Abstract

 In Nigeria as one of the developing economy, financial markets not have the capacity to meet the financial necessities of business firms. Companies exploit loans, leases and other interest-bearing financial obligations as sources of debt financing. Following upon the prior, I analyze the financial structure pattern and share values of Nigerian quoted companies by comparing 5 firms that are adopting traditional theory, pecking theory, net operating income and modified pecking order during the period spanning 1999-2014. The study adopted two theoretical frameworks: Pecking order and Static Trade-off Theories captured in a panel regression model. A sample of 25 companies was selected based on data quality and availability to address the requirements of the variables in the regression model in that comparison will be on 5 quoted companies such as Dangote Flour Mills Plc, Flour Mills Nigeria plc, Guinness Nigeria plc, Honeywell Flour Mills plc, Nestle Nigeria Plc

The results of the regression indicate that profitability, tangibility, volatility (operating risk), growth opportunities and company size are important factors influencing the choice of financial mix among Nigerian firms.

The findings are corroborative of theoretical predictions and empirical evidence. Therefore, I provide useful recommendations for leverage decisions for managers of Nigerian firms and the management of the Nigerian stock market.

Keywords: Share values, financial structure, capital structure, Nigerian firms, pecking order and static trade -off theories, net operating income.

CHAPTER ONE

1.1       INTRODUCTION

1.1.1    BACKGROUD OF STUDY

Traditionally, short-term borrowings are excluded from the list of methods of financing the firm’s capital

expenditure as such, long-term claims are said to form the capital structure of the enterprise. Firms that are in

need of finances exchange their financial securities (shares, debentures, etc) for funds provided by (individual

and institutional) investors. Capital structure is therefore a combination of debt and equity to finance the assets

of a firm. Capital structure decision is concerned with the ratio of debt to equity that will maximize the returns of

the firm. Debt is a source of finance which has several advantages. First of all is that interest paid on it, is tax

deductible which lowers the effective cost of debt. Secondly, debt holders get a fixed return; so stockholders do

not have to share their profits if business is extremely successful. Debt also has disadvantages. First, the higher a

company’s interest rate ratio, the higher its interest rate. Secondly, if a company falls on hard times and

operating income is not sufficient to cover interest changes, stockholders will have to cover the shortfall; and if

they cannot, bankruptcy will result (Eugene, 2009).

After enough analysis and evaluation is has been noted that financing arrangements determine how and the amount of financing that can be obtained from funds providers. The total value of a firm, depend on how well the firm made its investment decisions, as the higher the yield on investments the higher the earnings/income to the firm.

The capital of any business firm is the base leading which the business operates.

It absorbs costs and losses, multiplies fixed assets and in all, enhances growth through mergers and acquisitions. In most countries, governments frequently provide financial support to business firms to facilitate them kick-start and maintain their operations and surmount teething problems. Such help may take pre-eminence during economic decline which is often characterized by low demand for goods and services occasioned by low level of income; falling gross domestic product (GDP); business failure and loss of jobs. The reasons for governments’ policy direction are legion: to prevent corporate failure and its contagious effects on the economy; maintain a desired level of employment and price stability and above all, encourage entrepreneurial development.

Studying the capital composition of firms in developing countries like Nigeria will enable financial managers, the governments and other stakeholders incorporate sectors prevent corporate failure, hence its attendant consequences on the economy.

According to Owolabi and Inyang (2012), developing countries such as Nigeria often times grapple

with the twin problems of a weak and political instability. This has direct effect on foreign investments a major source of capital for Nigerian firms.

Dagogo and Ollor (2009), observed that the failure of previous financial policies of government to achieve desirable economic growth was a concern that demands restructuring of the Nigerian system, especially in the glare of an ailing economy. Thus, the introduction of the Structural Adjustment Programme (SAP) in 1986 and the privatisation programme in 1989 were in response to failed institutional measures to promote growth in the industrial sector. Uche (2000), was of the view thatt SAP was designed to achieve balance of payment viability by altering and restructuring the production and consumption patterns of the economy, eliminating price distortions, reducing the heavy dependence on consumer goods, imports and crude oil exports, enhancing the non-oil export base, rationalising the role of the public sector, accelerating the growth potential of the private sector and achieving sustainable growth. To achieve these objectives, the main strategies of the programme were the adoption of a market exchange rate for the Naira, the deregulation of external trade and balance of payment arrangements, reduction in the price and administrative control and more reliance on market forces as a major determinant of economic activity

Nevertheless business firms are catalysts operating in the corporate sector which is the engine room of

growth and development in an economy.

Abor (2008) observed that corporate sector growth is vital to economic development. Therefore, it is

imperative for firms in developing countries to be able to finance their activities and grow overtime if they are ever to play an increasing and prominent role in proving employment as well as income in terms of profits, dividends and wages/salaries to households.

Therefore, debt increases creditor’s claims and equity increases when a firm issues shares to raise capital or pay dividends in form of bonus shares. On the other hand, the creditor’s claims increase when a firm borrows on both short and long terms.

The aim of determining financial structure is to distinguish structure of financial fund in order to

minimize shareholders’ wealth (Akparpour and Aghabeygzadeh, 2011).

The decisio to combine equity, long-term and short-term debts as the capital mix is called financial

structure. When financing their activities, firms, especially those with limited liabilities, combine debt and

equity. Equity capital includes common and preference shares while debt includes such instruments as long-term loan stock, mortgage and debenture bonds. The combination of long-term interest bearing obligations and equity is referred to as capital structure. This work is not centered on capital structure decision. However, attempts have been made to explain the concept – capital structure. It refers to the mix of long-term sources of funds, such as debentures, long-term debts, preference share capital and equity share capital including reserves and surpluses (i.e. retained earnings) [Pandey, 2000]. Teker et al (2009) explained that the capital structure of a company consists of a particular combination of debt and equity issues to relieve potential pressures on its long-term financing. To examine such issues, many theories have been developed in the literature and they generally focus upon what determinants are likely to influence the so-called leverage decisions of the firms. Among these, the Modigliani and Miller (MM) theory, trade-off theory, pecking order theory or signally theory have been said to mainly play a crucial role in identifying and testing the various properties of the leverage decisions (Teker, et al 2009). Pandey (2000) argued that it is being increasingly realized that a company should plan its capital structure to minimise the use of the funds in order to adapt more easily to the changing macroeconomic

conditions surrounding businesses. In the developing economies such as Nigeria, financial structure decisions are taken based on the level of development of the domestic markets. Amjed (2008) observed that financial markets are complete almost perfect in developed counties. Therefore, parameters for making financial structure decisions are mainly the cost benefits of a particular source of financing these countries. Whereas in developing countries, financial markets are not fully capable of meeting the financial needs of the corporate sector. Non conventional securities particularly debt securities are not warmly welcomed by the markets. Therefore, firms rely on the commercial bank loans and lease financing as source of debt. With this challenge, the firms in developing economies have to balance their capital structure in such a way that short term sources of financing are inclusive.

Financial structure decisions are one of the most contentious areas in corporate finance. The issue in

contention revolves around the optimal financial mix.

In developing countries such as Nigeria, financing decisions are taken based on the level of development of the domestic markets.

Firms in developing countries rely on commercial bank loans and lease financing as major sources of debt.

Transactions in the stock market are guided by the following legislations, among others:

 Investments & Securities Decree No. 45, 1999.

 Companies and Allied Matters Decree 1990.

 Nigerian Investment Promotion Commission Decree, 1995.

 Foreign Exchange (Miscellaneous Provisions) Decree, 1995. \

In an effort to deepen the Capital Market and expand the product range, The Stock Exchange in 2008 created five new tradable indices, which was launched in the first quarter of 2009. These indices namely are:

 NSE 30 Index

 NSE Banking 10 Index

 NSE Insurance 10 Index

 NSE Food/Beverage 10 Index

 NSE Oil/Gas 5 Index

Prices of new issues on the exchange are determined by issuing houses/stockbrokers, while on the secondary market prices are made by stockbrokers only. The market/quote prices, along with the All-Share Index, are published daily in The Stock Exchange Daily Official List, The Nigerian Stock Exchange CAPNET (an intranet facility), The Nigerian Stock Exchange website, Newspapers and on the stock market page of the Reuters Electronic Contributor System. The Exchange maintains an All-Share Index formulated in January 1984 (January 3, 1984 = 100). Only common stocks (ordinary shares) are included in the computation of the index. The index is value-relative and is computed daily.

Flour Mills of Nigeria Plc (FMN) incorporated in September 1960, is one of Nigeria's leading food and agro-allied companies which has grown into a diversified group with a broad product range, an iconic brand –“Golden Penny”, and extensive distribution network.

FMN was listed on The Nigerian Stock Exchange in 1978 and presently has a paid-up Share Capital of N1.193 billion and Market Capitalisation of N183.7 billion on 31st March 2013. With current ownership structure of 55.65% overseas shareholders and 44.35% Nigerian and Institutional investors, there is a broad ownership base of over 78,000 shareholders. The Group employs over 8,000 direct and indirect employees with diverse ethnic, cultural and religious background who work harmoniously together to deliver superior value to customers nationwide.

Recently, the Company's flour operations witnessed new investments in milling technology and gained accreditation to the Quality Standard ISO 9001:2008 recognizing that its flour manufacturing facilities are world class and operating within an internationally recognized Quality System. Group's Income for the year ended 31st March, 2013 was at N302 billion, while it posted an After Tax Profit of N7.73 billion.

During the financial year ended 31st March 2013, FMN made two strategic acquisitions in pursuit of its long term growth objectives, viz – Thai Farm International Company Ltd, a leading cassava flour processing company and ROM Oil Mills Limited, an integrated edible oil processing company. Additionally, FMN successfully merged with two of its subsidiary companies to consolidate group structure, reduce overhead, streamline operations and create synergies.

Flour Mills Nigeria Plc (FLOURMILL) is a leading player in the domestic food and agriculture sector, with interests in a myriad of other sectors of the economy. The company recently released its Q3'14 (April – December 2013) results to the Nigerian Stock Exchange (NSE), in which revenue grew 17% YoY to N240.2 billion ahead of our forecasted figure of N227.1 billion by 5%. On a QoQ basis, turnover was up 6%, faster than the 2% growth seen in Q3’13.The relatively strong top line growth comes from the company's core business – the food and agriculture segments, which reported revenue increases of 20% and 31% YoY. These two segments contributed 96% to Q3’14 top line figures, largely in line with the combined contribution seen in the corresponding period of 2013. In addition to continuous volume push from existing factories, the growth seen in the food and agriculture segments is also partly attributable to increased capacity from recent investments. These investments include the recently commissioned 750,000 mtpa sugar refinery and the joint venture technical support agreement with Adecoagro on Kaboji Farms.

Dangote flour mills plc Share capital of the company: N’000

AUTHORISED* 3 billion Ordinary Shares of 50 kobo each 1,500,000 issued and fully paid* 3 billion Ordinary Shares of 50 kobo each 1,500,000

* At an Extra-Ordinary General Meeting held on 21st May 2007, the authorised share capital was increased from N1.5 billion to N3 billion and the issued share capital was increased from N1.5 billion to N2.5 billion through the allotment of 250 million shares to existing shareholders via a bonus issue, 1.05 billion million shares to the former shareholders of Dangote Agro Sacks as consideration for 99% acquisition of DAS by DFM and 700 million shares to the former shareholders of Dangote Pasta as consideration for 99% acquisition of DP by DFM

Dangote Flourmills, recently acquired by Tiger Brands south Africa has been recording major losses since 2012. The company is undergoing serious surgical operations as the new owners struggle to grapple with the huge mess they took over. The company has in the last two and a half years posted over N11billion in losses with the latest being N4.3billion for the 9 month ending June 2014.

Despite this fact, the market prices Dangote Flourmills at N7.5!! Why is this so? Currently, the company has a negative retained earnings of N8.7billion meaning it cannot pay dividends until it makes well over N10billion in profits thus reversing the N4billion in loses today. How that is possible I would not know. The flour mill market has been under serious intense completion lately with margins shrinking by the day.

The price is also about 5x its Net Book value of N2.2 (as at June 2014). That is the market is pricing share of a loss making company at 5x what its equity. This suggest the market believes it probably has assets which is worth more than its balance sheet classification. That is it probably has properties and investments worth more than the value recorded in their balance sheet. Total assets per share is currently about N11.27.

Is this a right metric? I honestly do not think so. Its PP&E value has also been dropping lately indicating they have been selling. Even at that the cash remains in the business. I believe the reason why the share price is holding out is due to the following;

Guinness Nigeria Plc, a public limited liability company currently quoted on the Nigerian Stock Exchange, was incorporated on 29 April 1950 as a trading company importing Guinness Stout from Dublin. The Company has since transformed itself into a manufacturing operation and its principal activities continue to be brewing, packaging and marketing of Guinness Foreign Extra Stout, Guinness Extra Smooth, Malta Guinness, Malta Guinness Low Sugar, Harp Lager, Smirnoff Ice, Satzenbrau Pilsner Lager, Dubic Lager, Snapp and Topmalt.

Operating Results

The following is a summary of the Company’s operating results:

2013                                                                                         2012

N’000                                                                                      N’000

Revenue 122,463,538                                                            116,461,882

Operating profit 20,614,339                                                   21,895,799

Net finance costs (3,605,464)                                                 (1,512,641)

Profit before taxation 17,008,875                                           20,383,158

Taxation (5,145,149)                                                              (6,168,538)

Profit for the year 11,863,726                                                14,214,620

Other comprehensive income, net of tax (83,770)                   86,811

Total comprehensive income for the year 11,799,956                         14,301,431

Dividend, the Directors recommend, subject to approval at the next Annual General Meeting, the payment of a final dividend of N10.5 billion (2012: N11.8 billion), which, based on the number of ordinary shares in issue on 30 June 2013, represents a dividend of 700 kobo per ordinary share (2012: 800k). The dividend is subject to deduction of withholding tax at the applicable rate.

Shareholding and Substantial Shareholder, the issued and fully paid-up share capital of the Company is 1,505,888,188 ordinary shares of 50 kobo each (2012: 1,474,925,519 ordinary shares of 50 kobo each). The Register of Members shows that only one company, Guinness Overseas Limited (a subsidiary of Diageo Plc) with 699,892,739 shares (2012: 678,958,195 shares) and 46.48% shareholding (2012: 46.03% shareholding) held more than 10% interest in the Company. Diageo Plc also owns another shareholder of the Company, Atalantaf Limited, with 118,052,388 shares (2012: 114,613,969 shares) and a shareholding of 7.84% (2012: 7.77%). Total shareholding of Diageo Plc was 54.32% at year end (2012: 53.80%).

Honeywell flour mills Strong growth was achieved across our brands as reflected in a 20% increase in revenue from N38 billion to N46 billion. Profit after tax grew from N2.6 billion to N2.8 billion, a growth of 6% over the preceding year. Shareholders' Funds and Total Assets increased by 9% and 16% to N19billion and N55 billion respectively. Earnings per share rose from 33.97kobo to 35.86kobo in the preceding year.

Financial Highlights for the year ended 31 March, 2013.

Stock Exchange Information: Stock Exchange Quotation as at March 31 (in Naira per Share) 2.94 2.17 35 Number of Share Issued (in millions) 7,930 7,930 - Market Capitalization as at March 31 (in millions of Naira) 23,315 17,209 35

* The Directors propose a Dividend payment of 16 kobo (2012: 15 kobo) per share on the Issued Share Capital of 7,930,197,658 ordinary shares of 50 kobo each, subject to the approval of the Shareholders at the Annual General Meeting.

Nestle Nigeria Plc commenced operations in 1961 and was listed on the Nigerian Stock Exchange on April 20, 1979. The company is a subsidiary of Nestle S.A. of Switzerland, which together with Nestle CWA Limited own 62% of Nestle Nigeria Plc.

 At 31 December 2012, the reserve for own shares amounting to CHF 1875 million represented the cost of 18,201,713 shares earmarked to cover the Nestle Group remuneration plans and 18, 038, 445 shares held for trading purposes.

            During the year, a total of 4, 568 909 shares have been delivered to the beneficiaries of the Nestle Group remuneration plans. In addition, 7 646 039 shares have been acquired at a cost  of CHF 485 million, of which 3 402 620 shares to cover Nestle Group remuneration plans. Another group of company holds 18 188 445 Nestle S.A. shares. The total of own shares of 35 223 869 held by group companies at 31 December 2013 represents 1.1% of the Nestle S.A. share capital (36 240 158 own shares held 31 December 2012, representing 1.1% of the Nestle S.A. share capital).

Provided that the proposal of the Board of Directors is approved by the Annual General Meeting, the gross dividend amount CHF 2.15 per share, representing a net amount of CHF 1.3975 per share after payment of the swiss without holding tax of 35% .The last trading day with entitlement to receive the dividend is 11 April 2014. The shares will be traded ex-dividend as of 14 April 2014.

1.2       STATEMENT OF THE PROBLEM

Although the capital structure issue has received substantial attention in developed countries, it has remained neglected in the developing countries. The reasons for this neglect according to Bhaduri (2002) was, that until recently, developing economics have placed little importance to the role of firms in economic development, as well as the corporate sectors in many developing countries, faced several constraints on their choices regarding sources of funds, and that access to equity markets was either regulated, or limited due to the underdeveloped stock markets. Consequently in Nigeria, determining the actual effect a firm’s capital structure has on its market value has been a major challenge among researchers. Particularly, specifying what capital mix seems to optimize firms’ values has been a difficult puzzle to unravel. There has been a limited number of studies in Nigeria that have examined the firm’s choice of capital structure and its market value, but only a few of the findings ever expressed that a firm’s choice of capital structure could be influenced by the impact it has on its market value. According to Pandey (2005), the capital structure decision of a firm is a significant managerial decision; it influences the shareholders return and risk, and subsequently affects the market value of the firm.

1.3       AIM AND OBJECTIVES OF THE STUDY

Primarily, the study aims at investigating the nature of relationship that seems to exist between a firm’s choice of capital structure and its market value in Nigeria. The objectives of the study include:

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