ABSTRACT
In this st udy, I aimed at three objectives. First, t o determine the financial leverage of man ufact uring firms listed on the Ghana St ock Exchange. Sec ond, t o analyse the relati onship between financial leverage and pr ofitability. Third, t o examine the fact ors affecting financial leverage of man ufact uring firms that are listed on the Ghana St ock Exchange. Empl oying descriptive and trend analysis, my res ults sh owed that financial leverage of man ufact uring firms listed on the Ghana St ock Exchange has been varying over time precisely, financial leverage increased fr om 2006 t o 2007, declined thereafter until 2013 where a sharp increase was observed t o 2015 and then decreased again fr om 2016 t o 2018.This s uggests that man ufact uring firms rely m ore heavily on debt financing th us m ore exp osed t o the risk of financial leverage, bankr uptcy, whiles financing their operati ons.In terms of my sec ond objective, using the dynamic system Generalized Method of Moments (GMM) t o analyze the relati onship between financial leverage and man ufact uring firms’ pr ofitability, I established that debt t o t otal asset c omp onent of financial leverage is negatively linked t o pr ofitability whiles debt t o eq uity and eq uity t o t otal asset opti ons of financial leverage were p ositively linked t o pr ofitability of man ufact uring firms. Lastly, the st udy empl oyed panel regressi on, t o examine the key determinants of financial leverage. Fr om this regressi on, I find that ret urn on eq uity, pr od ucti on c ost, invent ory, firm size and tangibility are key determinants of financial leverage of the man ufact uring firms in Ghana.
CHAPTER ONE INTR OD UCTI ON
Backgr o und of the st udy
The m otive behind the establishment of m ost firms is creati on of shareh olders wealth or increase in firm’s val ue. H owever, maximizati on of shareh olders wealth springs fr om
optimal capital str uct ure. F or many years, the c oncept of capital str uct ure has been an
object of intense ide ol ogically infl uenced debate. C onseq uently, capital str uct ure has been defined fr om different sch olarly perspectives. F or instance, H ung (2012) referred t o capital str uct ure as a decisi on made by a firm t o finance its operating activities using a specific pr op orti ons of debt and eq uity. M ore over, Marq uis (2001) identified the main s o urces of financing available t o b usiness as debt and eq uity financing. B usinesses are theref ore req uired t o maintain a right balance between debt and eq uity financing in other t o attain
optim um capital str uct ure. Whereas capital str uct ure reflects using specific mix of debt and eq uity t o f und their assets or operati ons (Ab or, 2005), financial leverage highlights usage of m ore of firm’s debt t o certain mix of its eq uity t o f und the operati on of that firm (Gill, 2008). Debt financing represents b orr owings which establishes a debt or-credit or relati onship between firms and the b ond h olders whereas eq uity financing res ults fr om st ock iss ue and it is characterized by interest received by owners of the c orp orati on. There is n o hard and fast r ule t o be applied in determining pr op orti ons of debt t o eq uity, th us, a dilemma in determining ideal financial leverage p ositi on of firms.
M odigliani & Miller (1958) pi oneered capital str uct ure irrelevancy the ory, which reveals capital str uct ure plays n o significant r ole in estimating firm’s w orth. Regardless of a firm being highly leveraged or n ot has n o bearing on firm’s w orth unlike operating pr ofits. Firm’s val ue hangs on pr ofit margins and c orresp onding risk attached t o an investment
(H orne, 2002). D urand (1952) intr od uced the net inc ome appr oach of capital str uct ure, and p osited that m ore leverage w o uld impact the c ost of capital which res ults in increasing firm’s val ue. He emphasized that firms manip ulate their c ost of capital by using debt capital. M odigliani & Miller (1958), was of the view that b usinesses retain pr op orti ons of debt in capital str uct ure t o lessen weighted average c ost of capital, unf olding int o maximizing firm’s w orth. An optimal capital str uct ure is one with incl usi on of s ome am o unt of debt, b ut n ot in f ull. A right blend of debt t o eq uity red uces financing c ost of firms which c o uld devel op int o bankr uptcy (Gill, 2011). C u ong and Cahn (2012) stated that a firm’s t otal leverage sh o uld n ot g o bey ond 59.27% since an increasing debt rati o impacts firms negatively. This c ontradicts the earlier w orks by Gill et al (2011), wh o f o und a p ositive c orrelati on between financial leverage and firms’ val ue.
Whether a firm h olds m ore eq uity or m ore debt, it is gr o unded in the ch oice of c orrect capital str uct ure hence the imp ortance of capital str uct ure cann ot be overl o oked (C opeland & West on, 1984). Alth o ugh, the st udy on capital str uct ure has gained m uch attenti on in recent times, this st udy aims at analysing the tr ue effect of financial leverage on pr ofitability
of firms. It is h owever alien in many devel oping c o untries as till date many researchers f oc us their research lenses on fact ors affecting financial leverage in the devel oped c o untries. Ghanaian man ufact uring ind ustries have been plag ued by setbacks fr om b oth the external and internal envir onment . Many hardly s urvive after five years of
operati ons and th ose wh o find feet in their b usinesses remain adamant and unable t o expand int o other markets d ue t o mis use of capital, partic ularly, financial leverage. This paper sheds light on fact ors affecting financial leverage of man ufact uring firms in Ghana.
