CAPITAL STRUCTURE AND CORPORATE PERFORMANCE
The actual impact of capital structure on corporate performance in Nigeria has been a major problem among managers and researchers that have not been resolved. The issue of determining an optimal capital structure cannot be overemphasized considering the dwindling fortunes of firm’s aftermath of the global economic recession which might not have been unconnected with their inappropriate capital structure. To this end, the study examines the relationship between capital structure and corporate performance. It is motivated by a desire to explain debt (leverage) used by five (5) manufacturing related companies listed in Nigeria stock exchange during the period of 2006 – 2010 financial year and its related performance. A number of performance metrics which affect leverage was examined. These include Return on Capital Employed (ROCE), Return on Equity (ROE), Return on Asset Managed (ROAM), Earnings Per Share (EPS). Also, this paper discussed the financial difficulties faced by manufacturing companies in Nigeria. In light of this discussion, a number of question which then arose as to how related are these performance measures to the capital structure. This then lead to the formulation of seven hypotheses which were empirical analysed using the Ordinary Lease Square (OLS) regression technique on the company’s secondary data sources. The empirical findings revealed that out of the four (4) performances variable only three (3) of them had significant relationship with its capital structure which is represented by the leverage ratio. The result of this study suggests that, contrary to some capital structure theory, there is a negative association between the level of debt and corporate performance. This can be attributed to the high cost of borrowing and the underdeveloped nature of the debt market in Nigeria. And also, the tax savings that the companies receive by using debt does not seem to be sufficient to outweigh the costs of using debt. It is therefore, recommended that there should be moderate use of debt by manufacturing companies and other companies in general because in financial parlance, debt is a good example of the proverbial two edged sword.
TABLE OF CONTENTS
Statement of the Research Problem
Objectives of the Study
Scope of the Study
Relevance and Significance of the Study
CHAPTER TWO: LITERATURE REVIEW
Theories of Capital Structure
The Relationship Between Corporate Performance and Capital Structure
CHAPTER THREE: METHODOLOGY
Population and Sample
Sources of Data
The Research Instrument
Model Specification/Data Analysis Plan
Operationalization of Variables
Limitation of the Study
CHAPTER FOUR: PRESENTATION AND ANALYSIS OF DATA
Analysis of the Regression Result
Discussion of Findings
CHAPTER FIVE: SUMMARY, RECOMMENDATIONS AND CONCLUSION
Summary of Findings
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, 2009). 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 it’s 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 standardize financial information to facilitate meaningful comparisons. It provides the basis for answering some very important questions concerning the financial well-being of the firm. Its objectives is to determine the firm’s financial strengths and to identify its weaknesses (Mahdi, 2009).This study would therefore seek to establish the fact that there is a relationship between the capital structure and corporate performance.
STATEMENT OF THE RESEARCH 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 structure.
To this end, the following problem questions are relevant and will be addressed by the study.
What is the relationship between capital structure and return on capital employed (ROCE)?
What is the relationship between capital structure and return on Equity (ROE)?
What is the negative relationship between capital structure and earnings per share (EPS)?
What is the negative relationship between leverage and return on asset managed (ROAM)?
OBJECTIVES OF THE STUDY
The study aims at fulfilling the following objectives
To ascertain if there is a relationship between capital structure and return on capital employed (ROCE).
To find out if there is a relationship between capital structure and return on Equity (ROE).
To find out if there is a relationship between capital structure and earnings per share (EPS).
To ascertain if there is a relationship between leverage and return on asset managed (ROAM).
The testable hypotheses of this research work can be stated thus:
Ho1: There is a negative relationship between capital structure and Return on Capital Employed (ROCE)
Ho2: There is a negative relationship between capital structure and Return on Equity (ROE)
Ho3: There is a negative relationship between capital structure and Earning per share (EPS).
Ho4: There is a negative relationship between Leverage and Return on Asset Managed (ROAM)
SCOPE OF THE STUDY
The entire firms in the Nigeria Stock Exchange will constitute the population of the study. A sample of five (5) companies was selected to test the theoretical model. For these firms, data were collected for a five year period (2006 – 2010) from public available source. The choice of this period is 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.
RELEVANCE AND 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 Salehhi and Kumars Biglar, 2009).
To this end this research would help investors to ascertain the impact of capital structure (debt and equity mix) on financial performance.
Mahdi, S. and Kumars, B, (2009). “Study of the Relationship between Capital Structure Measures and Performance Evidence from Iran”. International Journal of Business and Management, 4: 97 – 103.
Pandey, I. M. (1999). Financial Management, 8th Edn., Vikas Publishing House, PVT Ltd, New Delhi India, 529 – 559.
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