THE IMPACT OF CAPITAL STRUCTURE, OWNERSHIP AND CORPORATE GOVERNANCE ON THE PERFORMANCE OF QUOTED NIGERIAN COMPANIES

ABSTRACT

The problem of how firms choose and adjust their strategic mix of financing securities and the impact such mix has on corporate performance has called for attention and debate among corporate financial experts. This is so because the choice made should ordinarily aim at improving firm value. This is however not always so, as existing literature show that the owners of firm and managers of such firm might have different objectives. Most observers have the belief that the difficulty facing firms in Nigeria has much to do with financing and management issues; that is choosing the appropriate mix of debt and equity and then who manages what. These issues are quite important to the survival of firms and as such require further empirical investigation. Notably also, Nigerian stock market is still developing, and so are the standards and practices of corporate governance, so it is of interest to assess whether the agency and information problems usually studied and found in more active markets have also a bearing on the functioning of a much thinner one, like ours. It was against this background that we decided to examine the impact of capital structure, ownership and corporate governance on firm performance, using a sample of fifty five non-financial quoted companies from five sectors only, operating in Nigeria from 1994 to 2013. The study adopted ex-post facto design and time series data analysis. The target population of the study was all the non-financial quoted companies in the Nigerian Stock Exchange, and then a stratified non-probability sampling technique was used to identify firms. Panel data for the selected firms were generated and analysed using descriptive and multivariate regression, as method of estimation. The result obtained indicates that leverage level of quoted firms in Nigeria has a significant positive or negative impact on performance, depending on the measure of leverage adopted. Ownership structure also has a significant impact on firm performance in Nigeria, though the individual effect of the various explanatory and control variables are generally mixed. Moreover, corporate governance variables measured by firm board  size  and  firm  board  composition  was  found  to  have  significant  positive  impact  on  firm performance, whereas CEO-Chair duality has negative but not significant impact on performance. The study concludes then, that the position of the Chief executive officer of a company in Nigeria and that of the Board chairman should be separated and occupied by different persons, to reduce agency problem. Nigeria should also encourage diverse ownership of shares, as concentrated ownership, contrary to free- riders notion may negatively impact on performance, due to their undue influence on the managers of firms.

CHAPTER ONE INTRODUCTION

1.1     BACKGROUND OF THE STUDY:

Capital   structure,   sometimes   known   as   financial   plan,   represents   the proportionate relationship between the various long-term form of financing, such as debentures, long-term debt, preference capital and common share capital, including reserves and surpluses (retained earnings). In other words, capital structure in financial term means the way a firm finances its assets through the combination of equity, debt, or hybrid securities (Saad, 2010). How an organisation is financed is of paramount importance to both the managers of firms and the providers of funds. This is because if a wrong mix of finance is employed, the performance and survival of the business enterprise may be seriously affected. Consequently, it is being increasingly realized that a company should plan its capital structure to maximize the use of the funds, improve performance and to be able to adapt more easily to changing conditions (Hovakimian et al, 2004; Margaritis and Psillaki, 2010).

From the extant literature, corporate financing decisions are quite complex processes and  existing  theories  can  at  best  explain only  certain  facets  of  the  diversity  and complexity of financing choices. It has been emphasized in some literature for instance that the separation of ownership and control in a professionally managed firm may result in managers exerting insufficient work effort, indulging in perquisites, choosing inputs or outputs that suit their own preferences or otherwise failing to maximize firm value (Fama and Jensen, 1983; Demsetz and Villalonga, 2001 and Frijns et al, 2008). There is  however, a  general  consensus  that  the  structure of  corporate ownership matters because it determines the incentives and motivation of shareholders related to all  activities  and  decisions  occurring  in  the  firm.  Ownership  structure  is  also  an important internal mechanism of corporate governance. In economic terminology, the ownership structure affects the agency costs, and hence the firm’s value (Jensen and Meckling, 1976; Davies et al, 2005 and Wahla et al, 2012).  In the same perspective, corporate governance is important concept that relates to the way and manner in which

financial resources available to an organization are judiciously used to achieve the overall corporate objective of an organization. Corporate governance exists to provide checks  and  balances  between  shareholders and  management and  thus  to  lessen agency problems. In other words, it represents an important effort to ensure accountability and responsibility in an organisation (Imam and Malik, 2007; and Uwalomwa, 2012).

Capital Structure, in general is largely attributed to the early work of Modigliani and Miller (1958). In their seminal paper, Modigliani and Miller postulate the irrelevance of capital structure for corporate value, based on certain assumptions. These include: absence of taxes, absence of bankruptcy risk, efficient and integrated capital markets. For  them,  under  perfect  market  assumptions,  it  is  not  the  source  of  capital  that increases the firm value, but the assets that the capital finances. The cost of different capital sources varies in a non-independent manner.  Hence, there is no reason for an opportunistically switch between equity and debt.

This restrictive hypothesis of Modigliani and Miller, has however, been punctured by numerous consequent  studies  aimed  at  showing  an  existing dependence between financial choices and corporate value. In other words, the conditions making one capital structure better than the other hence optimal are successively debated. Thus, corporate financing decisions are analysed in the presence of corporate tax (Modigliani and Miller,

1963),  income  tax  (Miller,  1977),  bankruptcy  costs  (Titman,  1984),  agency  costs (Jensen and Meckling, 1976; Myers, 1977), and Information asymmetry (Myers, 1984). From these  perspectives, the  external financing has  costs and  advantages whose consideration is necessary.

In Nigeria, financial constraints and insider abuse have been the major factors affecting corporate firms’ performance. According to Salawu and  Agboola (2008), the move towards a free market, coupled with what they called widening and deepening of various financial markets has provided the basis for the corporate sectors to optimally determine their capital structure. The overall target of this is to improve corporate performance for the benefit of the stakeholders.  Firm performance generally is an important concept that  relates  to  the  way  and  manner  in  which  financial  resources  available  to  an

organization are judiciously used to achieve the overall corporate objective. It aims at keeping the organization in business and creates a greater prospect for future opportunities.

Most Nigerians as noted by Ogebe et al, (2013) are of the opinion that corporate decisions are mostly dictated by managers and board of directors. Equity issues are often favoured over debt in spite of debt being a cheaper source of fund; and when debts are employed, it is usually on the short term basis, which tends to have a mixed effect on firm performance. This action could be attributed to the manager’s tendency to protect his job and avoid the pressure associated with debt commitment. This entire scenario and the like require further investigation through empirical study, to establish the fact.

In  line with this, the main focus of  this study is  to examine the impact of  capital structure, ownership and corporate governance on performance across different industrial sectors of quoted companies operating in Nigeria. In other words, we shall examine the theories that emphasize the importance of leverage in agency conflicts, as well as the importance of ownership and corporate governance in the determination of the firm’s capital structure policy and their effect on firm performance (as in Jensen and Meckling, 1976; Champion, 1999; Myers and Majluf, 1984; Faulkender and Petersen,

2006; Ganiyu and Babalola, 2012; Agyei and Owusu, 2014).

1.2     STATEMENT OF THE PROBLEM:

The issue of corporate performance has of late attracted more attention in the corporate world more than ever before as can been seen both in the print and electronic media.  Reasons  for  this  renewed interest are  however  not  farfetched. In  the  first instance, corporate scandals, coupled with economic downtown around the world in recent years, contributed mostly in raising awareness among stakeholders, investors and regulators, on the need to ensure better and sustained performance of corporate organisataions. In order to achieve this feat, efforts are under way in many countries, including Nigeria to produce better empirical measures and or review strategies on corporate investment, ownership and governance and to estimate their impact on the value and decision-making process of firms. Along this line, subsequent researchers such as Hassan and Butt (2009); Warokka et al (2011); and Uwuigbe (2013) had thus called for an intensified focus on the existing corporate governance structures, and how they ensure accountability and responsibility.

This study builds on this line of research by providing empirical evidence from Nigerian quoted companies on the impact of capital structure, ownership and corporate governance on firm performance. Notably also, Nigerian stock market is still developing, and so are the standards and practices of corporate governance, so it is of interest to assess whether the agency and information problems usually studied and found in more active markets have also a bearing on the functioning of a much thinner one, like ours. Indeed, the recent crash of Nigerian Stock Market has shaken investors’ faith in the capital markets and efficacy of corporate governance practices. The Nigerian stock market for instance, emerged as one of the world’s best performing stock market in

2007 with a return of 74.73%. However, by 31st  December, 2008, it earned a less

enviable record as one of the world’s worst performing stock market in 2008, after losing about N5.7Trillion in market capital and 47% in the NSE All Share Index (Yahaya et al,

2011).

Equally relevant, is the issue of privatization of public enterprises and divesture of shares by government. This programme which started in 1987 and the second phase in

1993/94, deals with strategy for reducing the size of government and transferring assets and service functions from public to private ownership. This study will further help to understand the effect of that programme, especially in relation to ownership, management and performance of quoted companies involved in the programme.

Notably  then,  the  problem of  how  firms  choose  and  adjust  their  strategic  mix  of securities and the effect such mix has on corporate performance has of late called for a great deal  of attention and  debate among corporate financial literature. This is  so because the choice made should ordinarily aim at improving firm value. This is however not always so, as existing literature show that the owners of firm and managers of such firm might have different objectives.   In  other  words, conflicts of interest between owner’s manager and outside shareholders, as well as those between controlling and minority shareholders have been the subject of debate in corporate literature (Driffield et al, 2006).  Most observers have the belief that the difficulty facing firms in Nigeria has much to do with financing and management issues; that is choosing the appropriate mix of debt and equity and then who manages what. These issues are quite important to the survival of firms and as such require further empirical investigation.

Theoretical evidence exists in  the  corporate finance literature, on  the  interactions between capital structure, ownership structure and corporate governance on firm value (Mahr-Smith, 2005 and Magaritis et al, (2010). Yet theoretical arguments alone cannot unequivocally predict these relationships. Moreover, the available empirical evidence, in the literature was carried out mostly with the data obtained in other developed and few emerging economies. This necessitates the need to use data obtained locally to verify their  applicability in  a  developing economy  like  Nigeria. Based  on  the  information available to us, the few empirical works in this area in Nigerian firms that are available centred mainly on capital structure and firm performance, and not much on the interrelationship between capital structure, ownership/corporate governance and firm performance. Other firm-specific factors that affects cross variability of capital structure are also not given fair treatment in most of these studies. For instance, a similar work by Onaolapo  and   Kajola  (2010)  concentrated  only  on   capital   structure  and  firm performance without recourse to ownership structure, the same with the recent work by

Lawal et al (2014). Similarly, an unpublished thesis by Ani Wilson (2009), in Banking and Finance Department, UNEC focused mainly on firms in financial service sector, specifically  on  the  Commercial  Banks.  This  study  targets  at  bridging  the  gap  by providing new evidence on the relationship between capital structure and diverse ownership and governance structure and corporate performance, using mainly accounting firm-level data from Nigerian quoted companies. More specifically, we firstly assess the effect of leverage on firm performance as stipulated by the Jensen and Meckling, 1976 agency cost model. We consider explicitly the effect of equity ownership structure and corporate governance on both capital structure and firm value (Hasan and Butt, 2009). We further consider the effect of separation of ownership from control and management on firm value/efficiency as in Bryan et al (2006) and Margaritis and Psillaki (2010). In addition, we shall consider also the issue of reverse causality from performance to  capital structure, as  in Warokka et  al,  (2011). Moreover, we shall consider the main source(s) of capital for firms in Nigeria, as well as other factors that determine their capital structure.

To address this, some of the pertinent questions we may ask, include: Does the leverage level of a firm have any significant impact on its performance in an emerging economy such as Nigeria, secondly would a more concentrated and mix ownership structure  lead  to  better  firm  performance,  thirdly  what  influence  does  ownership structure and corporate governance have on the firm’s performance, fourthly what effect does performance of a firm has on capital structure decisions, and lastly, do firm- specific  factors  that  affect  cross-sectional  variability  of  capital  structure  in  other countries have similar effects on Nigeria firms’ capital structure?. These questions and the like are addressed empirically in this research study.

1.3     RESEARCH OBJECTIVES:

The  broad  objective  of  this  study  is  to  examine  the  impact  of  capital  structure, ownership and corporate governance on firm performance. The specific objectives are:

(i)       Find out the impact of leverage on firm performance in Nigeria.

(ii)      To determine the impact of ownership structure on firm performance in Nigeria

(iii)     To  examine  the  impact  of  corporate  governance  on  firm  performance  in

Nigeria.

(iv)     To determine the effect of firm’s ownership structure on debt structure.

(v)      To determine the effects of firm performance on capital structure decision of

Nigerian quoted firms (a case of reverse causality).

1.4     RESEARCH QUESTIONS:

Specifically the major questions which this research work aims at addressing are:

(i)       To what extent does leverage level lead to better performance of Nigeria firms?

(ii)      To what extent does the ownership structure affects the performance of firms

in Nigeria?

(iii)     To what extent does corporate governance affects the performance of firms operating in Nigeria?

(iv)     To what extent does ownership structure of firm in Nigeria influence its debt

structure?

(v)      To what extent does performance of a firm influence the capital structure decision of the firm in Nigeria?

1.5     RESEARCH HYPOTHESES:

With reference to the above research questions, we develop the under listed hypotheses to test in order to achieve the above set objectives:

(i)        Leverage level does not have any significant impact on firm performance in

Nigeria.

(ii)      Ownership structure, both concentration and mix does not have significant impact on firm’s performance in Nigeria.

(iii)     Corporate  governance  variables  do  not  have  significant  impact  on  firm performance.

(iv)      Ownership structure has no significant effect on debt structure of firms in

Nigeria.

(v)      Corporate  performance  has  no  significant effect  on  the  capital  structure decision of quoted firms in Nigeria (A case of reverse causality).

1.6      SCOPE OF THE STUDY:

The broad topic is to examine the impact of capital structure, ownership and corporate governance on performance of Nigerian quoted firms. The firms that formed part of this study include those whose stocks are traded in the floor of Nigerian Stock Exchange (1st tier-market) with the exception of the financial service sector and those in Alternative Securities Market (ASeM).

There are reasons for the exception. The first is that firms in the financial service sector are highly regulated and differ remarkably in their operational mechanisms from those in the industrial sectors. Secondly to avoid introduction of bias in data collection and analysis, as firms in the Alternative market have lower capital requirement than those in

1st tier market. Thirdly, it may not be quite possible to effectively cover all the firms in

different sectors /sub Sectors within the limited study period, due to the large number of firms involved.

In light of the above, the area of concentration of this study centred on firms in the manufacturing/construction, trading and other service sub-sectors. Specifically, sample firms operating in only five sectors, based on the NSE newly adopted Classification of firms, operating in the capital market, across the country, will form part of the study (FACTBOOK, 2011/2012).

The study period is from 1994 to 2013. This period is believed to be long enough, for better assessment of the influence of the different business period in Nigeria, with respect to the study objectives. In addition, it covers the second era of implementation of privatization and commercialization of public enterprise in Nigeria, which involves among  others, public offer  of  equity  shares through  the  Nigerian Stock  Exchange (NSE).

1.7     SIGNIFICANCE OF THE STUDY:

This study will be beneficial to the following:

(i)       Shareholders and other investors:   Many investors and shareholders alike, lack the requisite knowledge and understanding on the investment activities in the  capital  market.  The  findings  of  this  study  will  therefore  aid  the shareholders and other investors particularly in Nigeria, in making their investment decisions.  In other words they will be better informed on where and  how to  invest,  as  well  as  the  need  to  monitor  the  activities  of  the managers of their respective firms to ensure that right decisions were taken for the achievement of the desired objectives.

(ii)      Managers and Captains of Industries:   Corporate financial managers have several objectives, one of them is to boost up the wealth of shareholders and lower the cost of capital. If goals are going to be achieved, managers need to make sure the firm’s resources are utilized efficiently and effectively. This study will therefore be of great benefit to managers in deciding the right combination of equity and debt to finance their operations and to maximize firm value and at the same time improve their own welfare and contribute to the economic development of the nation. In other words, the findings of this

study will assist managers of corporate organisations in making effective and efficient financing decisions in the management of their firm business outfits, for the benefit of the shareholders.

(iii)     Consultants and Financial Analysts: The findings of this study will be useful to the Consultants and financial analysts in their work of giving financial advisory services to firms and other investors in the country.

(iv)     Academia: In the academic world, the study will add to the existing body of knowledge, as well as make up for dearth of scholarly papers in Nigeria on the issue of company’s capital structure, ownership, governance and market values.

(v)      Government and other Policy Makers:

The study will be of immense assistance to Government and other policy makers in monitoring the activities of firms in the country. In other words it will assist Government in developing better policies for quoted companies in the nation.

1.8     LIMITATIONS OF THE STUDY

(i)       Limitation based on methods is likely to be the main problem of this study.

With the use of pooled ordinary least square (OLS) in our analysis, there might likely be group or individual effects among sampled firms. More also, as panel contains observation on the same cross sectional units over several time periods, there are most likely to be cross sectional effects on each firm or on a set of group of firms. In other words pooled OLS disregard inter-firm variations, which may result to the problem of multi-collinearity.

(ii)      The second is the problems usually involved in non-probability sampling, normal distribution of data and the use of regression analysis.

These problems among others however, will appropriately be addressed as much as possible.

1.9     OPERATIONAL DEFINITION OF TERMS

Given below are the definitions of some of the operational terms as used in the study:

Adverse Selection Hypothesis: This proposes that problems may arise in the relationship between agent and principal due to divergent of interests, and the principal not being able to verify properly if the agent behaves correctly.

In other words, it may be a case of hidden information: agents may not reveal the true information of the state of affairs (adverse selection); or the case of hidden action: agents may not deliver properly on their task (moral hazard).

Alignment of Interest Hypothesis: This hypothesis proposes that an organisation’s corporate goals would be advanced, as reflected by enhanced performance, where there is alignment or convergence of interests. The hypothesis further argues that managerial share ownership can reduce managerial incentives to consume perquisites, expropriate shareholders wealth and to engage in other non- maximizing behaviour.

Agency Cost: The costs of monitoring the managers so that they act in the interests of the shareholders are referred to as Agency Costs.

Agency Relationship is a contract under which one or more persons (the principal(s)

engage another person (the agent) to perform some service on their behalf which involves delegating some decision-making authority to the agent.

Entrenchment Hypothesis:

The entrenchment hypothesis is the alternate hypothesis to the convergence of interest hypothesis. It propounds that agent, represented by managers in the public corporation, as a result of separation of owners and management will indulge in excess perquisite consumption, which will hurt operating performance.

Information Asymmetry:

This is a nonpublic knowledge about a corporation possessed by people in special positions inside a firm.

Managerial Self Interest Hypothesis: This hypothesis states that the possibility of losing employment if the company should fail places a responsibility on risk-averse managers to lower unemployment risk by ensuring continued viability of the firm.

Market Timing Hypothesis:

This is a theory about how firms and corporations in the economy decide whether to finance their investment with equity or with debt instruments, depending on market situation (e.g., which instrument is cheaper at that point in time).

Ownership Concentration:

This refers to the distribution of shares owned by majority shareholders, which can be individuals, institutions or families. Ownership concentration measures the influence or power of shareholders as well as their peculiar incentive mechanisms and preferences. Ownership Mix:

Ownership mix is related to the identity of the owners. It further refers to the presence of certain institutions or  groups  such  as  government  or  foreign  partners,  among  the partners.

Perking Order Theory:

This states that firms prioritize their sources of financing (from internal financing to equity) according to the law of least effort, or of least resistance, preferring to raise equity as a financing means “of last resort”. Hence: internal financing is used first; when that is depleted, then debt is issued; and when it is no longer sensible to issue any more debt, equity is issued (Frank and Goyal, 2003).

Signaling Theory:

Signaling theory deals  with information asymmetry, based  on  the  assumption that information about an organization is not equally available to all parties at the same time. Signaling theory states that corporate financial decisions are signals sent by the company’s managers to investors, in order to shake up these asymmetries.

Trade off Theory:

This states that there is an advantage to financing with debt (namely, the tax benefit of debts) and that there is a cost of financing with debt (bankruptcy costs of debt).

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