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EMPIRICAL ANALYSIS OF CAPITAL STRUCTURE
AND MARKET VALUE OF COMPANIES
ABSTRACT
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 CONTENTS
Title
Abstract
CHAPTER ONE:
BACKGROUND OF STUDY
1.0 Introduction
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
References
CHAPTER
TWO: LITERATURE REVIEW
Introduction
2.0
Versions of Capital Structure
2.1 Debt Financing
2.2 Gearing
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
References
CHAPTER THREE:
RESEARCH METHODOLOGY
3.0 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 DATA
4.0 Introduction
4.1 Presentation of Results
4.2 Analysis of Results
4.3
Summary
CHAPTER FIVE:
SUMMARY, RECOMMENDATION AND CONCLUSION
5.1
Introduction
5.2
Summary of Findings
5.3
Recommendation/Policy Implication
5.4
Conclusion
Bibliography
Appendix
CHAPTER ONE
BACKGROUND OF STUDY
1.0 INTRODUCTION
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 PROBLEMS
What 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 OBJECTIVE
This
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 STUDY
The
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
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 STUDY
This 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.
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