ABSTRACT
The issue of value creation for stakeholders of the firm as a result of the composition of its financial mix can be traced to the seminal work of Modigliani and Miller (MM) in 1958. Their argument is the irrelevance of the financing mix of firms on value. Thus, whether the firm uses equity or debt, the value of the firm does not change. There have been several theories after the works of MM carried out by several scholars either criticizing or supporting the Modigliani and Miller Irrelevance theorem. The Trade-off theory of capital structure suggests that there is an advantage to finance the firm with debt and also a cost of financing with debt. As a result, firms are assumed to trade-off the tax benefits of debt with the bankruptcy cost of debt when making their financing decisions. However, present and potential investors need single information which is, the value creating potential of the firm no matter the composition of the firm’s financing mix. Therefore this study had the following objectives; to determine the impact of debt financing on the ability of the firm to make profit; to determine the impact of debt financing on the ability of the firm to maximise the use of its assets; to determine the impact of debt financing on the firm’s earning power on per share basis; to determine the impact of debt financing on the ability of the firm to reward shareholders on per share basis; to determine the impact of debt financing on the firm’s ability to meet its’ financial obligations as at when due and to determine whether debt financing enhance the value of Nigerian firms. The ex post facto research design was adopted to enable the researcher make use of secondary data and determine cause-effect relationship for twenty-eight quoted Nigerian firms for the period 2004-2008 on a firm by firm as well as on aggregate basis. The Ordinary Least Square (OLS) estimation technique was adopted using SPSS statistical software to evaluate objectives one to five where ratio values of Total Debt Rate (TDR) was used as the independent variable while Net Profit Margin (NPM), Total Asset Turnover (TAT), Earnings Per Share (EPS), Dividend Per Share (DPS) and Current Ratio (CR) as dependent variables, while adopting a bankruptcy model, the Multiple Discriminant Analysis Model (MDA) to evaluate objective six using MDA’s Z-score benchmark of 2.675 to determine value (Rashmi and Sinha, 2004; Xing and Cheng, 2005). The study revealed that on a firm by firm basis there were mix variations of the impact of Total Debt Rate on the firms’ value parameters (NPM, TAT, EPS, DPS and CR) across firms sampled while on aggregate basis; there was a positive non-significant impact of Total Debt Rate on Net Profit Margin; there was a negative non-significant impact of Total Debt Rate on Asset Turnover Rate; there was a positive non-significant impact of Total Debt Rate on Earnings per Share; there was a positive non-significant impact of Total Debt Rate on Dividend per Share and there was a negative non-significant impact of Total Debt Rate on Current Ratio and twenty firms created value as a result of the firms’ use of debt financing representing 71.4% of firms sampled while eight firms representing 28.6% of firms did not create value. From the foregoing therefore, the use of debt financing enhances the value of Nigerian firms, thus could be used to enhance shareholders’ wealth, however further studies could still be carried out as to determine why some firms did not enhance value as a result of the used of debt finance in the financial mix of Nigerian firms .
TABLE OF CONTENTS
Title Page                                                                                                i
Approval Page                                                                                               ii
Certification Page                                                                       iii
Dedication                                                                                                       iv
Acknowledgements                                                                                v
Abstract                                                                                 vii
List of Tables                                                                                 xi
List of Figures                                                                                          xii
List of Appendixes                                                                                     xiii
Chapter One Introduction                                                                   1
1.1      Background of the Study                                                  1
1.2      Statement of the Problem                                                    4
1.3      Research Objectives                                                           8
1.4      Research Questions                                                            8
1.5      Hypotheses of the Study                                                 9
1.6      Scope of the Study                                                                   9
1.7      Significance of the Study                                                        10
1.8      Limitation of the Study                                                  11
1.9      Definition of Terms                                                              11
References                                                                                      13
Chapter Two            Review of Related Literatures                        16
2.0      Introduction                                                                                    16
2.1      The Nigerian Stock Exchange                                                         18
2.2      The Financing Decision of the Firm                                    19
2.3      The Concept of Debt and Debt Financing                     20
2.4      The Concept of Value of the Firm                  24
2.5      Valuation Methods                                                            25
2.5 .1Â Â Capital Asset Pricing Model (CAPM)Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â 25
2.5.2   Discounted Value Method                                               26
2.6      The Concept of the Firm’s financing Structure                       27
2.6.1   Trade-off Theory                                                                 30
2.6.2   The Pecking-order Theory                                       32
2.6.3   The Agency-cost Theory                                                    32
2.7      Overview of the Modigliani and Miller Theorem                     36
2.8     Bankruptcy, Cost of Bankruptcy and Effect on the Firm         41
2.9      The Concept and Uses of Financial Ratios                       44
2.10    Profitability and Debt Financing of the Firm                         48
2.11    Asset Utilization and the Value of the Firm        48
2.12    Shareholders Earnings (EPS) and the Firm’s Value           49
2.13    Dividends, Dividends Decision and Value of the Firm           51
2.14    Liquidity and the Firms’ Value                         57
2.15    The Concept of Multiple Discriminant Analysis          58
References                                                                           63
Chapter Three          Research Methodology                            75
3.1      Research Design                                                                   75
3.2      Sources of Data                                                         75
3.3      Sample Size                                                          76
3.4      Sampling Technique                                                           76
3.5      Model Specification                                                             77
3.5.1   Model Justification                                                                    79
3.5.2   Assumptions for Multiple Discriminant Analysis                   80
3.5.3   Explanatory Model Proxies                                                 81
3.6      Techniques of Analysis                                            83
3.6.1   The Correlation Coefficient                                               83
3.6.2Â Â Â The Coefficient of Determination (r2)Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â 84
3.6.3   Durbin Watson (d) Test                                           84
3.6.4   The Student T-test                                               85
References 86
Chapter Four                       Presentation and Analyses of Data         88
4.0      Introduction                                                                                 88
4.1      Data Presentation                                                                  88
4.2      Test of Hypotheses and Analyses of Data                              95
4.2.1   Test of Hypothesis One                                                95
4.2.2   Test of Hypothesis Two                                                     103
4.2.3   Test of Hypothesis Three                                                  112
4.2.4   Test of Hypothesis Four                                      121
4.2.5   Test of Hypothesis Five                                                129
4.2.6   Test of Hypothesis Six                                                 137
References 141
Chapter Five Summary of Findings, Conclusions and Recommendations 142
5.0       Introduction                                                                               142
5.1      Summary of Findings and Policy Implications                     142
5.1.1   Comparison of the Findings with the Objectives of the Study   145
5.2      Conclusion                                                                                  148
5.3      Recommendations                                                                            151
5.3.1   Recommendation for Selected Stakeholders                            152
5.3.2   Recommended Areas for Further Studies                   153
References 154
Appendix 156
Bibliography 278
LIST OF TABLES
Table 4.1 Summary Results of Ratio Analyses for the 28 firm under Study 89
Table 4.2        Summary of Value Parameter Aggregate Values   91
Table 4.3        SPSS Model Summary of Impact of Total Debt Rate on Net Profit Margin on Firm by Firm basis                                       95
Table 4.4        SPSS Aggregate Result of the Impact of Total Debt Rate on Net Profit Margin                                   102
Table 4.5        SPSS Model Summary of Impact of Total Debt Rate on Total Asset Turnover on Firm by Firm basis                                           104
Table 4.6 SPSS Aggregate of Impact of Total Debt Rate on Total Asset Turnover 111
Table 4.7        SPSS Model Summary of Impact of Total Debt Rate on Earnings per Share on Firm by Firm basis                   113
Table 4.8 SPSS Aggregate of Impact of Total Debt Rate on Earnings per Share 120
Table 4.9        SPSS Model Summary of Impact of Total Debt Rate on Dividend per Share on Firm by Firm basis               122
Table 4.10 SPSS Aggregate of Impact of Total Debt Rate on Dividend per Share 128
Table 4.11      SPSS Model Summary of Impact of Total Debt Rate on Current Ratio On Firm by Firm basis                               129
Table 4.12 SPSS Aggregate of Impact of Total Debt Rate on Current Ratio 136
Table 4.13Â Â Â Â Â Â Summary of Result of Multiple Discriminant Analyses138
LIST OF FIGURES
Figure 2.1      Trade-off Theory                                    31
Figure 2.2Â Â Â Â Â Â Â MM proposition 2Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â 37
Figure 4.1       Aggregate Values for Total Debt Rate             92
Figure 4.2       Aggregate value for Net Profit Margin              92
Figure 4.3       Aggregate value for Total Assets Turnover              93
Figure 4.4       Aggregate value for Earnings per Share           93
Figure 4.5       Aggregate Values for Dividend per Share          94
Figure 4.6       Aggregate Values for Current Ratio                94
Figure 4.7       MDA Z-score for the 28 Firms                140
CHAPTER ONE INTRODUCTION
- BACKGROUND OF THE STUDY
The Modigliani-Miller theorem is one of the cornerstones of modern corporate finance. At its heart, the theorem is an irrelevance proposition; the Modigliani-Miller theorem provides conditions under which a firm’s financial mix does not affect its value. No wonder, Modigliani (1980, xiii) explains the theorem as follows:
… with well-functioning market (and neutral taxes) and rational investors,
who can undo the corporate financial structure by holding positive or
 negative amount of debt, the market value of the firm-debt plus equity,
     depends only on the streams of income generated by its assets. It follows,
      in particular, that the value of the firm should not be affected by the share
       of debt in its financial structure or by what will be done with the returns
         paid out as dividend or reinvested (profitably)…
In fact, what is currently understood as the Modigliani-Miller theorem comprises three distinct results from a series of papers (1958, 1961 and 1963). The first proposition establishes that under certain conditions, a firm’s debt-equity ratio does not affect its market value. The second proposition establishes that a firm’s leverage has no effect on its weighted average cost of capital (that is, the cost of equity capital is a linear function of the debt-equity ratio) while the third proposition establishes that the firm’s value is independent of its dividend policy.
Miller (1991:217) succinctly explains the intuition for the theorem with a simple analogy, he says;
…think of the firm as a gigantic tub of whole milk. The
farmer can sell the whole milk as it is, or he can separate
out the cream and sell it at a considerably higher price than
the whole milk would bring…
He continues
…the Modigliani-Miller proposition say that if there were no
costs of separation (and of course, no government dairy
support program), the cream plus the skim milk would bring
the same price as the whole milk…
The essence of Miller’s argument is that, increasing the amount of debt (cream) lowers the ratio of outstanding equity (skim milk) – selling off safe cash flows to debtholders which leaves the firm with more valued equity thus keeping the total value of the firm unchanged. Put differently, any gain from using more of what might be seem to be a cheaper debt is offset by the higher cost of riskier equity. Hence, given a fixed amount of total capital, the allocation of capital between debt and equity is irrelevant because the weighted average of the two costs of capital to the firm is the same for all possible combinations of the two.
Spurred by Modigliani and Miller’s (1958, 1961 and 1963) arguments, that in an ideal world without taxes a firm’s value is independent of its debt-equity mix, economists have sought conditions under which the financial structure of the firm would matter. Economic and financial theories suggest that several factors influence the debt-equity mix such as differential taxation of income from different sources, informational asymmetries, bankruptcy cost/risks, issues of control and dilution and the agency problem (see Hart, 2001).
Thus, in line with the above, the question now is? Do corporate financing decisions affect firm’s value? How much do they add and what factor(s) contribute to this effect? An enormous research effort, both theoretical and empirical has been devoted towards sensible answers to these questions since the works of Modigliani and Miller (1953, 1961, and 1963). Several foreign and local scholars have theoretically and empirically studied the impact of the firm’s financial mix on the value of the firm from different perspective (see, Jensen and Meckling, 1976; Jensen, 1986; Fama and Miller, 1972; Myers, 1977; Miller and Scholes, 1978; Elton and Gruber, 1970; among others).
In fact, Elton and Gruber (1970) studied the link between taxes, financing decisions and firm value and found that personal taxes make dividend less valuable that capital gain and stock prices fall by less than the full amount of the dividend on ex-dividend days. Fama and Miller’s (1972) study on the financial structure of the firm was on leverage and they argue that leverage (debt finance) can increase the incentive of the stockholders to make risky investment that shift wealth from bondholders but do not maximize the combined wealth of security holders, thus, value is not created. Jensen and Meckling (1976) evaluating financial structure from the agency cost model submit that higher leverage allow managers to hold a larger part of its common stock thereby reducing agency problem by closely aligning the interest of the managers and other stockholders, thus asserting that since the interest of stockholders are protected, value is created. In another paper by Jensen (1986), he said leverage (debt finance) used by the firm enhances value by forcing the firm to pay out resources that might otherwise be wasted on bad investment by managers.
Myers (1977) argues that leverage (debt finance) can make firms to under invest because the gains from investment are shared with the existing risky bonds of the firm. In effect, the agency effect of financing decision work through profitability and can make firms to take better or worse investments and to use assets more or less efficiently. Miller (1977) re-evaluating earlier MM theories on financial structure argues that if common stock is priced as tax free but personal tax rate built into the pricing of the stock, corporate interest payment is then the corporation tax rate. Hence, the tax shield at the corporate level is offset by taxes on interest at the personal level thus debt does not affect firm value. He therefore submit that if there are two firms with the same earnings, before interest and taxes, the more levered firm’s higher after-tax earnings are just offset by the higher personal taxes paid by its bondholders. Therefore, given pre-tax earnings, there is no relationship between debt and value.
In Nigeria, some empirical studies have been done in this area of corporate finance and its effect on the value of the firm. Among such was Ezeoha (2007) who examine the impact of major firm characteristics on the financial leverage of quoted companies in Nigeria and used panel data from 71 quoted Nigeria companies, for 17 years period (1990 – 2006). The result showed that the relationship between corporate ownership and financial leverage was positive across the proxies but more significant within the classes of foreign and indigenous firms. The relationship with asset tangibility was found to be non significant and negative, using total debt ratio or short term debt ratio as the dependent variable. It was also seen from the research study that the relationship between leverage and profitability was significant and negative (see Ezeoha, 2007)
Also, Adelegan (2007) examine the effect of taxes on business financing decisions and firm value in Nigeria. The study which analyses 85 manufacturing firm in Nigeria from 1984 to 2004 found that dividend and debt covey information about profitability of the firm. This information obscures any tax effect of financing decision. However, there was evidence that earnings and investment were key determinants of the firms’ value in Nigeria. The study also found positive relationship between dividend and value and negative relationship between debt and value in firms examined.
Though, there have been studies in this area of corporate finance in Nigeria, However, most have clustered around the estimation of corporate cost of capital (Inanga 1987, Adelegan, 2001) determinants of dividend decisions (Inanga, 2001; Odedekun, 1995), and financing decision (Adelegan, 2007; Ariyo 1999; Ezeoha, 2007). To the best of the researcher’s knowledge, no study has been carried out using firms’ value parameters to study its’ impact on the value of the firm adopting the bankruptcy model. This is a gap which this study attempts to fill. The essence is to determine from an investors’ or potential investor’s point of view whether value parameters from the financial statements and accounts of quoted firms in Nigeria are affected by the use of debt in the financial mix and the overall impact of debt financing on the value of selected firms taking into account the cost of debt which is bankruptcy.
