumption. The M & M presentation became a subject of considerable
debate both in theoretical and empirical research. The work of M & M has
been criticized by many scholars in view of the fact that in the real world
situation, the main assumptions never hold. They argued that in a „non-perfect‟
world, there are factors influencing capital structure decision of a firm.
Since
the presentation of M & M‟s irrelevance propositions, a lot of issues have
been raised with respect to capital structure. Many researchers have attempted
to establish whether their theory is realistic and capable of resolving basic
financing decision problems regarding optimal capital structure for individual
firm and the effect of an appropriate financing mix on firm performance and in
what condition is the choice of capital structure relevant (Aliu 2010). Their
studies however, have provided different opinion on the direction of their
association. The mixed and inconclusive findings provided motivation for
further studies in this area to determine whether capital structure has an
influence on financial performance of firms in different sectors of the
economy. The fact that manufacturing firms in Nigeria frequently use leverage
to finance their operation through debt or equity or both, the extent to which
capital structure affects their operation has been an issue of concern. It has
been argued that the fastest trend through which a nation can achieve sustainable
economic growth and development is neither by the level of its endowed material
resources nor that of its vast human resources but technological innovation,
enterprise development and industrial capacity. In the modern world,
manufacturing sector is regarded as a basis for determining a nation economic
efficiency.
Arising
from the strategic importance of the manufacturing sector to an economy such as
Nigeria‟s, it is important for investors and shareholders to understand the
effect of capital structure on the performance of manufacturing firms. This is
because capital structure decision on how to finance their assets by debt or by
equity will affect relationship with the final result for any given period
since it influences the returns and risks of shareholders and consequently
affects the market value of the shares. In view of this, it becomes imperative
to study the relationship between capital structure and financial performance
of manufacturing firms in Nigeria.
M.Sc Project Topics in Accounting and Finance
CAPITAL STRUCTURE AND FINANCIAL PERFORMANCE OF LISTED MANUFACTURING FIRMS IN NIGERIA
Department: Accounting and Finance (M.Sc)
Format: MS Word
Chapters: 1 - 5, Preliminary Pages, Abstract, References, Appendices.
Delivery: Email
Delivery: Email
No. of Pages: 91
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