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ABSTRACT
This study examined the impact of capital structure on firms performance in Nigeria using a sample of seven (7) firms in Nigerian Building Material Industry listed on the Nigerian Stock Exchange during ten(10) years period,(2007-2016) are used as observation for this study. Data was generated from financial statement of the firms within that period. Regression analysis was run to determine the level of impact of capital structure surrogated by short term debt, long term debt and Total debt to total asset on the performance epitomized by Return On Asset. The analysis revealed that short term debt has a negative significant impact on firm performance; long term debt has a negative significant impact on firm performance. The result also revealed that Total debt has a negative relationship on firm performance. The study recommends that the management of the listed firms are advice to issue additional shares and have more investors so as to defray the risk of external control and tendency of liquidation.
TABLE OF CONTENTS
Title Page - - - - - - - - - i
Declaration - - - - - - - - - ii
Certification- - - - - - - - - - iii
Dedication- - - - - - - - - - iv
Acknowledgement- - - - - - - - - v
Abstract- - - - - - - - - - vii
Table of Content- - - - - - - - - viii
CHAPTER ONE: INTRODUCTION
1.1 Background to the Study - - - - - - 1
1.2 Statement of the Problem - - - - - - 4
1.3 Research Questions - - - - - - - 5
1.4 Objectives of the Study - - - - - - 6
1.5 Statement of Research Hypotheses - - - - - 6
1.6 Scope of the Study - - - - - - - 7
1.7 Significance of the Study - - - - - - 7
CHAPTER TWO: LITERATURE REVIEW
2.1 Introduction - - - - - - - - 9
2.2 The Concept of Capital structure - - - - 9
2.3 Concept of Financial Performance - - - - - 22
2.4 Review of Empirical Literature - - - - - - 24
2.5 Theoretical Framework - - - - - - 28
CHAPTER THREE: RESEARCH METHODOLOGY
3.1 Introduction - - - - - - - - - 33
3.2 Research Design - - - - - - - - 33
3.3 Research Population - - - - - - - 33
3.4 Sampling and Sampling Techniques - - - - - - 34
3.5 Method of Data Collection - - - - - - - 35
3.6 Method of Data Analysis - - - - - - - 35
3.7 Techniques of Data Analysis - - - - - - 37
CHAPTER FOUR: DATA PRESENTATION AND ANALYSIS
4.1 Introduction - - - - - - - - - 39
4.2 Descriptive Statistics - - - - - - - - 39
4.3 Correlation matrix -- - - - - - - - 41
4.4 Analysis of Regression Results - - - - - - 42
CHAPTER FIVE: SUMMARY, CONCLUSION AND RECOMMENDATIONS
5.1 Summary - - - - - - - - - 44
5.2 Conclusions - - - - - - - - - 45
5.3 Recommendations - - - - - - - - 45
Bibliography - - - - - - - - - 47
Appendix - - - - - - - - - 51
CHAPTER ONE
INTRODUCTION
1.1 Background to the Study
Capital structure is the means by which an organization is financed. It is the mix of debt and equity capital maintained by a firm. To understand how companies finance their operations, it is necessary to examine the determinants of their financing or capital structure decisions. Company financing decisions involve a wide range of policy issues. (Green, Murinde and Suppakitjarak, 2002). Knowledge about capital structures has mostly been derived from data, from developed economies that have many institutional similarities (Booth, Aivazian, Demirguc, & Maksimovic 2001).
Capital structure refers to a mixture of a variety of long term sources of funds and total debt to total asset including reserves and surpluses of an enterprise. The historical attempt to building theory of capital structure began with the presentation of a paper by Modigliani & miller (MM, 1958). They revealed the situations under what conditions that the capital structure is relevant or irrelevant to the financial performance of the listed companies. When determining the capital structure, a number of issues like cost, various taxes and rate, interest rate have been proposed to explain the variation in Financial Leverage across firms (Van Horne, 1993; Hampton, 1998; Titman & Wesselss, 1998).
These issues suggested that depending on the attributes that the cost of various sources of capital the firm’s select capital structure and benefits related to debt and equity financing. The relationship between capital structure and financial performance is one that received considerable attention in the finance literature. How important is the concentration of control for the company performance or the type of investors exerting that control are questions that authors have tried to answer for long time prior studies show that there is a relationship between capital structure and financial performance which is the key issues of state owned enterprise.
Capital structure of a firm is the mix of debt, equity and other sources of finance that management of a firm uses to finance its activities. Different firms use different proportion or mix. A firm may adopt to use all equity or all debt. All equity is preferred by investors as they are not given conditions on the type of investment and usage of funds from providers. All debt is preferred by investors in a country where debt interest is tax deductible. Firms use a mix of debt and equity in various proportions in order to maximize the overall market value of the firm. (Abor, 2007).
A financial expert (Pandey, 1999) differentiated between capital structure and financial structure, Pandey opined that the various means used to raise fund represented the financial structure of the enterprises. While capital structure is the proportionate relationship between long term debt and equity. Capital structure that encourage the debt provider to give their scarce resources to the business, Capital structure consists of two component which include internal fund (retained earnings) and external fund (debt & equity). The debt equity mix can take any of the following forms 100% equity: 0% debt, 0% equity: 100% debt, or x% equity: y% debt. From these three alternatives, option one is that of the unlevered firms, that is the firm shuns the advantage of leverage (if any). Option two may not actually be realistic or possible in real life economic situation because no provider of fund will invest his money in a firm without equity capital this partially explains the term “trading on equity” that is it is the equity element that is present in the firm.Option three is the most realistic one in that it combined both a certain if any) is exploited (Dare and Sola 2010).
Studies on capital structure attempt to explain the mix of securities and financing sources used by companies to finance investment (Myers 2001). Brigham (2004) defined capital structure as the way in which firm finance its operations which can either be through debt or equity capital or a combination of both. According to (Myers, 2001), there was no universal theory on the debt to equity choice but noted that there were some theories that attempted to explain the capital structure mix.
Researchers continue to analyze capital structure and to determine whether optimal capital structure exists. An optimal capital structure is usually defined as the one that offer a balance between ideal debt to equity range so as to minimize a firm’s cost of capital, while maximizing shareholder’s wealth. Hence, capital structure decisions have great impact on the financial performance of the firm. Exactly how firms choose the amount of debt and equity in their capital structures remains an enigma. Are firms mostly influenced by the traditional capital structure of their industries or are there other reasons behind the actions? The answer to this question is very important, because the action of managers will affect the performance of their firm, and also influence how investors perceive the firm. The identification of management interest with the long-run financial performance or prospect for the firm together with the discretion available to managers can be characterized as one of that maximize positive impact of the firm’s financial performance for its long-run survival.
However, financial performance of a firm is the degree of it goal achievement which can be measured using Return on Asset (ROA), Return on Equity (ROE), Return on Investment (ROI), Gross profit margin etc. The existence of a link between a firm’s capital structure and its financial performance has been atopic of discussion in finance research (Saeedi & Mahmoodi, 2011). Performance is the degree of a company achieving it strategic goals as well as indicator for the examination of the Company’s overall competitiveness (Xu, 2007). If there is no proper mix of Capital Structure, the financial performance of the business enterprises may be seriously affected. A firm can finance its operation by either debt or equity or combination of these two mix, debt and equity are two major classes of liabilities, with debt holders and equity holders representing the two types of investors .Equity holders are residual claimant bearing most of the risk and have greater control over decision.
1.2 Statement of the Problem
Capital structure is one of the contentious issues in finance. Various theories have been put forward by researchers to justify the existence of optimal capital structure of a firm. It is in fact a puzzle. The theories have been developed to try to unearth the financing preferences managers may have in selecting a particular capital structure. (Abor, 2007). Different nations have different tax regulations and culture (Suh2008) hence the results of one nation may not apply to other nations as the interactions between various variables may not be the same. Hence, there is need for study in developing nation as most studies are centered by developing nations. Organisation often face challenges in determining optimal capital structure. An incorrect financing decision may lead to financial distress and eventual bankruptcy (Eriotis, Vasiliou, & Neokosmidi, 2007). Different levels of debt and equity used in capital structure suggest that managers may employ firm-specific strategies for improved performance (Gleason, Mathur, & Mathur, 2000). Although financial theory suggests that firms should strive to obtain an optimal capital structure (i.e., one that minimizes a firm's cost of capital), no specific method has been identified to help financial managers determine the optimal level of leverage (Eriotis et al., 2007).
However, prior studies have been conducted on capital structure world over, and specifically in Nigeria most of the studies, notably the work of Kajolaand Onaolapo (2010), conducted their study on capital structure and firm performance in Nigerian manufacturing sector and the result shows that a firm’s capital structure surrogated by Debt Ratio has a significantly negative impact on the firm’s financial measures Return On Assets, ROA and Return On Equity, ROE. Osuji and Odita (2012), assessed the impact of capital structure on the financial performance of Nigerian firms and the result also shown that capital structure has a negative impact on the firm’s financial measures ROA and ROE while, Babalola (2012) focused on the impact of firm’s capital structure on firms’ profitability in Nigeria.
Most of the studies are on other sectors thereforeconducting a study on building material industry is necessary.
Other studies have viewed capital structure as an antecedent to firm strategy leading to performance evaluation, such as diversification into new businesses. While these studies have definitely contributed to some understanding of the linkages between firm performance and capital structure, they have largely ignored some basic issues confronting researchers and managers alike, namely: Does it matter how firms finance their assets? And do different modes of financing make a difference? While anecdotal evidence suggests that the amount and type of financing should be closely tied to a firm’s performance and few researchers have looked at the firm performance/financing interaction.
The choice of an appropriate financing mix constitutes a critical decision for the survival and continuous growth of any business organization not only because of the need to maximize returns to the various interest holders, but also because of the impact such informed decision has on the performance of an organization in a competitive environment. The survival and growth of a firm need resources but financing these resources has limitations. Therefore, applying these limit resources should be in the way that creates an appropriate share of value for providers and users of resources because without capital the firm would be unable to run, grow and expand their business.
1.3 Research Questions
The study attempts to find answers to the following specific questions:
I) To what extent does short term debt affect financial performance?
II) What is the effect of long term debt on financial performance?
III) How does total debt to total asset affect financial performance?
1.4 Objective of the Study
The main objective of this study is to examine the impact of capital structure on the financial performance of quoted Nigerian Building Material Industry. Specificobjectives include:
i. To examine t
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