In an attempt to examine the effect of financial structure on corporate performance of listed non-financial service firms in Nigerian Stock Exchange, this research work adopted the model of Shubita and Alsawalhah (2012) with slight modifications. In their model, the researchers postulated financial performance as a function of short term debt to total assets, long term debt to total assets and total debt to total assets.
They also included two control variables namely size and sales growth.
To examine the effect of financial structure on return on assets, return on equity, net profit margin as well as gross revenue of quoted non-financial service firms, the multivariate model below was estimated.
Specifically, the model is adopted to incorporate the four financial performance measures (return on assets, return on equity, net profit margin and gross revenue) and the three financial structure proxies (total debt to total assets, total debt to total equities and short term debt to total assets) and taking into consideration that financial
57 performance measures will be regressed on the financial structure variables, equation 3.1 was re-casted as:
Model 1
Model 2
Model 3
Model 4
Where:
ROA is return on assets: It measures the overall effectiveness of management in generating profits with its available assets. This ratio is often referred to as return on investment. Financial structure affects the performance of an organization. On the standpoint of the pecking order theory, more profitable firms will have less debt because retained profits are available for financing growth opportunities. These firms build their equity relative to their debt. Return on assets as applied in this research work was calculated by dividing the firms‘ operating profit (earnings before interest and taxes) by total assets. Mwangi and Birundi (2015), Zaroki and Rouhi (2015) and Javed, Younas and Imran (2014) have applied this return on assets as a corporate performance measure.
ROE is return on equity: This refers to the return earned on the ordinary shareholders‘ investment in the firm. The return on equity points out the efficiency of using the own capital of the company; that is why its level is important primarily for
58 shareholders, who may thus determine whether the remuneration they get rewards the risk assumed. The actual cost of debt to the firm is the after-tax cost of debt, which is the market interest rate less the marginal tax rate proportion. The use of debt therefore reduces the amount of tax to be paid by a firm and increases the return to shareholders whilst the use of equity does not enjoy such a benefit. The return on equity used in this research was expressed as a percentage and calculated by dividing profit before interest and tax by owner‘s capital. Soumadi and Hayajneh (2015), Tauseef, Lohano and Khan (2015) and Fimani and Moghadam (2015) applied this measurement of firm performance.
NPM is net profit margin: This accounting based performance measure can be tagged as forward looking because profit for the period is measured against sales for the current period. Profit margin is calculated as profit after tax divided by turnover or net sales. The essence is that it provides information on the percentage of profit that sales are able to generate. San and Heng (2011), Pratheepkanth (2011) and Mohammadzadeh, Rahimi, Rahimi, Aarabi and Salamzadeh. (2013) have utilized profit before tax as an indicator for performance of firms.
GRV is gross revenue growth: Gross revenue is accounting measure that determines the total revenue of a firm before any deduction or allowances, as for rent, cost of goods sold, taxes, etc. are made. Firms with high sales due to economies of scale have high revenue and greater need for fund, internal fund via retained earnings are likely to exhausted, hence need for external fund. Revenue growth from sales is positively related with financial structure. Bevan and Danbolt (2002), Chen and Chen (2011) and Rajan and Zingales (1995) applied this indicator in determining the effect of financial structure on corporate performance.
59 TDTA is the ratio of total debt to total assets: This is a financial structure variable.
It measures the proportion of total assets financed by a firm‘s creditors. The higher this ratio, the greater the amount of debt used to generate profits. Total debt to total assets ratio was calculated by dividing total debt by total assets. Khanam, Nasreen and Pirzada (2014), Bokhari and Khan (2013) and Ebrati, Emadi, Balasang and Safari (2013) utilised it in their works.
TDTE is the ratio of total debt to total equity: Debt to equity ratio represents the debt ability on the equity. If the debt increases than the equity then it will show that your firm is more risky. This ratio could be used as a control tool for managers to reduce waste of cash flows in inefficient activities. According to the company‘s commitment to pay interest at specified times and also repay the debt securities, managers try to increase efficiency and performance. Debt to equity ratio was adopted in the studies of Bandt, Camara, Pessarossi and Rose (2014), Oguna (2014) and Shubita and Alsawalhah (2012).
STDTA is the ratio of short term debt to total assets: Short term debt refers to liabilities that are due to be paid within one accounting year. In order to determine whether a firm will be able to meet its short-term debt obligation, accounting metric called a debt ratio is used. Myers (2001) noted that firms with high short term debt to total asset have a high growth rate and high performance as short- term debt is cheaper than the long-term debt. Short term debt to total assets was calculated by dividing short term liabilities by total assets. Hassan et al (2014) and Shubita and Alsawalhah (2012) used it in their research.
TANG is tangibility: Tangibility is critical for a firm to perform efficiently. A firm with more tangible assets can use them as collateral for debts and can reduce the lenders‘ risk. It is a control variable and is measured by dividing the total fixed assets
60 to total assets of the firms. Mwangi and Birundi (2015), Zaroki and Rouhi (2015) have utilized this index
FMS is firm size: Firm size as applied in this study is the natural logarithm of firm‘s total assets. The larger the firm size the greater the performance as the risk of bankruptcy is lesser in larger firms compared to smaller firms. Bandt, Camara, Pessarossi and Rose (2014) used this index.
GRT is growth opportunities: As the firms grow, their requirement of finance tends to increase. The capacity to finance the increasing demand depends on internal finance. If a firm entirely relies on internal fund, then the growth may be restricted.
Managers may forgo some profitable projects. If a firm goes for external finance, then chances of risk increases. Myers (1977) argues that firms with growth potential will tend to have less capital structure. Growth is likely to put a strain on retained earnings and push the firm into borrowing. The growth opportunities was reflected by percentage changes in firm‘s turnover. Boroujeni, Noroozi, Nadem and Chadegani (2013) used this variable.
RISK is firm risk: It is the deviation of an actual outcome from the expected outcome in the presence of uncertainty. The possibility of suffering damage or loss in the face of uncertainty about the outcome of an action, future events or circumstances.
The more risk a firm face the more it is prone to financial distress. Risk in this work is expressed as the ratio of net profit to total asset. This indicator has been applied by Bokhari and Khan (2013) and Ebrati, Emadi, Balasang and Safari (2013).
TAX is tax: This is the amount of profit paid as corporate tax by firms. If the tax rate is high firms‘ may retained earnings may be negatively affected which in turn impact on their performance. Bandt, Camara, Pessarossi and Rose (2014) and Shubita and Alsawalhah (2012) have applied this surrogate.
61 to are the coefficient of the explanatory and control variables and is the error term. It has a zero means, constant variance and non-auto correlated.