Capital Structure And Corporate Performance In Nigeria

Taking financing decision is one of the major functions of a financial manager. A corporation may decide to use all equity capital or a combination of debt and equity capital. However, the decision to use debt as part of a corporation capital is important as it can magnify shareholders returns and also increase the risk of such returns.

The relationship between capital structure and corporate performance implies that there are certain factors that can improve performance. These ranges from managerial skills, professionalism, dividend policy and so on.

Introduction

1.1 Background of the Study

One of the most important factors in the survival of any corporation is capital, various corporation have designed different capital structures based on what is most suitable to them. But the question is, how do corporation determine their capital structure. How do they decide or reach a decision in terms of the ratio of debt to equity in the capital structure? Corporations are faced with the task of designing a capital structure that is optimal that is the particular combination of funds that minimize the cost of capital while maximizing the firms" value. Moreover, the financial manager is faced with the task of finding that optimal capital structure that will help the corporation.

Basically, a corporation may employ two sources of funds in financing its operations or for further expansion. These are the short term sources of fund and to the long term sources of fund.

Obviously every corporation has its goals and objectives to achieve. Therefore it is the duty of the financial manager to find out the sources of fund to use. The financial manager must understand that the decision on the type of fund used will not only have a significant influence on the shareholders returns but can also be risky to the survival of the business. Again, the cost of capital must be taken into consideration as the capital structure will also affect the market value of the firm and weighted average cost of capital. For these reasons, capital structure must be properly understood since it provides an understanding of how capital funds might be allocated to investment opportunities given a particular mix.

A corporation"s capital structure can be increased or a decreased in the ratio of debt to equity. An increase in debt is referred to as leverage. The term leverage refers to an increase in the proportion of debt in a corporation"s capital structure in relation to equity. However most authors hold different views about the relevance of capital structure decision of corporations.

Modigliani and Miller (1958) provided solution to the question on the relevance of capital structure in their own understanding. They believed that there is no optimal capital structure. They illustrated that the valuation of a company will be independent from its capital structure under certain key assumptions. These assumptions are that internal and external fund may be regarded as perfect substitutions in a world where capital functions perfectly, where there are no transaction or bankruptcy cost, no distortion, taxation and the productive activity of the form is dependent on its method of financing ones these fundamental assumptions are cleared, capital structure may become relevant.

Moreover, the controversy of the concept of capital structure is unresolved, therefore, proper care must be taken by corporation to arrive at a capital structure that will make the most returns on investment as the survival of the corporation depend on how much returns is realized from its investment that will meet the day to day activities and at the same time satisfy the shareholders.

1.2 Statement of the Problem

There is a controversy among financial analyst relating to the effect of financial leverage on the weighted average cost of capital and the market value of the corporation when the ratio of financial leverage to equity is varied. The question here is whether an optimal capital structure exist. Some school of taught are of the opinion that the way and manner in which these corporation are financed does not affect the value of the corporation while some school of taught also believe that the use of debt in the financing mix magnifies the value of the corporation. If the first assertion is true, then the financial manager will be indifferent to the sources of financing. If on the other hand, the financial mix will affect the value of the corporation the proper capital structure planning will be worth undertaking. In the light of these, this study intends to address the following problems:

What is the relationship between the financial leverage of a corporation and its earning per share (EPS)?

What is the relationship of the financial Asset per share (NAPS)?

What is the relationship between the financial leverage and net assets per share (NAPS)?

1.3 Objective of the Study

More specifically, the objectives of this study were to determine the relationships between;

The financial leverage of a corporation and its earning per share (EPS).

The financial leverage of a corporation and its Net Assets per share (NAPS).

The financial leverage of a corporation and its Dividend per share (DPS).

1.4 Research Hypothesis

The research hypotheses relevant to the above questions and objective were:

H0: The financial leverage of a corporation is not positively related to its earnings per share (EPS).
H1: The financial leverage of a corporation is positively related to its earnings per share (EPS).

H02: The financial leverage of a corporation is not related to its Net Asset per share (NAPS).
H2: The financial leverage of a corporation is related to its Net Asset per share (NAPS).

1.5 Scope and Limitation of the Study

The research work is to show the relationship between capital structure of a corporation and its performance. The time period for the research to work will cover a period of 5 years (2005-2009) of a selected corporation in Nigeria.

Also, the sample size is concentrated on Nigeria corporations in order to avoid complication resulting from a combination of both capital structure of financial and non-financial corporation. Non-financial corporations were selected and use in this study. Geographically the study, which will be specifically be restricted to corporation in Edo State in Nigeria for proper conduct of this research.

a) Availability of Research Material:

The research material available to the researcher is insufficient, thereby limiting the study

b) Time:

The time frame allocated to the study does not enhance wider coverage as the researcher has to combine other academic activities and examinations with the study.

c) Organizational Privacy:

Limited Access to the selected auditing firm makes it difficult to get all the necessary and required information concerning the activities.

1.6 Significant of the Study

Despite the importance of finances decision in a corporation there is still no arrangement in the relationship between the capital structure and the importance of a corporation. Empirical test carried out by some authors have not agreed on the best capital structure a corporation should use. The researcher of this research work believes that this work will provide the following benefits.

The research work will broaden the understanding of interest group such as investors. It will enable them understand published performance of corporations better and help them make proper decision on which share to buy, hold or sell.

The research work will be of benefit to government as it will broaden their understanding of the validity of capital structure and factors that this information can be used by the government to implement policies that will improve the capital structure of the financial sector in Nigeria.

The research work will be useful to corporations as information on the capital structure in Nigeria and other capital structure theory can help them decide better debt to equity mix.

The research work will be useful to further researchers who may decide to carry out research work on this topic since it will serve as a guide and a reference material for further research work.

1.7 Operational Definition of Terms

Capital Structure

The capital structure is how a firm finances its overall operations and growth by using different sources of funds.

Corporate Performance

Business performance management is a set of performance management and analytic processes that enables the management of an organization"s performance to achieve one or more pre-selected goals.

Debt

Debt is money owed by one party, the borrower or debtor, to a second party, the lender or creditor.

1.8 Organization of the Study

This research work is organized in five chapters, for easy understanding, as follows

Chapter one is concern with the introduction, which consist of the (overview, of the study), historical background, statement of problem, objectives of the study, research hypotheses, significance of the study, scope and limitation of the study, definition of terms and historical background of the study.

Chapter two highlights the theoretical framework on which the study is based, thus the review of related literature.

Chapter three deals on the research design and methodology adopted in the study.

Chapter four concentrate on the data collection and analysis and presentation of finding.

Chapter five gives summary, conclusion, and recommendations made of the study

Summary, Conclusion and Recommendation

5.1 Introduction

It is important to ascertain that the objective of this study was to examine capital structure and corporate performance in Nigeria.

In the preceding chapter, the relevant data collected for this study were presented, critically analyzed and appropriate interpretation given. In this chapter, certain recommendations made which in the opinion of the researcher will be of benefits in addressing the challenges of capital structure and corporate performance in Nigeria.

5.2 Summary

A remarkable difference between the capital structure of Nigerian firms and firms in developed economies is that Nigerian firms presumably prefer short‐term finance and have substantially lower amounts of long‐term debt. This reveals that Nigerian firms rely heavily on short‐term financing rather than long‐term finance. This difference in long‐ versus short‐term debt, to an extent, might limit the explanatory power of the capital structure theories in Nigeria. It suggests that the theoretical underpinnings of the observed correlations are still largely unresolved. The results of this empirical study suggest that some of the insights from modern capital structure theories are portable to Nigeria in that certain firm‐specific factors that are relevant for explaining capital structure and corporate performance in the Western countries are also relevant in Nigeria. This is true despite profound institutional differences that exist between Nigeria and the Western countries. Overall, the empirical results from this study offer some support for the pecking order theory and static tradeoff theory of capital structure. Therefore, in line with the findings of this study, it is suggested that Nigerian firms should try to match their high market performance with real activities that can help make the market performance reflect on their internal growth and accounting performance. The firms should rely less on short‐term debt, which forms the major part of their leverage, and focus more on developing internal strategies that can help improve their accounting performance as their accounting performance for the period studied was very low. The firms should also use more of equity to maximize their market performance in such a way that it yields growth opportunities

5.3 Conclusion

The soul difference between the capital structure of Nigerian firms and firms in developed economies is that Nigerian firms presumably prefer short term finance and have substantially lower amounts of long term debt. This reveals that Nigerian firms rely heavily on short term financing rather than long term finance. This difference in long-versus short term debt, to an extent, might limit the explanatory power of the capital structure theories in Nigeria. It suggests that the theoretical underpinnings of the observed correlations are still largely unresolved.

5.4 Recommendations

In line with the findings of this study, the following recommendations are made:

Nigerian firms should try to match their high market performance with real activities that can help make the market performance reflect on their internal growth and accounting performance.

The firms should rely less on short term debt, which formed the major part of their leverage and focus more on developing internal strategies that can help improve more on their accounting performance as their accounting performance for the period studied was very low.

The firms should develop a good strategy targeted at using more of equity to maximize their market performance in such a way that it yields growth opportunities.

The findings show that quoted companies in Nigeria do not use much of long term debt in their respective capital structure choices. This may be due to the general poor participation of both public and private sectors in the bond market. The Nigerian Stock Exchange should therefore strive to remove any rigid policies which could hinder the effective participation of the companies. Economic policies that could help further develop the capital market in such a way that it can absorb increase in demand for funds should be formulated.

Though there is high positive impact of leverage on market performance of the firms, it does not translate to better internal/accounting performance.

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