EMPIRICAL ANALYSIS OF CAPITAL STRUCTURE AND MARKET VALUE OF COMPANIES
The central point of this research work is how capital structure could impact on the share price of quoted companies in Nigeria. The researcher desires to reflect on the positive impact which capital structure has on market value of quoted companies in Nigeria.
Data used for this research work were collected from secondary sources, which include annual reports and accounts of selected companies in Nigeria and Nigerian stock exchange fact book. These data where analyzed using regression (ordinary least square) method. Review of literature was done to gain greater understanding of the subject matter.
It is therefore recommended that companies should ascertain that capital structure mix that maximizes the market value of the company that will automatically increase shareholder wealth.
TABLE OF CONTENTSTitle
CHAPTER ONE: BACKGROUND OF STUDY
1.1 Statement of Problems
1.2 Research Objective
1.3 Scope of the Study
1.4 Research Hypothesis
1.5 Significance of Study
1.6 Limitations of the Study
1.7 Definition of Terms
CHAPTER TWO: LITERATURE REVIEWIntroduction
2.0 Versions of Capital Structure
2.1 Debt Financing
2.3 Capital gearing
2.4 Cost of Capital
2.5 Changes in Capital Structure as it Affect Share Prices/Cost of Capital
2.6 The Relationship between the Use of Financial Leverage and Share Prices
2.7 Financial Innovation for Improving Capital Structure
2.8 The theories of Capital Structure
2.9 The Role of the Capital Market in Share Prices Valuation
CHAPTER THREE: RESEARCH METHODOLOGY3.0 Introduction
3.1 Research Design
3.2 Populations and Sample Size
3.3 Sources of Data
3.4 Data Presentation and Analysis
CHAPTER FOUR: PRESENTATION AND ANALYSIS OF DATA4.0 Introduction
4.1 Presentation of Results
4.2 Analysis of Results
CHAPTER FIVE: SUMMARY, RECOMMENDATION AND CONCLUSION5.1 Introduction
5.2 Summary of Findings
5.3 Recommendation/Policy Implication
CHAPTER ONEBACKGROUND OF STUDY
Corporate organizations do need funds for varying commercial activities as well as growth; and these funds that could be obtained from various sources are equity capital, retained earnings and debt. According to Unugbro (1998), capital structure is determined by the mixture of long term and equity used by a firm. Capital structure thus denotes the permanent long-term debt, preference share, and ordinary share and excludes short-term debts and overdrafts. Therefore, capital structure is used to denote the proportionate relationship between debt and equity of a corporate organization.
All sources of funds usually have their associated cost of capital and it imposes different obligations cost on the firm. The firm uses these funds obtained to finance it’s operation in anticipation that the corresponding rate of return would be sufficient to cover the resulting cost. An optimal capital structure could be ascertained by comparing respective cost of capital obtained. According Owualah (1998) an optimal capital structure is itself one where the mix of this proportions creates a financial structure for a company that it’s potential value for the owners. According to Pandey (2005:5) the mix of debt and equity is known as firm’s capital structure.
The financial manager must strive to obtain the best financing mix or the optimum capital structure for his or her firm. The firm’s capital structure is considered optimum when the market value of share is maximized. An organization’s capital structure can also be achieved when the Weighted Average Cost of Capital (WACC) is minimized. According to Stephen, Randolph and Bradford (2001:368) thus, there is a choice of the firm’s capital structure so that the WACC is minimized. For this reason, structure is better than another if it results in a lower weight average cost of capital.
According to Jerry and Gordon (1987), the firm’s target capital structure is an important consideration to its financial manager. An appropriate capital structure is a critical decision for any business organization and this decision is very important not just because of it’s needs to maximize shareholder’s wealth or increase the market value of the company, but also because of the impact such decision has on the company’s ability to deal with the competitive environment.
The concept of optimal capital structuring implies that a company’s choice of financing mix between debt and equity matters a great deal but however in reality it has been discovered that there is an acceptable balance between debt and equity financing that most companies should strive to attain in order to maximize their market value or increase shareholder’s wealth. According to Arthur, David, John and William (1998:520), the objective of capital structure management is to mix the permanent sources of funds used in a manner that will maximize the company’s common stock price. Therefore the variation of a company’s capital structure to achieve the acceptable balance between it’s debt and equity when and as time needed.
In Nigeria, just as in other developing countries, not much as been documented on capital structure and the market value of companies.
It is often believed that factor that drive market price per share go beyond ideal or proper mix of debt and equity.
The focus of this paper is to undertake an empirical analysis of the relationship of capital structure and shareholder value in Nigeria.
Management thus need to develop an optimal capital structure which implies a perfect mix between the company equity and debt in an optimal way to achieve the main goal of maximizing the shareholders wealth as well as to improve on it’s market value of both the owners and potential shareholders.
1.1 STATEMENT OF PROBLEMSWhat ever the capital structure decides a company decides upon, it will definitely have an effect on the company especially in the aspect of it’s market value, thus in order to analyze the extent to which capital structure relates to market values, there is need to seek answers to the following questions.
1. Does capital structure actually affect the market value of company?
2. Does any significant relationship actually exist between capital structure and market value of company?
3. What effect does the capital structure have on the company present and future cash flows?
4. What factors influence the decision of management as regards capital structure?
5. What are the other factors that effect market value?
6. Does the optimal capital structure actually achieve the goal of maximizing shareholders wealth?
7. Does optimal capital structure improve on market value for potential shareholders?
1.2 RESEARCH OBJECTIVEThis research work seeks to achieve the following objectives.
1. To find out the relationship between capital structure and market value of companies (share price).
2. To find out the strengths and direction of the relationship
3. To create awareness to the public on the need to invest in an optimal capital structured company.
4. To find out why the public still has low awareness about the factors that determine low or high market value of quoted companies.
5. To analyze the effect of other factors on share price.
6. To analyze the effect of a fair market value to the company and it’s investors.
1.3 SCOPE OF THE STUDYThe scope chosen by the researcher is the contemporary scope, which is it is time framed. The data obtained from the published accounts and annual reports of quoted companies of interest for 10 years from 1997-2006. The particular annual reports were selected after considering its status in the Nigerian stock exchange (N.S.E).
1.4 RESEARCH HYPOTHESIS
The following hypothesis will be tested
1. (H0): Capital structure does not have significant relationship, does not determine market value.
(H1): Capital structure does have a significant relationship and this determines market value.
2. (H0): Optimal capital structure does not maximize shareholders wealth.
(H1): Optimal capital structure maximizes shareholder’s wealth.
3. (H0): Optimal Capital structure does not improve on market value
(H1): Optimal capital structure improves on market value.
1.5 SIGNIFICANCE OF STUDYThis study attempts to produce information to bridge the information needs of the potential and actual investors as well as for management of companies. Therefore the following categories will benefit immensely from the finding of this research work.
1. For the potential Investor: It could serve, as a guide in determing the value of the company that would finally have an influence on their investment decision.
2. For management: It would expose them to improved practices as well as help control share prices.
3. For shareholders: It would help them to estimate and evaluate the returns suitable from their investments.
4. For Government: It would be beneficial to government in the area of policy formulation and implementation towards sustaining the capital structure policies already in place.
5. For the public: it will enlighten the public on the need to invest in a well capital structured company with effective policies. It will also benefit the public in the area of providing relevant information for the future researchers own research work.
6. For employees: It would help them access other potentials after which their efficiency and productivity will increase thereby increasing the productivity of the company as a whole.
7. For customers: It would expose them to knowing the company better, thereby making the demand for the companies product increase. It would also make them evaluate the returns suitable from investment.
DEFINITION OF TERMS
a. Capital: Capital relates to the proportion of different types of securities both dist and equity issued by a company
b. Capital Structure: Capital structure relates to the mix of the long-term sources of funds used by the company.
c. Liquidity: It is the ability of the company to meet short term maturing obligation as they fall due.
d. Dividend: This is the payment made by quote a company to it’s share holders, it could be paid either in cash or stock dividends.
e. Stocks: Stocks refers to a fixed interest security issued by companies and it’s also part of the equity capital of the company.
f. Stock exchange: This is a place where stocks, security, share is constantly traded.
g. Capital Gains: It occurs when stock exchanged securities are sold at a higher price than it was paid for. Hence, it could be seen as a situation where the shad of a company appreciates in value because the earnings power of the company is appreciating.
h. Share: A share is the smallest indivisible unit of capital of a limited liability company which gives it’s holders the opportunity to receive an amount called divided.
i. Share price: Share price is the market price of share of a company as stated on the daily listings of activities in the stock exchange.
j. Leverage: This is the amount of debt that a firm utilizes in financing its activities. A company is said to be highly leveraged when it has a high proportion of debt stock in its capital structure.
k. Share Holder: This is a part owner of a limited liability company and he or she is entitled to vote in annual general meetings of the company and to receive dividends, and to obtain a share in the net assets of the company on it’s liquidation.
l. Quoted Company: This is a company whose share are listed on the stock exchange.