FINANCIAL LEVERAGE AND FINANCING DECISION EVIDENCE FROM NIGERIA
This study examined the relationship between financial leverage and financing decision. The data used for this study were obtained from the Nigerian Stock Exchange (NSE) between 2005-2010. A sample of 40 companies was used to carry out this study. The ordinary least square regression technique was used to test the hypotheses of the study. The study found a positive relationship between leverage and financing decision. Also firm size, profitability, interest charges and liquidity, all had positive relationship with financing decision.
The study recommends that firms who engage in the use of leverage should do so tat the least possible cost and also always try and employ the right financial mix when taking financing decision.
An appropriate financial structure is a critical decision for any business organization. The decision is important not only because of the need to maximize returns to various organizational constituencies, but also because of the impact such as decision has on an organization’s ability to deal with its competitive environment. Dare and Sola (2010).
A company can finance investment decision by debt and/or equity, this is known financing decision.
Afred (2007) suggested that a firm financial leverage implies the proportion of debt and equity in the total capital structure of the firm. Pandey (1999) differentiated between the firm. Pandey (1999) differentiated between finaical leverage and capital structure by affirming that the various means used to riase funds represent the firm capital structure, while founds represent the firm capable structure, while the financial leverage represents the proportionate, relationship between long-term debt and equity financing. However, whether or not an optimal financial structure exists, the need to minimize costs and thereby maximizing profit in relation to firm value is one of the most important and complex issues in corporate finance.
The numerous financing decisions are vital for the financing welfare of the company. An incorporate decisions about the financial structure may lead to significant financial distress and in all likelihood eventually result in bankruptcy. Ordinarily, board of management governing companies sets its financial structure in a way that companies value is maximized. Although, empirical research over the years links that there is an optimal financial structure, but there is no standardized methodology as of now that may enable financial managers to achieve an optimal level of debt.
Furthermore, the level of financial leverage of a certain company is determined by getting the total value of debt and equity. It is more risky for a company to have a high ratio of financial leverage. It has also been noticed that on the outcome of financial leverage, if the level of financial with debt is high, the more rise is anticipated profit on company’s equity, Dare and Sola (2010).
Thus, financial leverage is used in various circumstances as a means of altering the cash flow and financial position of a company. In the year 1958, Modigliani and Miller in their seminar work, theoretically examined and algebraically demonstrated the effect of financial structure on company value. Assuming perfect capital markets, they propounded to what is today widely known theory of “capital structure relevance and irrelevance theory, which means that the capital structure that a company chooses does not effects its value. Thereafter, many studies including Modigliani and Miller (1958) examined the effects of less restructure assumptions on the relationship between financial leverage and the company’s value.
Later in 1963, Modigliani and Miller took taxation under consideration and proposed that companies should employed as much debt capital as possible in order to achieve the optima capital structure, and the minimize costs and thereby maximizing benefit or firm value. Along the lines, with corporate taxation, numerous studies also analyzed the case of personal taxes imposed on individuals.
Miller (1977) suggested that tax rates in the tax legislation of some of the firm’s that evaluate the total value of the company depends on the relative percentage and importance of cash tax rate.
As further research examined the notion of financial leverage, several theories were propounded of an ptimal financial leverage based on balancing he advantages of debt financing structure. The main advantage of debt financing is the deduction available to interest payments while calculating taxable income, thereby allowing a tax shield for the companies. This enables companies to pay relatively lower taxes than they should, when using debt capital instead of using equity capital. The cost of debt can be analyzed primarily from two divergent aspects. On one hand, there is a higher probability that a company may be unable to meet its debt commitments (that is interest payments) leading to increased chance of bankruptcy.
On the other hand, there are agency costs of the leader’s monitoring and controlling the company’s actions. In addition, because of informational asymmetry, there are increased costs concerning the notion of financial leverage of the company that primarily arise because managers are in possession of superior information about the company’s future prospects as compared to the investors.
The effect of taxation on financial leverage has been extensively examined as a determinant of financial leverage. In addition, there are a few other determinants that attempt to throw light upon the methodology for determining the optimal financial leverage. These approaches tend to work towards establishing the debt level from the point of view of asymmetric information and agency costs. Jensen and Meckling (1976), pinpoint the existence of the agency problem which arises due to the conflicts either between managers and shareholders (agency cost of equity capital) or between shareholders and debt holders (agency cost debt capital).
1.2 STATEMENT OF THE PROBLEM
This research work tend to examine the effects of financial leverage on corporate finance in Nigeria.
The following research questions are stated in order to resolves the problem that currency confront the Nigeria economy.
(1) How does level of financial leverage of a company affects the quality of financing decisions?
(2) Is there significant relationship between financial leverage and quality of financing decision?
1.3 OBJECTIVE OF THE STUDY
(1) To ascertain the relationship between financial leverage and quality of financing decisions.
(2) To determine the effect of financial leverage on the quality of financing decisions.
1.4 RESEARCH HYPOTHESES
The following hypotheses would be tested in this study:
(1) There is significant relationship between financial leverage and quality of financing decisions.
(2) Financial leverage significantly impacts on the quality of financing decisions.
1.5 SCOPE OF THE STUDY
Due to the time constraint, this study will be limited to those area that are necessary for the purpose of investigation. Hence, the role of financial leverage and financing decisions on firms will be covered. Data from forty firms listed in the Nigeria Stock Exchange (NSE) within the period of six year 2005-2010.
1.6 SIGNIFICANCE OF THE STUDY
This study wants to contribute to the debate on the relationship between financial leverage and financing decisions. The findings and contributions will be useful to both public and private firms. Consultants and financial analysts will also find the study helpful in their financial and advisory service.
1.7 LIMITATION OF THE STUDY
In every research study, there is tendency that some factors will compete to limit the study. some of the factors are:
(1) Sample size: inability to get most data from companies.
(2) Financial constraint: the funds available to carry out the work is limited, especially surfing the internet materials.
(3) Time: this is usually the bane of most project work in the university.
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