IMPACT OF MONETARY POLICY ON CAPITAL STRUCTURE AND FINANCIAL PERFORMANCE OF FIRMS IN GHANA

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ABSTRACT

This research examines the impact of monetary policy on capital structure and financial performance of companies in Ghana. The research uses panel data from 2008-2017 for 33 firms on the Ghana Stock Exchange. A system GMM-technique is used to analyze the data. This technique allowed the researcher to control for autocorrelation to ensure a robust result is achieved.

The study finds that firms prefer to borrow long-term when monetary policy is contracting (increasing policy rate). Also, firms decrease their short-term debts when the base rate is increasing. The study finds that firm’s performance decreases as base rate increases. Policy rate has an insignificant relationship with the companies’ ability to make earnings on its assets and net- profit levels.

This research recommends that, when managers are making choices about debt/equity mix for funding their businesses, changes in monetary policy should be considered since it is better to borrow long-term debt when monetary policy is increasing. Firms should also seek to use their relationship with banks to ensure a stable interest rate in order to maintain their performance by negating the effect of base rate on their financial performance. Policy makers can also consider establishing a bond market in the country to facilitate access to long-term debt by firms. This will offer a variety of alternative to bank-loans when businesses want to increase long-term investment during increasing policy rate.

Keywords: Monetary policy, Capital structure, Financial Performance, Stock Exchange

CHAPTER ONE INTRODUCTION

This section discusses the study’s background, the research problem, the purpose and objectives of the work, the research questions, methodology and the significance of the study. In addition, it presents the scope and chapter organization of this research.

Background of the Study

The importance of a company’s financing structure and how a firm is financed has been the subject of intense debate between two schools of thought: the traditionalist view and the modernist view. The traditionalist view postulates that companies have an optimal capital structure and they can benefit from the tax advantages associated with debt finance by including some good stock of debt- finance in their capital structure. Miller & Modigliani (1958) as key pioneers of the modernist view, argue that the capital structure and financing decisions are exclusive of each other (Watson and Head, 2004). The key issue regarding capital structure is how to manage the cost and benefit of each source of finance and how to arrive at a choice that reduces the cost and increases value to the business. In making this decision, internal and external factors that impact capital structure has to be taken into consideration to ensure maximum benefit to the firm. Factors within the firm such as profitability and asset tangibility are within management control whilst external factors such as monetary policy, GDP and inflation are beyond their control. Given that questions relating to the relationship between corporate finance and monetary policy have received great prominence (Prasad and Ghosh, 2005), this paper focuses on how monetary policy impacts the capital structure and financial performance of companies in Ghana.

Current research in monetary theory have highlighted the significance of analyzing the influence of monetary policy on funding decisions of various companies. In particular, the credit view states

that businesses that rely on bank borrowing are more likely to be affected by monetary tightening compared to firms that depend more on capital markets and less on bank-financing (Bernanke and Gertler, 1995). Listed firms will be able to adjust their debt position by issuing equity whilst private firms cannot do so if they face higher information cost (Ghosh and Sensarma, 2004). However, a counter opinion by Rajan (2002) suggests that both banks and firms will benefit if they use their relationship to maintain the supply of funds and help avoid the effects of changing monetary policy (Bernanke and Gertler, 1995). Regarding the interface between monetary policy and financial performance, monetary shocks impacts consumption, aggregate demand and economic activity and this affects business performance.

In Ghana, raising debt or equity is a major challenge facing firms because the Ghana Stock Exchange (GSE) is not well developed and most firms rely on bank financing. The creation of the GSE was to help transition the country to a market economy where firms can easily raise capital to finance their operations. However, a study by Kyereboah-Coleman (2007) revealed that even though trading volume and share index have increased on the GSE, Ghanaian firms use about 90 percent of non-current liabilities in financing their operations. Abor and Biekpe (2005) also found that total debts constitute over 50% of the source of funds of listed corporations. This shows that debt-financing has become much more important than capital market financing in the country.

Monetary policy shocks also impacts on firm performance since it makes it easy or expensive for companies to borrow, expand operations and increase output. When the policy rate rises, interest rates on credit facilities become more expensive and businesses that depend more on bank financing are likely to incur high cost of borrowing funds. Also, a drop in the policy rates promotes borrowing and spending (Saunders and Cornett, 2008) and as firms borrow at cheaper rates, they are able to increase output and improve performance. In Ghana, the monetary policy dropped to

16% as at March 2019 and it is expected that this will result in price stability, increase consumption and output. The lower rate should translate to lower interest rate on credit so that businesses can borrow and spend more to improve their performance. Given that interest charged on credit in Ghana respond slothfully to fluctuations in monetary policy (Kovanen, 2011), this work also probes if performance of corporations in Ghana is affected by changes in policy rate.

Statement of the Problem

In Ghana, total debt constitute a greater portion of the capital structure of listed corporations, (Abor and Biekpe, 2005; Kyereboah-Coleman, 2007) and this highlights the significance of debt-finance to the growth of businesses in the country. Coupled with this is the fact that the GSE is not well developed to support firms to raise sufficient capital for their operations (Abor, 2007). The reliance on debt exposes these firms to monetary policy shocks and their ability to access credit since it directly affects the interest rates on credit given by banks to businesses. This means that in times of tightening monetary policy, the cost of debt finance will be high and firms may either borrow at a high cost, cut down operations or even shelf projects that will yield enormous profits and contribute to their growth. On the other hand, under monetary loosening, interest rates falls and bank-base financing becomes cheaper. This will allow corporations to obtain credit at a lower cost and expand their operations.

In developed economies, it has been found that listed firms will be able to adjust their debt position by issuing equity in reaction to monetary policy fluctuation (Ghosh and Sensarma, 2004). Will the same findings hold for listed firms in a developing economy like Ghana? Furthermore, Monetarist posits that monetary policy action has bigger effect on economic activity and unanticipated changes affects output and growth of businesses. Firm performance is also expected to improve because when prices are stable, consumption and investment spending increases and corporations

are also able to acquire credit at cheaper rates. The low interest rates coupled with increase in consumption, investment spending and output growth should improve the bottom line of businesses in the country. However, since, the real economic effects of movements in monetary policy takes time to transmit into the Ghanaian economy, it is yet to be known whether variations in the monetary policy rate will impact firm financial performance. This work then seeks to obtain further proof in Ghana on whether the policy rate variation influences financial performance.

Research Purpose

The purpose for this research is to examine the impact of monetary policy on capital structure and performance of companies in Ghana.

        Research Objectives

The primary object is to assess the effects of monetary policy on the capital structure and financial performance of listed companies in Ghana.