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DETERMINANT OF FINANCIAL LEVERAGE OF LISTED CONGLOMERATE FIRMS IN NIGERIA

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1-5 chapters |



Abstract

The theory of financial leverage and its relationship with firms’ performance has been an issue of great concern in corporate finance and accounting literature since the seminal work of Modigliani and Miller in 1958.This study investigated determinant of financial leverage of listed conglomerate firms in Nigeria. Analyses of the aggregate data were done using both descriptive and regression analysis. The major findings of the study revealed that an increase in the equity portion of total-debt equity ratio (TDER) has a significant positive effect on firms’ financial performance measured by return on equity (ROE). The study concludes among others that financial leverage surrogated by total-debt equity ratio (TDER) is an important indicator of firms’ financial performance and vice versa. Based on the major conclusions, the following recommendations were given among others that non-financial firms’ quoted on the NSE should increase the equity portion of the debt-equity mix in their capital structure in order to improve firms’ financial performance.

 

 

CHAPTER ONE

INTRODUCTION

  • Background of the study

Financial leverage decision is a vital one since the performance of a firm is directly affected by such decision; hence, financial managers should trade with caution when taking debt-equity mix decisions. The theory of financial leverage and its relationship with firms’ performance has been an issue of great concern in corporate finance and accounting literature since the seminal work of Modigliani and Miller in 1958 ( Al-Taani, 2013; Mohammed, 2010; Ogebe, Ogebe & Alewi, 2013). Modigliani and Miller (1958) asserted irrelevance of debt-to-equity ratio for firm value.  However, since they considered the assumptions of perfect markets, which no taxes, absence of transaction and bankruptcy costs, the theory about the debt irrelevance is hardly realistic. Later, Modigliani and Miller (1963) relaxed a no-tax assumption and developed a theory about tax benefits of debt. That paper gave rise to a serious academic discussion on the theory of financial leverage (Iavorskyi, 2013). However, there are certain costs associated with debt financing. Between the two extremes of whole equity financing and whole debt financing, a particular debt-equity mix (financial leverage) is to be decided. Therefore, a financial leverage decision should be designed in such a way that it maximizes shareholders return and minimizes risk. Similarly, since the value of the firm is directly related to its performance, financial experts study the relationship between financial leverage and firms’ performance in order to validate Jensen’s (1986) theory. However, empirical studies have not reached a consensus about the relationship between leverage and firms’ performance. This study is therefore, an attempt to contribute to the empirical studies on how financial leverage affects firms’ financial performance using 66 nonfinancial quoted firms’ in the Nigerian Stock Exchange (NSE). Moreover, despite the widespread interest in the way firms make their financing decisions, most of the researches on financial leverage have been conducted in the advanced countries’. This study on the other hand, is an attempt to fill this gap in knowledge; hence, the main problem of this research is to investigate how financial leverage affects the financial performance of quoted companies in the Nigerian Stock Exchange. Additionally, review of existing empirical studies on Nigerian quoted firms’ revealed at least eight methodological flaws with prior studies, and this study on the other hand, intends to fill these gaps by addressing the problems. First, Ezeoha (2008), Mohammed, (2010), Innocent, Ikechukwu and Nnagbogu (2014), and Abubakar (2015) all measured leverage as the ratio total liabilities to total assets. This measure does not indicate whether the firm is at the risk of default in the near future. Similarly, items such as account payables and pension liabilities included in total liabilities may influence this ratio. Second, Omowunmi (2012), and Chinaemerem and Anthony (2012) measured total debt ratio as the ratio of total debt (both short-term and long-term) to total asset. This measure according to Rajan and Zingales (1995), fails to take into account the fact that there are some assets that are offset by specific non-debt liabilities. For instance, an increase in the gross amount of trade creditors is reflected in a reduction of this measure of leverage. Given that the level of accounts payable and accounts receivable may jointly be influenced by industry consideration, it seems appropriate to use a measure of leverage unaffected by the gross level of trade creditors. We addressed the issues of measuring leverage by using the ratio of total debt (short-term and long-term debt) to total capital (defined as total debt plus equity). This measure is not affected by trade credit and factors that may have nothing to do with financing. According to Rajan and Zingales (1995), the effect of past financing decision is probably represented by this ratio. Third, prior studies on the effects of financial leverage on firms’ performance, to the best of the researcher’s knowledge, did not take into account the possibility of reverse causation from firms’ performance to financial leverage. If firm performance affects the choice of leverage, then failure to take this reverse causality into account may result in simultaneous equations bias. That is regressions of firm performance on a measure of leverage may confound the effects of financial leverage on firm performance with the effects of firm performance on financial leverage However, it is important to note that leverage is a function of the capital structures of the listed companies. Consequently, the market value of a share may be affected by the capital structure decision, and the company will have to plan its capital structure initially, at the time of its inception. Subsequently, whenever funds have to be raised to finance investments, a capital structure decision is involved (Pandey, 2010). A company can finance its investments by debt and equity, and a company may also use preference shares. The ratio of the fixed- charge sources of funds, such as debt and preference shares to owners’ equity in the capital structure is described as financial leverage or gearing (Pandey, 2010). The other alternative term ‘trading on equity’ is derived from the fact that it is the owners’ equity that is used as a basis to raise debt. The supplier of debt (lender) has limited participation in the sharing of company’s profits and therefore, may impose certain restrictions (protective covenants) on the firm (Waterman, 1953). Such restrictions include provision relating to collateral, sinking funds, dividend policy and further borrowing. The issuing firm agrees to these so-called protective covenants in order to market its bonds to investors (Bodie, Kane & Marcus, 2004). Financial leverage decision is a vital one since the performance of a firm is directly affected by such decision; hence, financial managers should trade with caution when taking debt-equity mix decision.

 

  • STATEMENT OF THE PROBLEM

 

Several researches have been done before all over the world concerning the leverage and its determinants, for example Nimalathasan & Valeriu (2010) pointed out that profitability if a determinant of leverage according to a study of listed financial institutions in Sri Lanka. The analysis of listed financial institution shows that Debt equity ratio is positively and strongly associated to all profitability ratios (Gross Profit, Operating Profit & Net Profit Ratios). The researcher is of the opinion that relative proportions of debt, equity, and other securities that a firm has, constitute its leverage. Since there is a mix of determinants of leverage in listed companies, this research is hereby seeking to examine the factors determining leverage in the listed banks in Nigeria.

 

  • OBJECTIVE OF THE STUDY

The general objective of this study is to analyze the determinants of financial leverage in listed conglomerate in Nigeria while the following are the specific objectives:

  1. To examine the relationship between equity return and leverage financing of listed conglomerate in Nigeria.
  2. To examine the relationship between financial risks and leverage financing in listed firms in Nigeria.
  3. To examine the relationship between markets value of asset and leverage in listed conglomerate in Nigeria.
  4. To examine the relationship between Non debt Tax and leverage in listed firms in Nigeria.
  5. To examine the relationship between profitability and leverage in firms in Nigeria.
  6. To examine the relationship between tangibility and leverage in listed firms in Nigeria
    • RESEARCH HYPOTHESES

Hypothesis one

H0: There is no significant relationship between equity return and leverage financing of listed conglomerate in Nigeria.

H1: There is a significant relationship between equity return and leverage financing of listed conglomerate in Nigeria.

Hypothesis two

H0: There is no significant relationship between financial risks and leverage financing in listed firms in Nigeria.

H2: There is a significant relationship between financial risks and leverage financing in listed firms in Nigeria.

 1.5 SIGNIFICANCE OF THE STUDY

The following are the significance of this study:

  1. This study will be useful for the business managers and financial administrators on how some factors determine leverage in a listed company. This study will also educate on the variations between the aggregates of determinants.
  2. This research will be a contribution to the body of literature in the area of the determinants of leverage in listed companies in Nigeria, thereby constituting the empirical literature for future research in the subject area.
    • SCOPE AND LIMITATION OF THE STUDY

The scope of the topic covers determinant of financial leverage of listed service companies in Nigeria. The researcher encounters some constrain which limited the scope of the study;

  1. a) AVAILABILITY OF RESEARCH MATERIAL: The research material available to the researcher is insufficient, thereby limiting the study
  2. 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.
  3. c) Organizational privacy: Limited Access to the selected auditing firm makes it difficult to get all the necessary and required information concerning the activities

1.7 DEFINITION OF TERMS

 DETERMINANT: In linear algebra, the determinant is a value that can be computed from the elements of a square matrix. The determinant of a matrix A is denoted det, det A, or

FINANCIAL LEVERAGE: Financial leverage is the degree to which a company uses fixed-income securities such as debt and preferred equity. Financial risk is the risk to the stockholders that is caused by an increase in debt and preferred equities in a company’s capital structure.

SERVICE COMPANIES: A service company is a business that generates income by providing services instead of selling physical products. A good example of a service company is a public accounting firm. They earn revenues by preparing income tax returns, performing audit and asset services, and even doing bookkeeping work.

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


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DETERMINANT OF FINANCIAL LEVERAGE OF LISTED CONGLOMERATE FIRMS IN NIGERIA

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