CHAPTER ONE
INTRODUCTION
1.1 BACKGROUND TO THE STUDY
In recent years, capital structure has become increasingly important in defining a company's financial performance and in meeting the expectations of stakeholders who want their company's value to grow. The management of corporate organizations must make decisions regarding the capital structure because such decision will impact on the performance of the firms. The aim of a firm’s capital structure may not be focused on wealth maximization but to safeguard management’s interest mostly in firms where control is dictated by directors and shares of the corporation carefully held (Dimitris and Psillaki, 2008). Capital structure selection is crucial for any organization for maximizing return to various stakeholders and also boost firm's ability to operate in a competitive environment (Goyal 2013). Capital structure decision are important when considering the factors that affects the performance of firms. The ratio of external source borrowed to internal source is a decision to corporate managers of a firm. The amount of long term and short term debt are used as measurement of a firm’s financial leverage. Capital structure represent a firm, financial framework which is made up of debit and equity used to finance the firm. While referring to a firm's balance sheet, which is a complete status of a firm in which all forms of assets and liabilities are recorded (Velnempy and Niresh, 2012). Capital structure in financial terms means the way firms finance their assets through the mixture of a company equity, debit or hybrid securities (saad 2010). Capital structure in accordance with previous researchers refers to the portion of a firm assets that are financed by borrowed fund which comprise of the firm’s profitability and liquidity performance of the firm, financial position of the firm ordinary share capital, preference shares, long term debt and short term. The relationship between short term debt and the financial performance of a firm is providing working capital to run the day to day activity of firms, the higher a working capital then the company is considered a well-managed firm with good potentials for firms growth. There are certain benefit and cost associated with using debt financing, and one of the benefits is that the firm can take advantage of tax shields benefits of debt by employing more debt in the capital structure. Firms must tradeoff tax shield benefits of debt against the financial distress and bankruptcy cost of debt (Abubakar, 2006). Capital structure is the foundation operates on, capital absorbs cost and losses. Capital structure is a crucial choice of the firm managers with the purpose to expand the value of the firm.. Initially, capital structure refers to a company's overall operations and expansion through the use of its own funds. According to Ateye ( 2013), governments in several countries frequently provide financial aid to businesses to help them start and maintain operations, and this assistance often overcomes some teething problems such assistance maintains pre-eminence during the downturn. Thus, the implication is the capacities in managing financial are important if a company or firm realize gain for its specialize resources, reduction in the valve obtained from strategic assets is gain through poor capital structure ( Kachor, 1997). Capital structure is the fundamental on how the firm finances its whole finance in the general operation and growth by using several means to fund its finance (Tsuji, 2011). According to (Pandy, 2009) financial performance measures the profitability and liquidity and provides useful parameters for measuring the prior performance of the firm and also the present state of the firm. Therefore, it is progressively relied that a firms needs to organize its capital structure for an optimum use of funds to enhance dealing with upcoming situation and how well a firm utilize its asset in operation to generate profit signifies the firms performance. On the other hand, the presence of bankruptcy cost goes in hand with the firm’s debt. Awunyo and Badu (2012) stated that finance managers aim to discover the capital structure that optimizes the firm's value. Ross (2002) added the demonstration of the importance of capital structure decisions to finance managers. His thesis demonstrated that capital structure is one of the most important factors that can help a firm optimize its value. His argument shows that capital structure decision is one of the crucial decisions that help to maximize company value. Furthermore, there are a lot of studies on capital structure and financial performance around the globe, but there are dearth empirical research with research listed service companies, in Nigeria to the best of the researchers knowledge there are only two empirical studies that examined capital structure and financial performance listed service companies sector by Tolulope and Olokoyo (2015) and David and Olorunfemi (2010, Ikpefan) The idea of relating company’s capital structure and its value started since the establishment of irrelevancy theory of capital structure by Modigliani and Miller in 1958. This theory was cited by Toraman (2013) which stated that, “firm value is independent of its capital structure”. In recent years, researchers come up with different perspectives of their studies; some revealed the positive relationship between capital structure and company profit while others revealed the negative relationship between the variables. Safiuddin (2015) and Adesina (2015) in their study results, they found that capital structure was strongly associated with firm’s performance. Narayanasary (2015) and Mwangi (2013) concluded a negative relationship between capital structure and company profitability. Because of the controversial results revealed by previous researchers, that situation provided an opportunity for a researcher to add the knowledge by analyzing the effect of capital on performance of service listed companies Nigeria. The results obtained were compared with the tradeoff theory of capital structure. The results were mixed; there was a positive association between the variables that was compatible with the tradeoff theory, as well as a negative relationship that was not consistent with the tradeoff theory. Since most Nigerian academics have been unable to establish a link between capital structure and commercial bank performance considering the listed companies, this study focuses on establishing a link between capital structure and the performance of publicly traded service companies and commercial bank performance, this study based on measuring the relationship between capital structure and performance of listed service companies.
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1.2 Statement of the Problem
Companies usually need resources for them to grow and develop their operating activities however; there are constraints in financing company resources. For this case, company resources will be applied with care so as to create enough shareholders value and for users of company resources. This study will be developed to assist finance managers and company managements and serve as guidance in making the best financial decisions of using debt and equity in order to improve their company’s financial performance. Mwangi (2014) who claimed that firm executives lack of proper advice for making effective financial decisions. The analysis of capital structure is an important tool for maximizing a company's financial performance, which is in the best interests of shareholders who expect dividends and capital gain from the company. Mansoon (2014) stated that “the decision of capital structure choices is of play a significant influence for firms and optimal capital structure is such a mix of debt and equity that maximizes the firm’s value and reduces the weighted average cost of capital”. Capital structure decision also helps managers to accomplish their financial strategies like investment and daily operational activities. The argument supported by Toraman (2013) who stated that the selection of capital structure components and uses play an important role during the determination of financial strategies of the company. Mireku (2014) further asserted that an organization's capital structure is inextricably tied to its ability to meet the expectations of its stakeholders. Several additional scholars in industrialized countries have looked into the impact of capital structure on firm performance. However, there are very few empirical research on the impact of capital structure on company performance of listed service companies in emerging nations, particularly Nigeria. This is the major problem would be addressed through this study.
1.3 Research Objective
The main objective of this study was to determine the effect of capital structure on profitability of service companies listed in the Nigerian stock exchange. The specific Research Objectives are: To investigate the effect of long-term debt to total asset ratio on Return on Assets of listed service companies in Nigeria. To examine the impact of total debt to total asset ratio on the Return on Assets of listed service companies in Nigeria. To investigate the effect of short term debt to equity ratio on Return on Equity of listed service companies in Nigeria. To determine the effect of long term debt to equity ratio on Return on Equity of listed service companies in Nigeria. To examine the impact of total debt to equity ratio on Return on Equity of listed service companies in Nigeria.
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1.4 Research question
The Research question of this study is; What is the effect of long term-debt to total asset ratio on Return on Asset of listed service companies in Nigeria? To what extent does total-debt ratio to total asset ratio on Return on Asset of listed service companies in Nigeria? What is the degree of impact of short-debt to equity ratio on Return of Equity of listed service companies in Nigeria? What is the effect of long term debt to equity ratio on Return on Equity of listed service companies in Nigeria? To what extent does total debt to equity ratio on Return on Equity of listed service companies in Nigeria?
1.5 Research Hypothesis
In the line of research questions and objectives, the following null hypothesis was formulated Ho1. Long-term-debt ratio to total assets has no effect on Return on Asset of listed service companies in Nigeria. Ho2. Total –debt ratio to total assets has no effect on Return on Asset of listed service companies in Nigeria. Ho3. Short term-debt ratio to equity has no effect on Return on Equity of listed service companies in Nigeria. Ho4. Long term debt ratio to equity has no effect on Return on Equity of listed service companies in Nigeria. Ho5. Total debt ratio to equity has no effect on Return on Equity of listed service companies in Nigeria.
1.6 Significant of the Study
The results of this study will provide financial guidance to managers, business consultants and investors with the necessary techniques of combining debt and equity and being able to maximize company performance. This study will assist decision makers especially finance managers and policy costs planners of both public and private companies to make more informed policy judgments about the balance of debt and equity capital, therefore increase shareholders value and reduce bankruptcy. This study will be used by investors and other people with the intention of investing to analyze the companies and see what kind of capital structure mix generates more profit for the company. This study will assist other academicians to write further studies concerning financial issues and add the knowledge to the community. Academicians who intend to write dissertations for Master's and Bachelor's Degrees programs provided in Nigeria and in other parts of the world may use the study results as the reference to support their studies. This study will assist finance managers and other finance officers in public listed companies to advice on their management about the best source of finance which contribute more profitability of the company. Investors and other company stakeholders after reading this study will be in a position to know the profitability and capital structure indicators of the companies in which they would like to invest and acquire returns in terms of dividends or capital gains
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1.7 Scope of study
The study will measure the impact of capital structure on firm’s performance of listed service companies in Nigeria, using 16 listed service companies in Nigeria as sample within the time frame of 2011 to 2020.
1.8 Limitation of the study.
However, in the course of carrying out this research, the researcher encountered several constraints which are worth noting. The researcher encountered difficulty in gathering data due to limited journal of this study due to time constraints. Despite these challenges, the researcher came out with valid and reliable result.
1.9 Organization of the study
This study is organized into five chapters. Chapter one is the introductory part, and it covers the background of the study, statement of the research problem, research objective, research questions, hypothesis of the study, significance of the study, scope of the study, limitations of the study, organization of the study and definitions of key terms. In chapter two, the researcher presents the review of related literature, consisting subheads which are treated in sections as the conceptual framework, theoretical framework and empirical framework. Chapter three is the research methods and it comprises the research design, the research area, population of the study, sample and sampling techniques, source and method of data collection, method of data analysis, model specification and decision rule among others. Chapter four is devoted to data presentation, analysis and interpretation of findings while chapter five gives the full summary of work done, conclusion and make recommendation base on the findings of the study.
1.10 DEFINITION OF TERMS
Capital Structure: Capital structure is how a firm would be able to fund its future investments projects via debt, equity or mixed. Company Profitability: This is an outcome or result of company business operations. That company result is the change amid the company revenue and expenditure. Balance Sheet: A statement that indicates the financial condition or the state of affairs of a business at a particular moment in time. Profit and Loss Account: A score board of the firm’s performance during a period of time. It reflects the results of operations for a period of time.
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