DETERMINANTS OF FINANCIAL LEVERAGE BEHAVIOUR IN PUBLIC COMPANIES IN NIGERIA
Financial leverage decision have been the most significant decisions to be taken by any business organization for maximization of shareholders wealth and sustained growth.
The study examines the determinants of financial leverage behaviour in public companies in Nigeria. It sets to fill the gap in the literature by investigating the potential determinants of capital structure among listed Nigerian public companies for the period of six years from 2005-2010 both years inclusive. It examines the impact of firm’s tangibility, size, growth, profitability and age on the leverage of the sample firms. Secondary data from the annual reports of the sample firm have been analyzed using multiple regression. The result reveal that size, age, growth, profitability and tangibility are strong determinants of leverage in the Nigerian companies.
Therefore, it is recommended that in carrying out debt financing decision, the financial managers of Nigeria listed public companies should deploy and properly measure size, age, growth, profitability and tangibility of the companies in order to have an optimum financing mix for their companies.
1.1 BACKGROUND TO THE STUDY
In general, companies may raise money from internal and external sources. They can raise fund from internal sources by plowing back part of their profits, which would otherwise have been distributed as dividend to shareholders or they can raise money from external sources by an issue of debt or equity. The firm’s leverage decision centers on the allocation between debt and equity in financing the company. However, how the leverage of a firm is determined in a world in which cash flows are uncertain and in which capital can be obtained by many different media ranging from pure debt instruments to pure equity instruments is an unsettled issue. Rahul (2005).
An important consideration in financial decision is determining optimal level of capital structure since a right choice can maximize shareholder’s value. This corporate finance decisions can lead to the success or failure of a business. Poor management of capital structure will result in poor performance of a firm. In today’s business world, companies need to be supported by finance activities in order to meet their working capital requirements and investment activities. The financial sources for companies are different, They can be supported by internal or external resources. However, it is the concern of financial managers to decide the right choice of finance to fund the business. Maryam P. and Barjoy Albin B. (2012).
Capital structure is expedient for decision making of business firms and facilitates maximization of return, on investment as well as boosts the efficiency of financing and dividend decision. Financing decision facilitates the survival and growth of a business enterprise, which calls for the need to channel efforts of business towards realizing efficient financing decision, which will protect the shareholders interest. This implies effective planning and financial management through combination of an optimum capital structure by managers so as to maximize the shareholder’s wealth. A firm can finance investment decision by debt, equity or both. Such capital gearing could have implication for the shareholders earning and risk which could eventually affect the cost crucial decision made by financial managers and borders on the mix of debt and equity used by firms in financing their assets. Perceived as the pivotal to the growth and future of a firm, it is useful in dividend policy project financing issue of long term securities, financing of mergers among others. Chantrasekharan.
Despite the dearth of research related to the determinant of financial leverage on Nigeria public companies, most of the studies have provided contradictory findings. Shehu (2011) concludes that like other developing economies, the area of research for financial leverage is still unexplored in Nigeria. More so, some of these workers mainly focused on petroleum, banking and some manufacturing industries beyond 2006. This study is unique in the light of looking at the listed firms in Nigeria covering a period of 10 years (2001-2010). This reveals noticeable gap in the empirical research on capital structure among listed firms in Nigeria. The dependent variable is leverage and the independent variables are tangibility, firm size, profitability, firm growth and firm’s age. Therefore it is posited that determinants of financial leverage have no significant impact on the capital structure of Nigerian listed firms.
1.2 STATEMENT OF THE RESEARCH PROBLEM
According to ward and price (2006) a profitable business will experience a higher return on equity (ROE) as borrowing increase. Ward and Price (2006) also postulate the impact of debt or leverage, since a profitable firm is able to earn at higher rate than it is paying for borrowed funds.
In addition, the interest rate has significant effects on the risk ness of debt. Below is an except from the business day that demonstrates the impact of interest rates. South Africa’s manufacturing output growth showed sharply in official data showed this week, suggesting the sector is under strain from higher interest rate. The reserve bank has raise rates by a cumulative fire percentage points since June 2006 as it grapples with spiraling inflation, and analysts say the higher cost of borrowing is weighing on the productive sector and the economy as a whole (Mapenzauswa 2008).
The financial leverage structure acquired great importance specially after the emergence of miller assumption in 1958. Which was built on assumptions of a perfect world. This assumption stated that there was no difference between the use of sources of internal and external funding, or debt and equity. This result is untrue because we live in the real world. Theoretically, it is possible to say that there is optimal financing which leads to reduce the cost of capital to its lowest level. But practically there are many factors governing the financial structure. These factors are represented by the degree of risk that the management is willing to carry when financing through borrowing in order to obtain greater profitability in addition to the sensitivity of the lenders due to high debt on the company and the nature of activity practiced by the company and the nature of activity practiced by the company and growth ratios, stability of sale, competition and the size of assets. Therefore, identification of these factors will contribute significant in determining the capacity of the debt in companies (Shlash & Alen 2008).
1.3 THE RESEARCH QUESTION
1. What are the determinants of financial leverage behaviour public companies in Nigeria?
2. Is there relationship between financial leverage and the determinants?
1.4 OBJECTIVES OF THE STUDY
This study seeks to achieve the following objectives.
1. Identifying the determinants of financial leverage behaviour in public companies in Nigeria.
2. To assess the relationship between financial leverage and the determinants.
1.5 THE RESEARCH HYPOTHESES
For better understanding of determinants of financial leverage in public companies, the following hypothesis can be frame.
1. There is a negative relationship between leverage ratios and firm size.
2. There is positive relationship between leverage ratios and profitability.
3. There is a negative relationship between leverage ratios and risk. 4.There is positive relationship between leverage ratio and tangibility.
1.6 SIGNIFICANCE OF THE STUDY
The significance of this study stems from the assumption that is illustrates the determinants of financial leverage in public companies, and provide help in how to select suitable financial structure of the company. The practical benefit of the study are the following.
1. Helping companies in taking decision related to capital structure, which increases the market value of the company.
2. Helping companies in estimating the financial risk, generates from the increase of debt ratio to owners equity, taking into account the determinants of financial structure and the risk of financial leverage.
1.7 SCOPE AND LIMITATION
A number of constraints which to a large extent affected the early completion of this work were faced.
1. Lack of sufficient data to meet the research needs of this project on time.
2. The insufficient in time schedule allowed for the research.
3. Finally, the inadequate finance in carrying out the research project in the manner and magnitude that one would have desired cannot be over emphasized.
1.8 DEFINITION OF TERMS
1. Finance Leverage
Financial leverage is caused due to fixed financial cost in firm. It is the ability of a firm to use fixed financial charges to magnify the effects of changes in EBIT on the earning per share. It involves the use of funds obtained at a fixed cost in the hope of increasing the return to the shareholders. The financial leverage employed by a company is intended to earn more return on fixed charge funds than their cost. the surplus (or deficit) will increase (or decrease) the return on the owners equity. The rate of return on the owner’s equity is levered above or below the rate of return on total assets.
The employment of asset or sources of funds for which the firm has to pay fixed cost or fixed return is termed as leverage.
A debt is an obligation owed by one party (the debtor) to a second party, the creditor usually, this refers to assets granted by the creditor to the debtor but the term can also be used metaphorically to cover moral obligation and other interaction not base on economic value.
Equity is the ownership interest of investors in a business in the form of common stock or preferred stock. Equity ownership in the firm means that the original business owners no longer own 100% of the firm but share ownership with others.
Arif, S. & Muhammad, S. (2011). The impact of financial leverage to profitability study of non financial companies listed in Indonesia stock exchange, European Journal of economics, finance and administrative science, 32, 136-148.
Bei, Z. & Wijewardana, P. (2012). Financial leverage, firm growth and financial strength. Evidence in Srilanka, journal of Asia pacific business innovation & technology management, 2, 13-22.
Chandrasekharan, C.V. (2012). Determinants of capital structure in the Nigeria listed firms, international journal of advanced research in management and social science 1(2), 108-133.
Kuben, R. (2008). Financial leverage and firm value, Gorden institute of business science journal. 1-102.
Maryan, P. & Barjoyaibin (2012). Leverage behaivour of Malysia manufacturing companies, a case observation of the industrial sectors companies in Bursa Malaysia international research journal of finance and economics, 90, 54-65.
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