Determinant Of Financial Leverage Of Listed Service Companies In Nigeria

Project and Seminar Material for Economics

Determinant Of Financial Leverage Of Listed Service Companies In Nigeria


Abstract


This study is on determinant of financial leverage of listed service companies in Nigeria. The total population for the study is 200 staff of selected banks in Uyo, Akwa Ibom state. The researcher used questionnaires as the instrument for the data collection. Descriptive Survey research design was adopted for this study. A total of 133 respondents made up human resource managers, accountants, customer care officers and marketers were used for the study. The data collected were presented in tables and analyzed using simple percentages and frequencies


Chapter One


Introduction

1.1 Background to the Study

The term leverage is used to represent the proportionate relationship between debt and equity (Pandey, 2010). The concept used to study the effect of various mix of debt and equity on the shareholders return and the risk in the capital structure of a firm is known as leverage (Bhanu, 2011). Leverage is an investment strategy of using borrowed money to generate outsized investment returns. Leverage as a business term refers to debt or to the borrowing of funds to finance the purchase of company’s assets. Business owner can use either debt or equity to finance or buy the company’s assets.

Generally in accounting and finance, the leverage is the most debatable topic and continues to keep researchers pondering. Leverage refers to the mix of debt and equity used by firm financing its assets. It is clear that leverage is an important management decision as it greatly influences the owner’s equity returns, the owner’s risks as well as the market value of the shares. In other word, how a firm is financed is very important not just go to the managers of the firm but also to fund providers (Bhanu, 2011). This is because if a wrong mix of finance is employed, the performance and survival of the business enterprise may be seriously affected. However, firms financing decision involve a wide range of policy issue which may be outside the direct control of the firm’s management. Company determines an appropriate leverage level which will ensure that business continues as a going concern (Bhanu, 2011).

At the time a firm faces a financial deficit that affects its financial condition; the manager of the firm should be able to make a managerial decision as well as a financial decision in order to maintain the viability of the firm. One way that can be chosen is to undertake a capital restructuring, especially debt restructuring. The decision taken on debt restructuring, of course, requires expertise and analytic capabilities so managers can make the right decisions of financial restructuring for the company (David and Olorunfemi, 2010). An ideal composition of capital structure which consists of debt and equity will minimize the cost of capital and maximize the firm’s value. Therefore, it is important for the firm’s manager to understand the determinants of leverage in listed companies.

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.


1.2 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.


1.3 Objectives of the Study

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

  1. To examine the relationship between equity return and leverage in listed banks in Nigeria.
  2. To examine the relationship between risks and leverage in listed banks in Nigeria.
  3. To examine the relationship between markets value of shares and leverage in listed banks in Nigeria.
  4. To examine the relationship between Non debt Tax and leverage in listed banks in Nigeria.
  5. To examine the relationship between profitability and leverage in listed banks in Nigeria.
  6. To examine the relationship between tangibility and leverage in listed banks in Nigeria

1.4 Research Hypotheses

Hypothesis one
  • HO1: There is no significant relationship between equity return and leverage in listed banks in Nigeria.
  • HA1: There is significant relationship between equity return and leverage in listed banks in Nigeria.
Hypothesis two
  • HO2: There is no significant relationship between risks and leverage in listed banks in Nigeria.
  • HA2: There is significant relationship between risks and leverage in listed banks 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.

1.7 Scope / Limitations 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;

a) Availability of Research Material:

The research material available to the researcher is insufficient, thereby limiting the study

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.

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

Chapter Five


Summary, Conclusion and Recommendation

5.1 Introduction

It is important to ascertain that the objective of this study was to ascertain determinant of financial leverage of listed service companies in Nigeria

In the preceding chapter, the relevant data collected for this study were presented, critically analyzed and appropriate interpretation given. In this chapter, certain recommendations made which in the opinion of the researcher will be of benefits in addressing the challenges of financial leverage of listed service companies in Nigeria


5.2 Summary

This study was on determinant of financial leverage of listed service companies in Nigeria. Six objectives were raised which included: To examine the relationship between equity return and leverage in listed banks in Nigeria, to examine the relationship between risks and leverage in listed banks in Nigeria, to examine the relationship between markets value of shares and leverage in listed banks in Nigeria, to examine the relationship between Non debt Tax and leverage in listed banks in Nigeria, to examine the relationship between profitability and leverage in listed banks in Nigeria, to examine the relationship between tangibility and leverage in listed banks in Nigeria. In line with these objectives, two research hypotheses were formulated and two null hypotheses were posited. The total population for the study is 200 staff of selected banks in Uyo, Akwa Ibom state. The researcher used questionnaires as the instrument for the data collection. Descriptive Survey research design was adopted for this study. A total of 133 respondents made up human resource managers, accountants, customer care officers and marketers were used for the study. The data collected were presented in tables and analyzed using simple percentages and frequencies


5.3 Conclusion

Results suggest that profitability, size, and asset tangibility are important determinants of corporate capital structure of the sampled firms in the period under study. In many situations, it provides evidence in support of the Pecking Order Theory. The study could not, however, provide support for the importance of non-debt tax shield; growth opportunities and dividend pay-out as firm-specific determinant factors. This could be due to the fact that Nigerian economy is still developing and yet to get to a threshold for meaningful effects of these variables.


5.4 Recommendation

  1. Should reduce the amount of debt in their financial structure especially where there are signs of financial deterioration which is usually associated with high cost of debt. This will enhance profitability and sustenance of operations.
  2. The use of debt should be contingent upon the size and growth of the firm.
  3. Increase debt in the financial structure of firms when profits are high; cost of equity capital are high and benefits of tax shield are high.
  4. Use long-term debts to finance fixed tangible assets while short-term debts should be used to finance shortterm obligations.
  5. Should incorporate risk in their profit planning or capital budgeting since business firms operate in volatile environment.
  6. Should apply the Pecking Order theory of utilising internally generated funds (retained earnings), followed by debt issue where there exist growth opportunities, and later equity issues.
  7. Government policies should be directed at improving the information environment for Nigerian firms since information asymmetry influences a firm’s choice of debt financing.
  8. Subsidising floatation cost and reducing listing requirements to encourage small firms gain access to the capital market.

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