THE IMPACT OF FINANCIAL STRUCTURE ON PERFORMANCE OF QUOTED FIRMS IN NIGERIA

ABSTRACT

Financial structure is financing decision undertaken by a firm in the course of funding its corporate investment. It entails the mixture of debt and equity capital to finance firm’s assets. The impact of financial structure has been inconclusive in literature. It is on the premise of the foregoing that the study sought to examine the impact of financial structure surrogate as short-term debt ratio, long-term debt ratio, stock/shareholders’ fund on performance of quoted firms in Nigeria (measured by return on asset). Panel data were collated from the published financial reports of ten firms over a six-year period ranging between 2011 and 2016. The data were subjected to pooled ordinary least square technique and Hausman tests. The Hausman tests indicated that random-effect model is more appropriate to estimate the four specified models. The results revealed that financial structure represented by short-term debt ratio (β=-0.21; p<0.05); long-term debt ratio (β=-0.33; p<0.05); stock/shareholders’ funds (β=-0.42; p<0.05) and short-term liabilities (β=-0.40; p<0.05) had significant negative impact on the performance of selected quoted firms in Nigeria. The study suggested amongst others that it is important for government to pursue genuine policy measures targeted at developing the security market to ensure high volume of corporate debt issue, liquidity of market and market efficiency in order to ensure smooth allocation and mobilization of funds to quoted firms in Nigeria.

CHAPTER ONE

INTRODUCTION

1.1 Background to the Study

Financial structure involves financing decision undertaken by a firm in the pursuit of financing its corporate investment. Financial structure involves the mix of debt and equity to finance the assets of a firm. The inherent risks in business environment have contributed to every corporate organization to structure its financing decision towards achieving the objectives of profitability and wealth maximization. According to Itiri (2014), the financing decision of a firm varies according to the rate of risk related to each financing options as well as the relationship between risk and return. Firm seek to adopt a mixed financial structure that guarantees minimum cost to achieve the goal of profit maximization. The effect of financial structure on performance of a firm is controversial due to broadened debate from various perceptions. The core argument among scholars in two dimensions namely irrelevance and relevance theories of financial structure. The irrelevance theories of financial structure contends that under the restrictive assumptions of perfect capital markets, homogeneous expectations of investors, symmetric information and absence of bankruptcy cost, financial structure has no effect on performance of firms (Onaolapo and Kajola, 2010). On the other hand, relevant theories with imperfect market assumptions maintained that financial structure has either positive or negative significant effect on performance of firms (Zeitun and Tian, 2007).

Financial structure relates to the combination of sources from which long-term funds are raised for the firm. Financial structure is equally the composition of a firm’s long-term funds consisting of common equity, preference equity and debt (Nwolisa & Chijindu, 2016). The financial structure of a firm consists of various sources, which are presented in the equity and liability side of the balance sheet. Financial structure indicates the ratio between owned and borrowed capital. While planning the financial structure of a firm, there should be proper balance between debt and equity. Although, there are no hard and fast rules as regard the optimal financial structure, a firm may opt for equity financing or may adopt the mix of equity and debt financing.

The financial structure decision of a firm is imperative for it to effectively compete in the corporate environment. The decision is equally important because of the need to maximize returns to various constituencies of a firm. The desire of most firms is to have a mix of debt, preferred stock and common stock which will maximize the wealth of shareholders (Modugu, 2013; Njagi, 2013). The average weighted cost capital depends on the combination of different securities in the financial structure. A change in different securities in the financial structure will change the financial structure. Thus, there will be a combination of different securities in the financial structure at which weighted average cost capital will be the least (Dare& Sola, 2010; Itiri, 2014).Nwolisa and Chijindu (2016) aver that a world without corporate taxes financial structure is useless. The value of the firm is independent of the financial structure decision as the value of a firm equals operating income divided by operating cost of capital. Thus, the mix between debt and equity is not important. Any benefit of low cost debt is completely offset by an increase in cost of equity due to use of borrowing.

In an attempt to explain the impact of financial structure decision on firm performance, several theories such as pecking order theory, trade-off theory and agency cost theory have been developed by scholars. The perking order theory maintains that equity is a less preferred means to raise capital because managers issue new equity (Njagi, 2013). Investors believe that managers overvalue the firms and are taking advantage of this overvaluation and they places a lower value to the issuance of new equities. The perking order theory preserves that businesses adhere to a hierarchy of financing sources and prefer internal financing when available and debt is preferred to equity. The agency cost theory championed by Jensen (1976) states that the relationship between managers, shareholders and debt holders influence the financial structure of a firm. The agency cost theory believes that the optimal financial structure of the capital emanates from a concession between sources of financing through common equity, preference equity and debts such that conflict of interest between suppliers of funds (equity and debt holders) and managers is appeased. Ebaid (2009) argues that the indebtedness allows shareholders and managers to align have similar objectives, but causes conflict between managers and shareholders on one hand, and creditors on the other-hand. The optimal level of indebtedness is the one that minimizes the total agency costs. Test of the agency theory regress measures of financial structure on performance indicators of firms and some control variables. The study attempts to examine the impact of financial structure on performance of quoted firms in Nigeria using recent data of quoted firms to cover gap in literature.

1.2 Statement of Problem

The impact of financial structure decision on performance of firms is inconclusive due to arguments from various points of view. The subsisting empirical studies to prove the impact of debt and equity mix on firm performance in Nigeria is streamlined to capital structure measures with established conflicting views deduced from the inconsistencies among their findings. Thus, the conclusions and results of past studies may be misleading. For instance, Adelegan (2007) report a negative and insignificant effect of financial structure on firm performance and leverage. Also, the findings of Itiri (2014); Nwaolisa & Chijundi (2016) indicate a negative and significant effect of financial structure on firm performance. In addition to these, Dare & Sola (2010) found a positive and significant effect of financial leverage on corporate performance of oil firms in Nigeria.

Financial structure variables have a better chance to produce unbiased result, because of different empirical implications as regard different types of debt instrument. However, in underdeveloped financial system in less developed countries likes Nigeria, the external debt finance of most firms is majorly short term finance, imposing extra burdens at very high costs on the firm. For example, Modugu (2013) argues that significant results are good reason for adopting different measures of leverage ratios because some of the theories of financial structure have different implications for not adopting the narrow definition of leverage ratios. Furthermore, it is worthwhile to differentiate short-term debt, long-term debt and total debt effects since they have different risk and return profiles (Zuraidah, et al, 2012). This disclosure pops an important research question on the effectiveness of financial structure in fostering the performance of quoted firms in Nigeria. To this end, the study sought to investigate the effect of different measures of financial structure on the performance of quoted firms in Nigeria.

1.3 Objectives of the Study

The main objective of the study is to examine the impact of financial structure on the performance of quoted firms in Nigeria. The specific objectives of the study are:

To investigate the effect of short-term debt ratio on the performance of quoted firms in Nigeria.
To explore the impact of long-term debt ratio on the performance of quoted firms in Nigeria.
To assess the effect of Stockholders (shareholders) on the performance of quoted firms in Nigeria.
To evaluate the effect of short term liabilities on the performance of quoted firms in Nigeria.

1.4 Research Questions

Based on the objectives of the study, the questions that necessitated the study are:

To what extent do short-term debt ratio impacts on the performance of quoted firms in Nigeria?
To what extent do long-term debt ratio affects the performance of quoted firms in Nigeria?
To what extent do Stockholders (shareholders) affects the performance of quoted firms in Nigeria?
To what extent do short term liabilities has effects on the performance of quoted firms in Nigeria?

1.5 Research Hypotheses

The research hypotheses guiding the study are stated as follows:

H01: Short-term debt ratio has no significant effect on the performance of quoted firms in Nigeria.
H02: Long-term debt ratio has no significant effect on the performance of quoted firms in Nigeria.
H03: Stockholders (shareholders) have no significant effect on the performance of quoted firms in Nigeria.
H04: Short term liabilities have no significant effect on the performance of quoted firms in Nigeria.

1.6 Significance of the Study

The study has immense benefits to financial analysts, investors and firms, regulators and future researchers. The study helps financial analysts to infer the nature of equity and debt position of sampled firms and also reveals the risk of interest bearing assets. The study equally enables decision makers to restrain from unwholesome practices in financing pattern of most firms when analysts can establish the real class of firm’s assets.

The study enables investors and firms to ascertain the risk nature of their investment in financial instruments. It also provides an in-depth knowledge to firms on the way to reduce the price of their floating assets relatively to inherent risk of the assets, in reducing the volatility of their earnings.

The study is also important to regulators and other participants in financial and real sector as it enlightens them on the need to enhance development in the sectors.

The study serves as a veritable material that can be consulted by students, researchers and academic on the subject matter in their future research undertakings.

1.7 Scope of the Study

The study examines the effect of financial structure on performance of firms with respect to non-financial firms in Nigeria. Firms in the financial sector such as commercial banks, merchant banks, insurance firms, mortgage banks and other specialized financial institutions are excluded in the study because their financial structure are excessively regulated as a result of the restrictions placed on them by regulatory authorities, which consequently influences their financial structure relative to performance.

Firms operating in the ICT, cement, food & beverage, pharmaceutical and agriculture industries are considered in the study. The study covers a six (6) year period ranging from 2011 to 2016.

1.8 Definition of Key Terms

The terms important to the study are defined as follows:

Capital: This refers to financial assets or the financial value of assets, such as funds held in deposit accounts, as well as the tangible machinery and production equipment used in the firm such as factories and other manufacturing facilities.

Financial Structure: This refers to the balance between all of the liabilities and equities of a firm. It covers the entire liabilities and equities side of a balance side of the balance sheet.

Equity: This refers to the ownership interest or claim of a holder of common stock (ordinary shares) and some types of preferred stock (preference shares) of a company. On a balance sheet, equity represents funds contributed by shareholders plus retained earnings and minus accumulated losses.

Debt: This refers to a duty or obligation to pay money, deliver goods or render service under an express or implied agreement. The use of debt in the financial structure of a firm creates financial leverage that can multiple yield on investment provided returns generated by debt exceed its cost.

Firm Performance: There is no consensus about the definition, dimensionality and measurement of firm performance. The concept is explained via ratio analysis. Ratio analysis helps managers and shareholders to analyze the financial health of a company. The performance of a firm can be captured from the angle of profitability, liquidity, leverage and wealth maximization.

Quoted Firms: These are public joint stock companies whose shares are traded either on the main stock exchange or related secondary market such as unlisted securities markets.