By
SULEIMAN, Hamisu Kargi
PhD/ADMIN/11934/2008-2009
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Successful firms usually achieve growth
through increase in sales which requires the
support of increased investments.
To achieve expected growth a firm has to
raise funds through various sources and the
financial manager should decide when, where
and how to acquire such funds to meet
investment need.
Decisions must be made about the use of
internal or external funds, the use of debts or
equity and the use of short-term or longterm financing and/or their combination.
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Capital structure represents the mix of the
various debt and equity used in financing firm’s
operation.
A firm can choose among many alternative
capital 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 of
the firm.
Therefore, decisions concerning the proportion
of debt and equity are quite challenging for the
management of a firm because a wrong decision
may lead to financial distress and eventually to
bankruptcy.
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A number of theories have been advanced in
explaining the capital structure of firm. The
theory of capital structure was earlier
developed by Modigliani and Miller (1958).
They argue that in the absence of corporate
taxes and other market imperfections, the
total value of the firm and its cost of capital
are independent of capital structure.
Since the seminal Modigliani and Miller
(1958) irrelevance propositions, financial
economists have developed a number of
theories in which the capital structure choice
becomes relevant.
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The pecking order theory developed by Myers
and Majluf (1984) and Myers (1984) does not
predict an optimal capital structure.
The theory predicts a strict preference of
corporate financing, in which investments are
financed by internal funds first, then by lowrisk debt and hybrid securities such as
convertibles, and equities as the last resort.
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The trade-off theory, based on research on
taxes (Modigliani and Miller, 1963) and
bankruptcy and financial distress costs
(Warner, 1977) and the insights from the
agency literature (Jensen and Meckling,
1976), suggests that firms have a unique
optimal capital structure that balances
between the tax advantage of debt financing
(i.e. debt tax shields), the costs of financial
distress and the agency benefits and costs of
debt (Bradley et al., 1984, Leary and Roberts,
2005 and Strebulaev, 2007).
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Market timing is another theory of capital
structure brought up by Baker and Wurgler
(2002). As claimed by its proponents in the
United States between 1968 and 1999, Baker
and Wurgler find out that firms prefer
external 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 theory
and establish the presence of pecking order
theory.
However, the result is inconclusive about
which of the two theories exerts the most
dominant effect on the capital structure of
Nigerian quoted firms during the period of
the study.
This might be because the study is testing
one theory against the other and is cross
sectional in nature.
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Despite these theoretical appeals to capital
structure, academicians and researchers have
not yet agreed on specific method that
corporate managers can use in order to attain
an optimal capital structure.
This may be because of the fact that theories
of capital structure differ in their relative
emphases. For example, the trade-off theory
emphasizes taxes and the pecking order
theory emphasizes information asymmetry.
How successful are these theories in
explaining the time-series patterns of
financing activities?
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The lack of footing for predicting the long
run effect of a specific financing mix makes
the financial decision more difficult in many
ways than both the investment and dividend
decisions.
Does the pecking order theory explain the
capital structure of Nigerian corporations?
Which financing option best explain the
capital structure decisions in Nigeria?
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The purpose of the study is to examine the
evidence of the pecking order hypothesis.
The study primarily addresses the issue of
how robust the pecking order hypothesis is in
explaining capital structure of conglomerate
firms in Nigeria.
It was hypothesised that pecking order theory
has no significant impact in explaining the
capital structure of conglomerate firms in
Nigeria.
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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 pecking
order hypothesis and argued that their results
were 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) examined
many individual financing decisions of firms
and find that these decisions are often in
conflict with many of the important
predictions of the pecking order hypothesis.
For example, equity is supposed to be the
last financing alternative, yet Fama and
French observe that most firms issue some
sort of equity every year.
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The study utilises data from secondary
sources (Fact Books and annual reports) in
respect of six firms quoted as conglomerate
on the Nigerian Stock Exchange.
The firms selected have sufficient data for the
study.
Data collected include total asset, equity,
debt and preceding year retained earnings of
the sampled firms which relate to eight years
financial periods from 2002 to 2009.
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The study adopts Watson and Wilson (2002)
model in analysing the data collected. The
model was based on Ordinary Least Square
(OLS) method in estimating the parameter of
the model.
Watson and Wilson (2002) use the model to
provide the evidence to support the Pecking
Order theory.
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The model specify that;
TA=f(RE, Debt and Equity)
The model is thus;
(TAit -TAit-1)/TAit-1 = Σβ + β1(Pit -Divit-1)/TAit-1
+ β2(Dit -Dit-1)/TAit-1 + β3(EIit)+vit
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If the theory holds, the following
relationship should be observe for β, which
is β1>β2>β3.
This relationship might imply that the source
of financing has a priority: first from a firm’s
retained earnings, then debt issuance, and
equity issuance falling at the bottom.
Model
1
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(Constant)
RetainedEarnings
Debt
Equity
Unstandardized
Coefficients
B
Std. Error
-.162
.297
.378
.409
.611
1.547
1.678
.760
Standardized
Coefficients
Beta
.174
.050
.416
t
-.545
.923
.395
2.207
Sig.
.589
.361
.695
.033
The result estimated multiple regression model of total asset
growth thus;
(TAit -TAit-1)/TAit-1 = -0.162 + 0.378(Pit -Divit-1)/TAit-1 + 0.611(Dit -Dit1)/TAit-1 + 1.678(EIit)+vit
The observed relationship for β in the result shows that
β3>β1>β2.
The result shows the coefficient of new equity issuance
(EQ) [1.678] is larger than the slope coefficients of
retained earnings (RE) [0.378] and debt issuance (D)
[0.611].
Model
1
R
.559a
R Square
.312
Adjusted
R Square
.266
Std. Error of
the Estimate
1.46798
DurbinWatson
1.967
a. Predictors: (Constant), Equity, Debt, RetainedEarnings
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the coefficient of multiple determination R2
(adjusted R2) of 0.312 (0.266) indicates that
about 31.2% or exactly 26.6% variations in the
observed behaviour of the total asset growth
is jointly explained by all the three
explanatory (independent).
The DW statistic is 1.967, approximately 2.0
indicates that there is no first order
autocorellation, either positive or negative.
The result of the estimates is therefore
reliable for prediction and need no
transformation of the original model.
Model
1
Regression
Residual
Total
Sum of
Squares
43.085
94.818
137.903
df
3
44
47
Mean Square
14.362
2.155
F
6.664
Sig.
.001a
a. Predictors: (Constant), Equity, Debt, RetainedEarnings
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The calculated F- statistic is greater than the
table F- statistic (i.e 6.664 > 4.31), therefore
this shows the regression is significant at 1%
level.
Base on the findings, the null hypothesis
which state that pecking order theory has no
significant impact in explaining the capital
structure of conglomerate firms in Nigeria is
rejected.
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The analysis though has overall significance
indicate that only equity tracks the firm’s
financing deficit better than retained earnings
and debt. Equity has the most significant
coefficient in the model. The findings
contradict
the
pecking
order
theory
developed by Myers and Majluf (1984) in
predicting
the
capital
structure
of
conglomerate firms in Nigeria.
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The findings of the study did not support the
pecking order hypothesis as the primary
financing theory for conglomerate firms in
Nigeria. Firms in this sector finance their
deficit mainly with equity issuance, the
opposite of what would be expected under
the hypothesis.
This choice exposes the firms to certain risk
such as dilution of ownership. However, due
to information asymmetry Nigerian investors
prefer immediate return in form of dividend
than having earnings retained to finance
future expansion
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The study support the position of Fama and
French (2005) that most firms issue some
sort of equity every year
The result of the study contradicts the
findings of Shyam-Sunder and Myers (1999),
Adesola (2009), Sheikh and Wang (2010) and
Chang et al (2010).
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Base on the findings, it can be concluded that
the
explanatory
variables
have
good
description
of
financing
policies
of
conglomerate firms in Nigeria and has
significant impact to the growth of the firms
but not in accordance with the pecking order
theory. The findings contradict the theory.
In
accordance
with
this
conclusion,
shareholders should be enlightened on the
importance of having earnings retained given
that it is the cheapest means of financing and
without external scrutiny.
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However, proper corporate governance is
needed to avoid agency problems as a result
of information asymmetry.
Capital market in Nigeria should be
restructured for channelling debt capital at
low cost and, to remove information
asymmetries
between
firm
managers,
investors and the market. This will eliminate
imperfections, improve investors’ confidence
and integrity of the system.
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