Effect Of Capital Structure On Earnings Per Share Of Conglomerate Firms

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Effect Of Capital Structure On Earnings Per Share Of Conglomerate Firms


Abstract


The topic of study is the Effect of capital structure on earnings per share of conglomerate firms in Nigeria. The researcher applied the expo facto research design. The researcher used the correlation and regression. Above methods in the analysis of the data. The findings of the study shows that: Debt equity influences the earnings per share of conglomerate firms in Nigeria. That time interest earned has significant effect on the earnings per share of conglomerate firms in Nigeria, and that long term debt has significant effect on the earnings per share of conglomerate firms in Nigeria. Based on these findings the researcher recommended the following; the researcher recommends that management of conglomerate should work very hard to optimize the capital structure in order to increase the returns on equity, assets and investment. They can do that through ensuring that their capital structure is optimal. The management of Nigerian quoted firms should increase their commitment into capital structure in order to improve earnings from their business transaction. The management of Nigerian quoted conglomerate firms must caution against the apparent benefits of greater leverage simply as a device for controlling managerial opportunistic behavior. First, debt and equity represent different constituencies with their own competing, and often mutually exclusive, goals. Secondly, as the level of debt increase, the capital structure can change from one of internal control to of external control.


Chapter One


1.0 Introduction

1.1 Background of the Study

The research topic-effect of capital structure on earning, per share of conglomerate firm in Nigeria is a topic of interest to many people and many experts have given some definitions to the element in the topic such definitions to the element in the topic such as capital structure, earning per share etc. Zakari (2008) defined capital structure as “the firms mix of different source of finance” that is to say that capital structure is the mixture or collection of both owner’s capital (equity capital) and boned funds (debts) used in running a business .As Emekekwue (1997) pointed out capital structure is made up of long term fund, medium term fund and short term fund.

On the other hand, earning per share is an indicator used widely by investor. Earning per share represent the amount of profit the company has earned during the year for each ordinary share, David Alexander and Ann Britton (1998).

According to Ikpe (2008) earnings per share is computed by dividing net profit after taxes by the number of common shares outstanding. It is stated mathematically this;

Earning per share (EPS) = Net profit after tax

No of common shares outstanding

Earning per share is a measure of financial performance of a firm. It is a measure of financial viability or unviability of that business .To measure financial performance requires the evaluation or appraisal of some factors. Put differently, financial performance is obtained through performance evaluation of the business.

Okwoh understands performance evaluation as “the cumulative consideration of the factor that may be representative indicators or appraisal of an individual or entity’s activity or performance in reference to some standards over a period of time”. Hansen and Mo wen in Okwo (2012) opine that financial measures focus mainly on figures which may not tell the whole story of the company. However financial measures are commonly used to evaluate performance.


1.2 Statement of the Problem

Failure to plan for the capital structure, that is, the appropriate capital mix of the business will often lead to problems in sourcing funds to finance the firm’s future operations and can even lead to the failure or liquidation of the business. This is so because improper capital mix can lead to earning per share problem as well. According to institute of chartered accountants study pack, the international accounting standard number 33 clarified earnings per share into basic earnings per share and fully diluted earnings per share. The formula for basic earnings per share is profit on ordinary activities after tax before extra ordinaiy items less preference dividend divided by No of ordinary per shares in issue and ranking for dividend. The implication of the formular is that where there is cumulative preference share, it is the entire cumulative preference dividend due in an accounting year that should be deducted. This definitely affects the earnings per share calculation where there is cumulative preference shares in the capital mix, and will result in lower earnings per share. Furthermore if all the ordinary shares in issue rank for dividend, there will be more number of ordinary shares that will divide the available profit. These will also reduce the earnings per share. Besides problems arising for improper planning of capital structure, there are other problem areas that affect, both the capital structure and earnings per share. One of such problem is power supply. The chief executive of Dangote conglomerate while discussing arrangement to build cement factory in Liberia, told the president of Liberia, that throughout Africa, the major issue is power supply: he stated “No power, No growth” (the Guardian newspaper of 12th Feb, 2014). He pointed out to the president that the new cement factory would require 1.2 megawatts of electricity and proposed that his own coal burning power plant (as alternative) would produce 2.0 megawatt. Now since Liberia could not produce the 1.2 megawatt, using the 2.0 megawatt, of Dangote firm would result into excess of 0.8 megawatt, and this will result into excess cost and therefore decline in (profit/earnings per share.

The Liberia/Dangote company power/electricity supply problem stated above is also applicable to Nigerian and affects many industries including the conglomerates in Nigeria to meet up with the power supply problem. The companies have to borrow enough fund to combine with their equity fund. Failure to plan well for the capital fund especially the debt fund will definitely affect the capital structure and earnings per share due to high cost of borrowing (owners / interests).

Many firms in the conglomerate sectors which had in the past contributed greatly to the economics of Nigeria are now phasing out or reducing their operations. The cause of the problem is traceable to the capital structure and earnings per share problems.


1.3 Objective of the Study

The main objective of this study is to ascertain the effect of capital structure on earnings per share of conglomerate. But to aid the completion of the study, the researcher intend to achieve the following specific objectives;

  1. To examine the effect of capital structure on the profitability of a firm
  2. To examine the relationship between capital structure and earnings per share of conglomerate
  3. To ascertain the role of capital structure on firms profitability
  4. To examine the impact of capital structure on the liquidity of the firm

1.4 Research Hypotheses

The following research hypotheses were formulated by the researcher to aid the completion of the study;

  1. H0: capital structure does not have any effect on the profitability of a firm
    H1: capital structure does have an effect on the profitability of a firm
  2. H0: there is no significant relationship between capital structure and earnings per share of conglomerate
    H2: there is a significant relationship between capital structure and earnings per share of conglomerate

1.5 Significance of the Study

It is believed that at the completion of the study, the findings will be of great importance to the management of this firm as the findings of this study will help elaborate the importance of capital structure on firms share earnings Financiers

To evaluate a firm’s creditworthiness for possible future financial assistance if need be. This study would also be of benefit for creditors to do comparisons between the individual enterprises within the sector under study.

Investors are interested in evaluating the efficacy with which management is utilizing a firm’s capital for the success of the business. Besides, this study will furnish investors with information relating to an appropriate capital mix for the firm.

Scholars and researchers will find this study useful if they wish to use the findings as a basis for current and further research on capital structure theories, focusing on developing countries. This research paper will be available in libraries and most likely on the internet for easy access by scholars and researchers.

Regulatory bodies for instance the Nigeria securities exchange and the Capital Market Authority will assess and monitor capital structure of commercial and service firms in Nigeria. They will provide oversight role in regards to the firms’ creditworthiness as portrayed in the financial statements.


1.6 Scope and Limitation of the Study

The scope of the study covers the effect of capital structure on earnings per share of conglomerate firm; but in the cause of the study there are some factors that 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 Operational Definition of Terms

Capital Structure

Capital structure is a mix of debt and equity including reserves and surpluses that makes up the finances of a company (Siddik et al., 2016). From the strategic management point of view, capital structure analysis has always been an important issue since it attempts to meet the expectations of the various interested parties in a firm (Sultan and Adam, 2015).

Debt

Debt refers to both short-term and long-term borrowing aimed at financing a firm’s activities. Companies prefer debt financing because interest paid on debt is not taxable hence improving the value of a firm (Iavorskyi, 2013).

Equity

Equity capital represents the shareholders’ interest on the firm’s assets after liabilities are deducted. In financial statements, equity can take the form of common stock (share capital), preferred stock, capital surplus, retained earnings and reserves (Stephen, 2012).

Financial Performance

According to a shareholder, a firm’s financial performance is a measure of how better a shareholder is at the end of the period in question compared to how the shareholder was at the beginning of the same period. The shareholder state can be determined using ratios derived from a firm’s financial statements or using a firm’s data as reflected in the stock market prices (Abbadi, 2012; Bhunia, Mukhuti, Roy, Harbour, Bengal and Delhi, 2011).

Financial Leverage

Financial Leverage is sometimes referred to as equity or debt ratios. These ratios measure equity value in an organization by evaluating a firm’s overall debt portfolio. These ratios compare debt or equity to a firm’s assets or outstanding shares with the sole objective of measuring the true value equity in an enterprise (Sultan and Adam, 2015).

Securities Exchange Market

Securities Exchange market mobilizes dormant domestic savings and reallocates the financial resources to active agents. To raise money through the securities market, the issuer issues a prospectus, which gives details about the prospective issue including the issue price per share and the total amount it aims to raise from the offer. The

Security

Exchange also boosts the inflow of international capital as well as a useful tool for privatization programmes (Hamilton and Brandt, 2014).

Return on Assets

The return on assets formula, sometimes abbreviated as ROA, is a company’s net income divided by its average of total assets. The return on assets formula looks at the ability of a company to utilize its assets to gain a net profit (Heikal, Khaddafi and Ummah, 2014).


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 the effect of capital structure on earnings per share of conglomerate.

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 the capital structure on earning per share.


5.2 Summary

It has been depicted from the analysis above that the capital structure of Conglomerate firms in Nigeria consists of more short term finance than long term debt. This reveals that Nigerian firms rely heavily on short term financing rather than long term finance. In determining the effect of capital structure on the financial performance of quoted conglomerates. The study concludes that the ROA and Assets Turnover ratio were significant, while ROE and EPS were insignificant in explaining corporate capital structure decisions. Hence the study recommends that the management of the quoted conglomerate should employ a critical analysis of the appropriate debt-equity mix suitable for the firm. An indepth analysis of business factors that affect a particular industry is necessary in other to obtain the benefits of debt-equity mix.


5.3 Conclusion

Financial leverage is made up of two major elements namely; debt and equity. Empirical studies have shown that there is no ideal mix of debt and equity applicable to all firms. Each individual firm should strive to come up with a blend of these two components of capital structure that will guarantee profitability and avoid bankruptcy. One such way to achieve this, is applying some of the commonly used capital structure theories into practice. For example, the pecking order theory advocates for prioritization of internal mechanisms of financing such as retained earnings over external sources of financing such as debt financing. It is evident from the study that companies listed in the bourse can raise funds through public offers easily than unlisted firms. Therefore, companies should take advantage of this avenue of easy access to funds to come up with an appropriate mix of debt and equity that will guarantee the firm with growth in earnings and perpetual growth. Managers should remember that Debt to Equity ratio is a measure of risk and bankruptcy. High Debt ratio in a firm’s capital structure exposes the firm to the risk of bankruptcy.


5.4 Recommendations

Firms ought to balance the composition of debt and equity in their capital structure in a manner that is cost effective and not detrimental to its future growth. Firms should therefore apply the relevant capital structure theories. According to the pecking order theory, just as the name suggests, firms should give priority to internal sources of financing before venturing into debt. The trade-off theory on the other hand promulgates the use of debt considering the tax benefits a firm is likely to reap for considering debt financing. Effect of Capital Structure on firms’ profitability

The researcher has studied the effect of capital structure on financial performance of commercial and service firms listed on the Nairobi Securities Exchange over the period of 2012-2016 by using one independent variable, Debt to Equity ratio and four dependent variables namely; Return on Equity, Profit Before Tax, Profit After Tax and Earnings Per Share. If other researcher(s) wants to carry out another research on the same topic, then the researcher should consider incorporating more independent variables in the study and the period of the study must be more than 5 years for better results. In addition, the firm should adopt an optimal capital structure and effective management team capable of turning around the firm’s fortunes in terms of improved profitability while at the same time minimizing the firm’s risk of bankruptcy. Besides, management and shareholders ought to be aware of other external factors that may have an impact on the firm’s performance.

Effect of Capital Structure on Earnings Per Share

The only measure of share performance used in the study was the Earnings Per Share. If someone wants to conduct another study on this topic, the researcher must consider other measures of share performance such as the price earnings ratio and market price per share.


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