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
- 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. An appropriate capital 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 a decision has on an organization’s ability to deal with its competitive environment. A company can finance investment decision by debt and/or equity. This is known as financing decision which could affect the debt- equity mix of firms. The debt-equity mix has an overall implication for the shareholders earnings and risk which will in turn affect the cost of capital and market value of the company. It is therefore imperative for financial managers of firms to determine the proportion of equity capital and debt capital (capital structure) to obtain the debt financing mix, that is, an optimal capital structure. Capital structure is used to represent the proportionate relationship between debt and equity. Equity includes paid-up share capital, share premium, reserves and retained earnings. The debt-equity mix can take any of the following forms: 100% equity: 0% debt, 0% equity: 100% debt and X% equity: Y% debt. From these three alternatives, option one is that of the Unlevered firm, 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 funds 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’s capital structure that encourages the debt providers to give their scarce resources to the business, option three is the most realistic one in that it combined both a certain percentage of debt and equity in the capital structure and thus, the advantages of leverage (if any) is exploited. This study is aimed at testing the impact of capital structure on corporate performance of Nigerian firms. The study is however focused on the Nigerian Petroleum Industry. Capital structure theories have attracted a great attention in the field of financial management and also has its attendant controversies. A firm’s capital structure decision can not be brush aside because of its ultimate effect on the value of the firm, Weighted Average Cost of Capital (WACC) and other salient variables. A financial expert (Pandey, 1999) differentiated between capital structure and financial structure. He affirms that the various means used to raise funds represented the financial structure of the enterprise. He defined capital structure as the proportionate relationship between long-term debt and equity. Equity is also defined to include share-capital, share premium, Reserves and surplus (Retained earnings). Equity is a good source of capital to business, particularly, the fund from the stock market has been a source of capital for the corporate sector. Emmanuga (1998) in his study on private sector dependence on capital market funds in Nigeria (Edo, 1997), using autoregressive model and estimation techniques, found out that capital market funds made a positive but insignificant impact on private sector. Capital structure is the proportions of debt instruments and preferred and common stock on a company’s balance sheet (Van Horne, 2002). The firm’s mix of different securities is known as its capital structure. The choice of capital structure is fundamentally a marketing problem. The firm can issue dozens of distinct securities in countless combinations, but it attempts to find the particular combination that maximizes it’s overall market value (Brealey and Myers, 1996). The effect of capital structure on the overall cost of capital in one hand and the value of the firm on the other hand has been a major source of controversy among finance scholars (Oloyede and Akinmulegun, 1999). This has also led to the controversy over the existence of optimum capital structure. 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
The capital structure is how a firm finances its overall operations and growth by using different sources of funds.
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 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
This material content is developed to serve as a GUIDE for students to conduct academic research
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