capital structure determinants

Topics: Corporate finance, Finance, Tax Pages: 19 (5793 words) Published: March 7, 2014
Journal of Finance and Investment Analysis, vol.1, no.2, 2012, 61-81 ISSN: 2241-0988 (print version), 2241-0996 (online)
International Scientific Press, 2012
Topic: capital structure determinants of
quoted firms in Nigeria and lessons for
corporate financing decisions
Michael Nwidobie Barine1
Abstract
Financial arrangements determine how and the amount of financing that can be obtained from fund providers. An optimal allocation between equity and debt is determined by the trade-off between the net tax advantage of additional corporate leverage and the costs associated with the increased likelihood of financial distress and reduced marketability of a firm’s corporate debt, and agency costs. To ascertain the determinants of this capital mix, research results from the regression analysis of data obtained from seventeen financially successful quoted firms in Nigeria show that this mix is positively determined by cost of equity, existence of debt tax shield, covenant restrictions in debt agreements, firm dividend policy, competitor’s capital mix and profitability; and negatively by cost of debt, parent 1 Department of Accounting and Finance, Caleb University, Lagos, Nigeria, email: Barikem@yahoo.com

Article Info: Received : February 18, 2012. Revised : March 24, 2012 Published online : May 31, 2012
62 Topic: capital structure determinants of quoted firms in Nigeria ... company influence and fear of financial distress necessitating new and financially unsuccessful firms to reduce debt/equity ratios when there exists a likelihood of increased financial distress and high cost of debt and increase it when cost of equity, profitability and benefits from tax shield is high, ensuring optimal tradeoff between costs and net tax advantage of additional leverage and costs and benefits of equity in firm capital structure.

JEL classification numbers: G3, M2
Keywords: capital structure, financing decisions, net tax advantage, leverage 1 Introduction
Financing arrangements determine how and the amount of financing that can be obtained from funds providers. The total value of a firm, depend on how well the firm made its investment decisions, as the higher the yield on investments the higher the earnings/income to the firm. The higher the firm’s income/earnings, the higher the flow of gains to the owners of the company. Financing decisions determines the value of the firm’s assets. Consensus on investment decisions and asset values among corporate finance managers of a firm also require decision of how the investments will be financed.

The decision on the finance sources according to Buckley et al (5), depend on five factors, namely:
(a) tax-reliance on debts reduces taxes paid by the firm and taxes paid by some bondholders. He noted that if corporate tax rates are higher than interest rate on bond, there will be value from using debt finance;

(b) types of assets the firm has, as financial distress depends on the type of such asset;
Michael Nwidobie Barine 63
(c) uncertainty of operating income as firm’s in this situation have a high probability of experiencing distress even without debt; and
(d) the Pecking Order theory effect, in which firm’s decide for and prefer internal financing to external financing irrespective of the cost of external financing.
(e) Cost-return payable on borrowed funds.
Decision on capital structure is a decision on a firm’s debt/equity ratio. Finance managers choose the capital structure that maximizes the value of the firm for share holders. Conversely, changes in firm’s capital structure hurt shareholders if the value of the firm decreases.

Ideally, Ross et al (17) suggested that the capital structure of a firm should be at the level where the debt/equity ratio makes the total value of the firm as big as possible. They opined that finance managers should choose the capital structure that they believe will have the highest firm value, because that will be more beneficial to the firm’s...

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