DETERMINANT OF LEVERAGE IN LISTED SERVICE COMPANIES IN NIGERIA

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 QUESTIONS

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

1.5       HYPOTHESIS

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.

Hypothesis three

HO3: There is no significant relationship between markets value of shares and leverage in listed banks in Nigeria.

HA3: There is significant relationship between markets value of shares and leverage in listed banks in Nigeria.

Hypothesis four

HO4: There is no significant relationship between non debt tax and leverage in listed banks in Nigeria.

HA4: There is significant relationship between non debt tax and leverage in listed banks in Nigeria.

Hypothesis five

HO5: There is no significant relationship between profitability and leverage in listed banks in Nigeria.

HA5: There is significant relationship between profitability and leverage in listed banks in Nigeria.

Hypothesis six

HO6: There is no significant relationship between tangibility and leverage in listed banks in Nigeria.

HA6: There is significant relationship between tangibility and leverage in listed banks in Nigeria.

1.6       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

This study is limited to listed banks in Nigeria from 2008 to 2014. The study will also cover the determinants of leverage in the listed banks in Nigeria.