IMPACT OF CAPITAL STRUCTURE ON CORPORATE PERFORMANCE IN NIGERIA

Abstract

This study examines the concepts of capital structure and corporate performance in Nigeria. The broad objective of the study is to examine the relationship between capital structure and return on capital employed and also to find out if there is a relationship between capital structure and return on equity. The random sampling technique is adopted in the study. The population consists of all quoted companies in the Nigerian capital market. Data were obtained from annual report and accounts of the sampled companies. Data collected were analyzed using the descriptive statistics while hypotheses formulated were tested using the ordinary least squares techniques. The findings indicated that there is a positive relationship between capital structure and return on asset managed and that there is a negative relationship between capital structure and return on equity. The study recommended among others that companies especially the manufacturing sector should not borrow the maximum amount they are able to and should hold a reserve of borrowing capacity.

TABLE OF CONTENTS

Title Page                                                                         i

Certification                                                             ii

Dedication                                                               iii

Acknowledgments                                                    iv

Abstract                                                                   v

Table of Contents                                                     vi

Chapter One: Introduction                                   

1.1   Background to the Study                                                 1

1.2   Statement of Problem                                              3     

1.3   Research Questions                                                         4

1.4   Objectives of the Study                                            4

1.5   Statement of Hypotheses                                         5

1.6   Significance of the Study                                                 6

1.7   Scope of the Study                                                   6

1.8   Limitations of the Study                                          7

1.9   Definition of Terms                                                   8

Chapter Two: Review of Related Literature

Chapter Three: Research Method and Design      

3.1   Introduction                                                             51

3.2   Research design                                                       51   

3.3   Description of the Population of the Study                      51

3.4   Sample Size                                                             52

3.5   Sampling Techniques                                              52   

3.6   Sources of Data Collection                                       52   

3.7   Method of Data Presentation                                   53

3.8   Method of Data Analysis                                          53

Chapter Four: Data Presentation, Analysis and Hypothesis Testing                                                   

4.1   Introduction                                                             56

4.2   Presentation of Data                                                57   

4.3   Data Analysis                                                           58

4.4   Hypothesis Testing                                                  59   

        Chapter Five: Summary of Findings, Conclusion

and Recommendations                                         

5.1   Introduction                                                             68

5.2   Summary of Findings                                              68   

5.3   Conclusion                                                              68

5.4   Recommendations                                                   70

References                                                               72

CHAPTER ONE

INTRODUCTION

1.1   Background to the study

The majority of Nigerian banks are in ruins which may not be unconnected with the capital structure (debt-equity mix) of the bank. It is therefore imperative for financial manager of bank to determine the proportion of equity-capital and debt-capital to obtain financing mix that will give us optimal capital structure. An optimal capital structure is a critical decision for any business organization (Pandey, 2005). The decision is important not only because of the need to maximize returns to various organizational constituencies but also because of the impact such decision has on an organization’s ability to deal with its competitive environment.

Capital structure is used to represent the proportionate relationship between debt and equity. Equity includes paid- up share capital, share premium, reserves and retained earnings. In the case of debt,
short term borrowing are traditionally excluded from the list of method of financing the firm capital budgeting decision and therefore the long-term claims (such as long term loan and debentures) are said to be a part of the capital structure. The question then is; how much equity do we have? Or how much equity can be raised from all sources? And where will the equity come from? For the majority of companies these questions are relevant, since the corporation did not need to maintain separate equity for their branches.

In as much as capital investment decisions have implications for many aspects of operations and often exert a crucial impact on survival, profitability and growth. Much of the theory in the corporate sector is based on the assumption that the goal of firm should be to maximize the wealth of its current shareholders. One of the major cornerstones of determining this goal is financial ratio. Financial ratios are commonly used to measure firm performances. Generally, corporation includes them in their annual reports to stakeholders. Investment analysts provide them for investors who are considering the purchase of a firm’s securities.

Financial ratio represents an attempt to standard
financial information to facilitate meaningful comparisons. It provides the basis for answering some very important questions concerning the financial wellbeing of the firm. Its objectives are to determine the firm’s financial strengths and to identify its weaknesses (Mahdi & Kumars, 2009). This study would therefore seek to establish the fact that there is a relationship between the capital structure and corporate performance.

1.2   Statement of problem

Survival and growth needs resources but financing of these resources has limitations. The analysis of the impact of capital choice on profit is as important as the overall existence of the companies’ themselves. It is especially important when one is considering the dwindling fortunes of the aftermath of the global economic recession which might not have been unconnected with inappropriate capital

1.3   Research questions

To this end, the following problem questions are relevant and will be addressed by the study.

i.      What is the relationship between capital structure and Return on Capital Employed (ROCE)?

ii.     What is the relationship between capital structure and Return on Equity (ROE)?

iii.    What is the negative relationship between capital structure and Earnings per Share (EPS)?

iv.    What is the negative relationship between leverage and Return on Asset Managed (ROAM)?

1.4   Objectives of the study

The study aims at fulfilling the following objectives.

i.      To ascertain if there is a relationship between capital structure and Return on Capital Employed (ROCE).

ii.     To find out if there is a relationship between capital structure and Return on Equity (ROE).

iii.    To find out if there is a relationship between capital structure and Earnings per Share (EPS).

iv.    To ascertain if there is a relationship between leverage and Return on Asset Managed (ROAM).

1.5   Statement of hypotheses

The testable hypotheses of this research work can be stated thus:

Hypothesis One

HO:   There is a negative relationship between capital structure and Return on Capital Employed (ROCE)

HI:    There is a positive relationship between capital structure and Return on Capital Employed (ROCE)

Hypothesis Two

HO:   There is a negative relationship between capital structure and Return on Equity (ROE).

HI:    There is a positive relationship between capital structure and Return on Equity (ROE).

Hypothesis Three

HO:   There is a negative relationship between capital structure and Earning per Share (EPS).

HI:    There is a positive relationship between capital structure and Earning per Share (EPS).

Hypothesis Four

HO:   There is a negative relationship between Leverage and Return on Asset Managed (ROAM)

HI:    There is a positive relationship between Leverage and Return on Asset Managed (ROAM)

1.6   Significance of the study

Performance measurement is the base of investing and financing decision. Debt holders evaluate performance to decide about interest rate. Investors, on the other hand are interested in evaluating the performance to have knowledge of success of management in applying their capital (Mahdi & kumars, 2009).

To this end this research would help investors to ascertain the impact of capital structure (debt and equity mix) on financial performance.

1.7   Scope of the study

The entire firms in the Nigerian Stock Exchange will constitute the population of the study. A sample of twenty (20) companies was selected to test the theoretical model. For these firms, data were collected for a five year period (2010 to 2015) to allow a thorough evaluation of the capital structure and corporate performance. Based on this, any conclusion, Referencing and recommendation arising from this study may be applicable to other industry or companies in Nigeria.

1.8   Limitations of the study

The problems encouraged in the course of this research include:

1.     Inadequate Study Materials: Research materials were of limited supply due to the practically of the study. Where they were available; the cost involved in sourcing for them was very expensive.

2.     Lack of access of current Data: Most managements and staff of the establishment would not want to disclose important or relevant information about their organization on this subject matter, except were such is permitted by law to be disclosed.

1.9   Definition of terms

1.     Return On Capital Employed (ROCE): This is the ratio that indicates the efficiency and profitability of a company’s capital investments.

2.     Return On Equity (ROE): The amount of net income returned as a percentage of shareholders equity. Return on equity measures a corporation’s profitability by revealing how much profit a company generates with the money shareholders have invested.

3.     Return On Asset Managed (ROAM): This is a measure of profits shown as a percentage of the capital that is
handled. Return on assets managed is calculated by taking operating profits and dividing it by assets (which could include accounts receivable and inventory). Asset turnover and operating margin are the two main drivers in returns on assets managed.

4.     Return On Asset (ROA): This 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. Sometimes this is referred to as “return on investment”. ROA tells you what earnings were generated from invested capital (assets)

5.     Earnings Before Interest and Taxes (EBIT): This is an indicator of a company’s profitability, calculated as revenue minus expenses, excluding tax and interest. EBIT is also referred to as “operating earnings”, “operating profit” and “operating income”.

6.     Return On Investment (ROI): This is a performance measure used to evaluate the efficiency of an investment or to compare the efficiency of a number of taking operating profits and dividing it by assets (which could include accounts receivable and inventory). Asset turnover and operating margin are the two main drivers in returns on assets managed.

7.     Return On Asset (RCA): This 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, RCA is displayed as a percentage. Sometimes this is referred to as “return on investment”. ROA tells you what earnings were generated from invested capital (assets)

8.     Earnings Before Interest and Taxes (EBIT): This is an indicator of a company’s profitability, calculated as revenue minus expenses, excluding tax and interest. EBIT is also referred to as “operating earnings”, “operating profit” and “operating income”.
6. Return On Investment (ROT) - This is a performance measure used to evaluate the efficiency of an investment or to compare the efficiency of a number of different investments.

10.   Earnings Before Interest and Taxes and Depreciation (EBITD): This measure attempts to gauge a firm’s profitability before any legally required payments, such as taxes and interest on debt, are paid. Depreciation is removed because this is an expense the firm records, but does not necessarily have to pay in cash.

11.   Earnings Per Share (EPS): This is the portion of a company’s profit allocated to each outstanding share of common stock. Earnings per Share serve as an indicator of a company’s profitability.

12.   Equity: A stock or any other security representing an ownership interest.

13.   Dividend Per Share (DPS): This is the sum of declared dividends for every ordinary share-issued. Dividend per Share (DPS) is the total dividends paid out over an entire year (including interim dividends but not including special dividends) divided by the number of outstanding ordinary shares issued.

14.   Share Premium: This is the excess amount received by a firm over the par value of its shares. This amount forms a part of the non-distributable reserves of the firm which usually can be used only for purposes specified under corporate legislation.

15.   Retained Earnings: This is the percentage of net earnings not paid out as dividends, but retained by the company to be reinvested in its core business or to pay debt. It is recorded under shareholders’ equity on the balance sheet.