This study examines the relationship between capital structure and market value of a company, it is motivated by a desire to explain debt (leverage) used by five manufacturing companies listed in Nigeria stock exchange in 2012 financial year. Debt financing were discussed, income gearing, cost of capital, cost of debt, the weighted average cost of capital, capital structure and its effect on share price/cost of capital, the relationships between the use of financial leverage and share price. It also discussed financial innovation for improving capital structure, issues and theories of capital structure, the role of the capital market in share prices valuation, factors that influence share prices and behaviour of share prices. In light of this discussion, a number of questions arose to determine if shareholders fund has a significant impact on the market value of the firm. This then led to the formulation of two hypotheses which were analyzed using the ordinary least square regression technique on the companies. The findings revealed that the two performance variable has significant impact on the market value of the firm. The result of this study was observed that variable of equity (shareholders fund) has a significant relationship with the market value. It was recommended among others that Nigerian companies should try to ascertain the optimal capital structure to be adopted as a policy in order to create a balance in satisfying the shareholders desire and management of capital structure decision. It was concluded that any researcher that intends to research on this area in finance in the future should investigate into other factors influencing the market value apart from capital structure.
TABLE OF CONTENTS
Chapter One: Introduction
Chapter Two: Literature Review
2.9.1 The factors that influence share price
Chapter Three: Research Method and Design
Chapter Four: Date Presentation, Analysis and Interpretation
Chapter Five: Summary of Findings, Conclusion and Recommendation
Background to the Study
One of the cornerstones of the modern corporate finance theory is the capital structure irrelevancy proposition (Modigliani & Moller 1958). Modigliana & Moller (1958) conclude that the market value of any firm is independent of its capital structure. It is observed that the options capital structure is closely related to the growth potential of the firms (McConnel & Servaes 1995; Jung, Kim & Stulz 1996) and some other valuables such as the size and the industry characteristics.
Debt policy and equity ownership structure matter and the way in which they matter differ between firms (McConnell & Servaes). Leland and Pyle (2007) propose that managers will take debt/equity ratio as a signed by the fact that high leverage implies higher bankruptcy risk (and cost) for low quality firms since managers always have information advantage over the outsiders, the debt structure may be as a signal to the market. Rose model suggests that the value of firms will rose with the leverage since increasing leverage increases the market perception of value.
Suppose there is no agency problem i.e. management acts in the interest of all shareholders, the manager will maximize the firm’s value by choosing the optional capital structure, highest possible debt ratio; high quality firms need to signal their quality to market, which the low quality firms try to imitate.
According to this argument, the debt level should be positively related to the value of the firm. Assuming information asymmetry, the pricing order theory (Myers & Majurf 1984) predicts that firms will follow the peeking order as optimal financial strategy. The reason behind this theory is that if the managers act on behalf of the owners, they will issue securities at a higher price than they are truly worth.
The more sensitive the security, the higher the cost of equity capital, since the action of the manager is giving a signal to the market that the securities are overpriced. Stulz (1990) urge that it can have both positive and negative effect on the value of the firm (even in the absence of corporate taxes and bankruptcy cost). He develops a model in which debt financing can both alleviates the over investment problem. Stulz (1990) assumes that managers have no equity ownership in the firm and receive utility by managing a larger firm. The “power of manager” may motivate the self interest managers to undertake negative present value projects. To solve this problem shareholders force firms to issue debt. But if firms are force to pay out funds, they may have to forgo positive present value project. Therefore, the optimal debt structure is determined by balancing the optimal agency cost of debt and the agency cost of managerial discretion.
According to Stulz (1990), McConnel and Servaes (1995) Jung, Kim, (1996), the influence of the debt on the firm’s value depends on the presence of growth opportunities. For firms facing low growth opportunities, debt ratios are negatively related to the firm’s value.
Capital structure is the mixture of permanent sources of funds a firm uses in financing its operations, primarily represented by long term debt, preference stock common equity, debenture which exclude all short term credit i.e. overdraft.
The amount of debt that a firm uses to finance its asset is called leverage. A firm worth a lot of debt in its capital structure is said to be highly levered while a firm worth no debt is said to be unlevered.
Pandy (2005, p.5) posited that the mix debt equity is known as a firm’s capital structure. The manager should rigorously strive to obtain the optimum capital structure for the organizational being. It should be noted that the firm’s capital structure is seen as a mixed or when it’s market value of shares is maximized or when it’s weighted average cost is minimized. An appropriate capital structure is a critical decision for any business organization and this decision is very important not just because of its need to maximize shareholder’s wealth or increase the market value of companies, but also because of the impact such decision has on the company’s ability to deal with the competitive environment.
In other developing countries of the world and Nigeria in particular, not much has been written on the conceptual linkage between market value of companies and capital structure, therefore the financial manager should seek that capital structure which maximizes the value of the firm (optional capital structure) are brought to bear. The firm’s optional capital structure should represent a balance between debt and equity. Such advantage that comes from using cheaper debt is just matched by the increase in the financial risk that comes form debt.
Statement of Problem
The capital structure mix that a company decision will definitely have an effect on its market value. A cursory look will be taken on the extent to which capital structure relates to the market values, there is need to seek answers to the following questions:
The hallmark of business enterprises are probability and accountability which enables the organization to gain public confidence on which the organization thrives. The research work seeks to achieve the following objectives:
Statement of Hypothesis
Alternative Hypothesis (Hi): Capital structure has impact on the market value of the firm.
Alternative Hypothesis (Hi): Shareholders fund has a significant impact on market value of the firm.
Significance of the Study
This study attempts to produce information to bridge the information needs of the potential and actual investors as well as for the management of companies.
Therefore the following categories will benefit immensely from the findings of this research work.
Scope of the Study
This research work encompasses a comprehensive survey of companies in Nigeria. The fundamental aim of this study is to analyze the relationship that subsist between capital structure and market value or share price. The data is obtained using a cross section of quoted companies in the Nigerian stock exchange for the period of 2010.
Limitation of Study
Definition of Terms
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