Capital Structures In Nigerian Firms - Patterns Determinants, Adjustment, Optimality And Costs

Abstract

This study is an attempt to extend the frontiers of knowledge about company finances, with particular empirical reference to Nigeria. It examines the extent to which Nigerian firms use owners’ funds (equity) and borrowed funds (debt). It covers a period of 10 years, from 1974 to 1983. The study  samples 87 non-financial companies quoted on the Nigeria Stock Exchange; the sample excuses the financial sector because its financing patterns sharply differ from those of the other sectors of the economy.

There are three parts to the study. The first part is the detailed review of the theory of optimal capital structure and the extensions made to it; the second part is the presentation of the observed patterns of financing while the third part comprises four areas that are concerned with the empirical investigation of the importance (or optimality) of capital structures, the factors that determine capital structure, the adjustment of capital structure, and the relevance of capital costs to the capital structures of the sampled firms. In this study capital structures is defined as the ration of total debt to total assets at book values.

The major empirical findings of the study are as follows, with reference to the areas of investigation enumerated above.

i) The observed patterns of financing confirm that Nigeria firms use debt more than equity, with emphasis on the short-term debt which accounts for 51 percent of total financing. However, the trend analysis shows a slight tendency toward substitution of equity for debt. The capital markets and banks are not the primary source of funds. Generally, Nigerian firms rely more on trade credits and other non-bank liabilities.

ii) There is a suggestion of economy-wide range of optimal capital structures (i.e., debt ratios at which the value of the firm is maximised), while the capital structure don not significantly differ within industries. The evidence is inconclusive in a test of capital structure differences between industries, and hence the existence of (industry-related) optimal capital structures in Nigeria firms is yet unresolved.

iii) Five factors are found to have significant influence on the proportion of total assets financed by debt. These factors are the target debt ratio, company size, dividend payout ration, degree of operating leverage, and the average return on investment.

iv) Changes (over time) in capital structures of Nigerian firms are systematic - as if the companies want to move the values of their debt ratios to some target levels. Debt ratios are, indeed, adjusted  to targets defined as industry averages and firm historical averages, with adjustment coefficients ranging between 0.002 and 0.970. The speeds of adjustment (I.e., rates of change of the adjustment coefficients over time) show that Nigeria firms adjust quickly to their target debt ratios. Inaddition to the target factor, capital structure changes are also influenced by the company size and asset composition. 

v) The post-tax cost of debt of Nigeria firms is 6.1 percent. The combination of the pre-tax cost of debt (11 percent) and the cost of equity results in an overall cost of capital of 9 percent to Nigerian firms, and a marginal cost of 6.2 percent.

Corporate capital structures in Nigeria are fairly cost elastic, although the influence of cost is found to be statistically insignificant. Also, there are no scale economies in the costs of capital structures in Nigerian firms, while no industry influence was found on the  cost of debt.