IMPACT LEVERAGE HAS ON SHAREHOLDERS
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1.1 BACKGROUND TO THE STUDY
The general problem all business entity face in Nigeria is the choice of finance. Firms at every stage of growth and development, from commencement to maturity need fund in order to survive. The aim of every business is to maximize the wealth and welfare of its owners. Without finance, the aim of all business cannot be met. As such, finance can be said to be the life wire of any firm without which there can be no survival. Financing is the acquisition of cash or other assets through means such as the sale of stocks, retaining net profit and increasing of debt. A firm’s capitalization consists of internally generated funds and due to the fact that a company may not be able to raise all the funds which it requires internally, it may depend on additional external financing, this bringing about leverage. The capitalization of the firm would therefore incorporate both internally generated funds and external funds. Due to the composition of these two sources of fund for the firm, there is a need to strike a balance between them. This balance is called the optimal capital structure. This is the appropriate use of debt and equity that minimizes the firm’s cost of capital and maximizes firms’ value. It should however be borne in mind that a non-optimal capital structure or lack of optimal debt and equity mix may lead to higher financing costs and the firm may reject some capital budgeting projects that would have increased shareholders’ wealth with an optimal financing.
The need for optimal capital structure will be for the firm to enjoy tax shield and reduce bankruptcy cost. In their seminal article, Modigliani and Miller (1958 and 1963) demonstrate that, in a frictionless world, financial leverage is unrelated to value, but in a world with tax-deductible interest payments, firm value and capital structure are positively related since interest payment from debt help to reduce corporate tax.
Leverage therefore is greatly considered when investment is being undertaken by investors. By this, investors prefer a firm that is less levered than one that is highly levered. However, the level of activity that can take place in a firm depends on the level of activity that goes on in the sector in which the firm operates as well as the financial strength of the firm. Leverage has a direct effect on the activity of the firm and as such will be greatly considered during the planning of the financial policy of the organization.
1.2 STATEMENT OF THE PROBLEM
Empirical studies tends to be less interested on how leverage determines shareholders value per se, and more on how changes in the capital structure of a company affects value (Hitt, Hoskisson, and Harrison, 1991), and thus its overall performance (Jensen, 1986).
Shareholders values vary with different level of debt usages. Shareholder values increase with increase of debt until the marginal benefits from leverage equal to the marginal bankruptcy costs, at this point, the Shareholders value reaches its maximum level, if we further increase the level of debt usages, Shareholders’ values not only increases but also decrease as per the trade-off theory as said by Jensen and Meckling (1976). As such, there is need to study the relationship that exists between these two phenomenons which are financial leverage and shareholders’ value. In the case of Nigeria, scanty of research has been done to investigate the relationship between financial leverage and shareholders’ value. The question of whether or not financial leverage has any impact on the value of shareholders of construction companies listed on the Nigerian stock exchange remains unanswered. This study is intended to provide answer to this question.
1.3 OBJECTIVE OF THE STUDY
This research aims at studying the impact leverage has on shareholders’ value of listed construction companies in Nigeria. Specifically, the objectives of the research are:
- To assess the relationship between debt ratio and net asset per share.
- To assess the relationship between debt ratio and Return on Equity.
- To assess the relationship between debt ratio and earnings per share.
1.4 SCOPE OF THE STUDY
This research focus on the construction companies listed on the Nigerian Stock Exchange (NSE). There are nine construction companies listed on NSE. However the research did not cover all the listed construction firms, this was due to insufficiency in terms of data of those companies for the period covered. From the survey carried out in obtaining data at the time of this study, five construction firms had data which were sufficient enough for the study. The period covered in the study runs from 2010 to 2014. All data used for the study were extracted from the financial statement of the selected firms and those financial statements were obtained directly from the NSE library.
1.5 SIGNIFICANCE OF THE STUDY
In a bid to make policies relating to capital structure through knowledge of the effect of financial leverage on the shareholders’ value of firms, this research will be useful to the government in making policies on finance that aim at protecting potential and existing investors.
In order to maintain competitive positions and add value to their companies, today’s financial managers need to make critical business, financial and investment decisions which lead to the long-run maximization of the shareholders’ wealth. This study is foreseen to respond to the need of management to know the impact financial leverage has on shareholders’ value and also help financial analyst when giving financial advices on issue pertaining to capital structure.
The scholars and Academicians; as new challenges and opportunities emerge in the business environment, change is inevitable. This calls for continuous research to ascertain the actual situations rather than living on assumptions. As such, this study will be useful for further research on this subject matter.
1.6 PLAN OF THE STUDY
This research is organized into five chapters.
Chapter one provides a brief background on the overall research, statement of the problem, research questions, Objective, scope and the significance of this study. Chapter two reviews the theoretical, methodological, and empirical literatures on leverage and capital structure. For the purpose of clarity, the empirical literature was presented on a table. Chapter three discusses the method and data used for this research. The focus of this chapter is on how the research was conducted in order to derive the findings and conclusions. The research process focuses on sources of data; method of data collection and method of data analysis. In chapter four, the findings of the research are discussed. This is a very essential part of the research as it explains the findings according to the objectives stated in chapter one.
Chapter five concludes the research and gives a summary of the study as well as some recommendations for future research.
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