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BySULEIMAN, Hamisu Kargi

PhD/ADMIN/11934/2008-2009

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Successful firms usually achieve growth

through increase in sales which requires thesupport of increased investments.

To achieve expected growth a firm has toraise funds through various sources and the

financial manager should decide when, whereand how to acquire such funds to meetinvestment need.

Decisions must be made about the use of

internal or external funds, the use of debts orequity and the use of short-term or long-term financing and/or their combination.

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Capital structure represents the mix of the

various debt and equity used in financing firmsoperation.

A firm can choose among many alternativecapital structures. It can either issue a large

amount of debt or it can issue very little debt. However, the optimal capital structure is the set

of proportions that maximizes the total value ofthe firm.

Therefore, decisions concerning the proportion

of debt and equity are quite challenging for themanagement of a firm because a wrong decisionmay lead to financial distress and eventually tobankruptcy.

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A number of theories have been advanced inexplaining the capital structure of firm. Thetheory of capital structure was earlierdeveloped by Modigliani and Miller (1958).

They argue that in the absence of corporate

taxes and other market imperfections, thetotal value of the firm and its cost of capitalare independent of capital structure.

Since the seminal Modigliani and Miller

(1958) irrelevance propositions, financialeconomists have developed a number oftheories in which the capital structure choicebecomes relevant.

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The pecking order theory developed by Myersand Majluf (1984) and Myers (1984) does notpredict an optimal capital structure.

The theory predicts a strict preference of

corporate financing, in which investments arefinanced by internal funds first, then by low-risk debt and hybrid securities such asconvertibles, and equities as the last resort.

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The trade-off theory, based on research ontaxes (Modigliani and Miller, 1963) andbankruptcy and financial distress costs(Warner, 1977) and the insights from theagency literature (Jensen and Meckling,

1976), suggests that firms have a uniqueoptimal capital structure that balancesbetween the tax advantage of debt financing(i.e. debt tax shields), the costs of financial

distress and the agency benefits and costs ofdebt (Bradley et al., 1984, Leary and Roberts,2005 and Strebulaev, 2007).

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Market timing is another theory of capitalstructure brought up by Baker and Wurgler(2002). As claimed by its proponents in theUnited States between 1968 and 1999, Baker

and Wurgler find out that firms preferexternal equity when the cost of equity is low,and prefer debt vice versa.

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In Nigeria Adesola (2009) tested the static

trade off theory against pecking order theoryand establish the presence of pecking ordertheory.

However, the result is inconclusive about

which of the two theories exerts the mostdominant effect on the capital structure ofNigerian quoted firms during the period ofthe study.

This might be because the study is testingone theory against the other and is crosssectional in nature.

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Despite these theoretical appeals to capitalstructure, academicians and researchers havenot yet agreed on specific method thatcorporate managers can use in order to attainan optimal capital structure.

This may be because of the fact that theories

of capital structure differ in their relativeemphases. For example, the trade-off theoryemphasizes taxes and the pecking ordertheory emphasizes information asymmetry.

How successful are these theories inexplaining the time-series patterns offinancing activities?

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The lack of footing for predicting the longrun effect of a specific financing mix makesthe financial decision more difficult in manyways than both the investment and dividend

decisions.

Does the pecking order theory explain thecapital structure of Nigerian corporations?Which financing option best explain thecapital structure decisions in Nigeria?

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The purpose of the study is to examine theevidence of the pecking order hypothesis.

The study primarily addresses the issue ofhow robust the pecking order hypothesis is inexplaining capital structure of conglomeratefirms in Nigeria.

It was hypothesised that pecking order theory

has no significant impact in explaining thecapital structure of conglomerate firms inNigeria.

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Some studies have examined how well the

pecking order hypothesis actually fit. Baskin(1989) and Shyam-Sunder and Myers (1999)tested a number of predictions of the peckingorder hypothesis and argued that their resultswere consistent with the theory.

Moreover, the findings of Adesola (2009),Sheikh and Wang (2010) and Chang et al

(2010) are in support of the theory.

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However, Fama and French (2005) examinedmany individual financing decisions of firmsand find that these decisions are often inconflict with many of the important

predictions of the pecking order hypothesis.For example, equity is supposed to be thelast financing alternative, yet Fama andFrench observe that most firms issue somesort of equity every year.

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The study utilises data from secondarysources (Fact Books and annual reports) inrespect of six firms quoted as conglomerateon the Nigerian Stock Exchange.

The firms selected have sufficient data for thestudy.

Data collected include total asset, equity,

debt and preceding year retained earnings ofthe sampled firms which relate to eight yearsfinancial periods from 2002 to 2009.

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The study adopts Watson and Wilson (2002)model in analysing the data collected. Themodel was based on Ordinary Least Square(OLS) method in estimating the parameter of

the model.

Watson and Wilson (2002) use the model toprovide the evidence to support the PeckingOrder theory.

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The model specify that;

TA=f(RE, Debt and Equity)

The model is thus;

(TAit-TAit-1)/TAit-1 = + 1(Pit-Divit-1)/TAit-1

+ 2(Dit-Dit-1)/TAit-1 + 3(EIit)+vit

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If the theory holds, the followingrelationship should be observe for , whichis 1>2>3.

This relationship might imply that the sourceof financing has a priority: first from a firmsretained earnings, then debt issuance, and

equity issuance falling at the bottom.

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The result estimated multiple regression model of total assetgrowth thus;

(TAit-TAit-1)/TAit-1 = -0.162 + 0.378(Pit-Divit-1)/TAit-1 + 0.611(Dit-Dit-1)/TAit-1 + 1.678(EIit)+vit

The observed relationship for in the result shows that

3>1>2. The result shows the coefficient of new equity issuance

(EQ) [1.678] is larger than the slope coefficients ofretained earnings (RE) [0.378] and debt issuance (D)[0.611].

-.162 .297 -.545 .589

.378 .409 .174 .923 .361

.611 1.547 .050 .395 .695

1.678 .760 .416 2.207 .033

(Constant)

RetainedEarnings

Debt

Equity

Model

1

B Std. Error

Unstandardized

Coefficients

Beta

Standardized

Coefficients

t Sig.

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the coefficient of multiple determination R2(adjusted R2) of 0.312 (0.266) indicates thatabout 31.2% or exactly 26.6% variations in theobserved behaviour of the total asset growthis jointly explained by all the threeexplanatory (independent).

The DW statistic is 1.967, approximately 2.0indicates that there is no first order

autocorellation, either positive or negative.The result of the estimates is thereforereliable for prediction and need notransformation of the original model.

.559a .312 .266 1.46798 1.967

Model

1

R R Square

Adjusted

R Square

Std. Error of

the Estimate

Durbin-

Watson

Predictors: (Constant), Equity, Debt, RetainedEarningsa.

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The calculated F- statistic is greater than thetable F- statistic (i.e 6.664 > 4.31), thereforethis shows the regression is significant at 1%

level. Base on the findings, the null hypothesis

which state that pecking order theory has nosignificant impact in explaining the capitalstructure of conglomerate firms in Nigeria isrejected.

43.085 3 14.362 6.664 .001a

94.818 44 2.155

137.903 47

Regression

Residual

Total

Model

1

Sum of

Squares df Mean Square F Sig.

Pre dictors: (Constant), Equity, Debt, RetainedEarningsa.

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The analysis though has overall significanceindicate that only equity tracks the firmsfinancing deficit better than retained earningsand debt. Equity has the most significant

coefficient in the model. The findingscontradict the pecking order theorydeveloped by Myers and Majluf (1984) inpredicting the capital structure ofconglomerate firms in Nigeria.

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The findings of the study did not support the

pecking order hypothesis as the primaryfinancing theory for conglomerate firms inNigeria. Firms in this sector finance theirdeficit mainly with equity issuance, theopposite of what would be expected underthe hypothesis.

This choice exposes the firms to certain risksuch as dilution of ownership. However, dueto information asymmetry Nigerian investors

prefer immediate return in form of dividendthan having earnings retained to financefuture expansion

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The study support the position of Fama andFrench (2005) that most firms issue somesort of equity every year

The result of the study contradicts thefindings of Shyam-Sunder and Myers (1999),Adesola (2009), Sheikh and Wang (2010) andChang et al (2010).

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Base on the findings, it can be concluded that

the explanatory variables have gooddescription of financing policies ofconglomerate firms in Nigeria and hassignificant impact to the growth of the firms

but not in accordance with the pecking ordertheory. The findings contradict the theory. In accordance with this conclusion,

shareholders should be enlightened on the

importance of having earnings retained giventhat it is the cheapest means of financing andwithout external scrutiny.

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However, proper corporate governance isneeded to avoid agency problems as a resultof information asymmetry.

Capital market in Nigeria should berestructured for channelling debt capital atlow cost and, to remove informationasymmetries between firm managers,investors and the market. This will eliminateimperfections, improve investors confidenceand integrity of the system.

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THANKS FOR YOURAUDIENCE!