Gusau Journal of Accounting and Finance, Vol. 2, Issue 1, April, 2021 1 Gusau Journal of Accounting and Finance (GUJAF) Vol. 2 Issue 1, April, 2021 ISSN: 2756-665X A Publication of Department of Accounting and Finance, Faculty of Management and Social Sciences, Federal University Gusau, Zamfara State -Nigeria Gusau Journal of Accounting and Finance, Vol. 2, Issue 1, April, 2021 2 DETERMINANTS OF CAPITAL STRUCTURE IN NIGERIAN LISTED MANUFACTURING FIRMS: A PANEL GENERALIZED METHOD OF MOMENTS (GMM) APPROACH USMAN, Onozare Safiya Balogun John Eshemokhai corresponding author balogunjohnascon@gmail.com Department of Accounting Nigerian Defence Academy, Kaduna, Kaduna State. Abstract In the present day, no large firm especially manufacturing industry has the wherewithal to single handedly finance its operation. Thereby, financing its operation through equity and debt financing become concerning. Despite these, there has been silence on the role play by audit committee on the need for capital structure. Therefore, the study examined the determinants of capital structure in Nigerian manufacturing listed firms using a Generalized Method of Moments (GMM) technique. The result from the GMM discovered that profitability, firm growth and audit committee were directly related to capital structure with their t-statistics (1.8821), (2.4549) and (1.9643) greater than t-values (t0.1= 1.645) and (t0.05 = 1.962) respectively. Also, liquidity ratio exhibited an inverse relationship but non-significance. Therefore, it was concluded that profitability, firm growth and audit committee were the major determinants of capital structure of listed manufacturing firms in Nigeria. It was recommended that Nigerian manufacturing industries especially the quoted firms should consider the feasibility study as carried out by audit committee before deciding on their choice of deb, equity or both. Also, the industries should embrace pecking order theory as propounded by Donaldson during the off-season period to reduce the severity of loan due to unforeseen circumstance. Key words: Capital structure, profitability, firm growth, audit committee, Generalized Methods of Moments (GMM) 1. Introduction Capital determines the extent at which an organization especially manufacturing firm could meet its customers’ demand. As organization grows, more capital is needed to expand production, meet customers and speculative needs which all together determine profitability. Due to its importance every financial manager in a firm especially a large firm like manufacturing industry is required to use financial expertise to determine the least cost of the combination of debts and equity to financial firm’s operation for a firm. Given this, Lawal, Edwin, Monica and Adisa (2014) stress that main core function of a financing manager in a firm is to identify the most cost-effective financing method of debts and equity that could be used to finance business operation. The combination of debt and equity used in financial operation is known as capital structure. According to Abdul, John and Idachaba (2019), capital structure is the amalgamation of firms’ debt and equity used in financing business and growth. Cengiz, Yunus and Sukriye (2013) remark that both old and new established business need funds to carry out their business activities. One importance fact about capital structure is that it enables firm to finance itself through equity, debts and securities. The growth in Nigerian manufacturing sectors has been small in the last five decades compared to other Sub-Sahara African countries like South African and Botswana. The growth in the sector to gross domestic product GDP has remained 1-digit value over the last five decade compared to other African countries with 2-digit value. For instance, the sector alone contributed 7.87% Gusau Journal of Accounting and Finance, Vol. 2, Issue 1, April, 2021 3 overall to GDP from 2001-2018 (Central Bank of Nigeria, 2018). Nigerian manufacturing industries is lagging behind in term of resource to perform optimal. In view of this, Falade, Aladejana, and Oluwalana (2018) remark that industries in Nigeria need resources to increase production capacity that have capacity to accelerate economic growth and development to an optimal level. Listed manufacturing industries in the country is not exempted from this also. In line with this, Abdul, et, al. (2019) remark that capital structure is very critical and fundamental in business operation because it determines its profit maximization, sustainability and attainment of the overall business’ objectives. Also, Musah (2018) maintains that capital structure is extremely important for a firm as a result of the ability of the firm to meet its stakeholders’ requirements. Despite these, there has been silence on the role play by audit committee on the need for capital structure. There is need for this because the audit committee often determines the financial stands of an organization; therefore, gives information on the needs for either loan or equity or both for organization. Given this, Joe and Kechi (2011) remark that corporate governance deals with day-to-day running of an organization in a way that give assurance to shareholders’ return on their respective investment and expected expectations. Therefore, the silence on the audit committee role as determinant of capital structure especially among listed manufacturing industries in Nigeria in literature, signaled a dire need for this study to examine the determinants of capital structure in Nigerian manufacturing listed firms using a Generalized Method of Moments (GMM) technique. According to Alfred (2007), capital structure is the percentage of both debt and equity acquired by an organization. Kennon (2010) defined it as percentage of capital (money) at work in a business. Also, Abdul, et al. (2019) see it as amalgamation of firms’ debt and equity used in financing business and growth. In this context, capital structure is the combination of debt and value of shared issued by a firm to finance its operation. Given this, Chechet and Olayiwola (2014) emphasized on its importance and note that both old and new established business need funds to carry out their business activities. Also, among its importance is that it helps organization to meet its stakeholders’ requirements. Akinsurile (2008) remarks that capital structure consists of debt capital, ordinary share capital and preference share capital that all together server as debts and equity used by an organization to finance its operations. Thus, when organization combine debt and equity for the purpose of value maximization it serves as the optimal capital structure. Gatsi and Akoto (2010) made it known that crucial strategic choice that is often made by corporate managers is the choosing of a firm’s capital structure. Inanga and Ajayi (1999) classified various capital structure of a firm into preference capital, equity capital and long-term loan (debt) capital. Preference Capital involves the use of the type of capital structure that is raised vie the issue of preference capital. According to Adeyemi and Oboh (2011) preference share is the combined debentures and equity features that firm benefit in the capital market. In addition, capital equity deals with all share premium, reserves, share-capital and surpluses that are retained by a firm. Also, equity capital involves both firm’s contributed capital and retained earnings. The contributed capital involves funds that are invested in the business in exchange for shares of stock or ownership while the retained earnings is the profit accrue to the firm from past investment that have been kept by the company which is often used for expansion, growth or Gusau Journal of Accounting and Finance, Vol. 2, Issue 1, April, 2021 4 balance sheet of the firm. On the other hand, debt capital deals with capital raise by firm vie capital market in order to finance its operation that is repay back in the future. It is a long-term bond that firm often used to finance large scale investment decision because the firm has a longer year of repayment. According to Akinleye and Akomolafe (2019) one importance thing about debt capital is that there is no more obligation to perform by a firm once the money is paid back. 2.1 Empirical Review Olajide, Soetan and Simon-Oke (2017) conducted research on the relationship between capital structure and firm performance from Africa countries applying Generalized Method of Moments (GMM) for its analysis. The empirical results revealed that a negative relationship existed between capital structure and firms’ performance across African countries, with relatively high Agency costs among the firms. On the contrary, Ezenwakwelu, et. al (2019) studied the link between capital structure determinants and performance of startup firms in developing economies. The findings showed a significant and positive relationship between capital structure determinants and performance of markup firms in developing countries and concluded that the level of debt and equity in a company’s capital structure has risk and return implications. Hailegebreal and Wang (2018) investigated the determinant factor of financing decision of firms operating in 13 African countries with different financial, institutional, legal and economic environments. Findings showed that asset tangibility, financial distress cost, profitability and non-debt tax shield are strong firm specific determinants of capital structure. From the result also, banking sector development, lending interest rate, corporate tax rate and GDP growth rate proved to be the most important country specific determinants of capital structure. Also, rule of law is found to be strong determinants of capital structure of African firms. However, in Kenya, using random effects model and feasible generalized least square (FGLS) by Mwangi, Makau and Kosimbei (2014) studied capital structure and performance of the selected 42 non-financial companies listed in the Nairobi Securities Exchange, Kenya. The empirical results showed that capital structure has significant negative relationship on financial performance. In the same way, Rasa and Jurgita (2012) studied the effect of corporate governance decisions on capital structure on Lithuanian food and beverages companies for the period 2005 to 2010. The study found negative relationship between capital structure and financial performance. Salawu (2007) examined an empirical analysis of the capital structure of selected quoted companies in Nigeria for the period of 1990 to 2004 applying panel data. Findings showed that all the firms, leverage is negatively correlated with capital structure. The finding confirmed that indeed profitability ratio had a direct and significant association with short-term debt and equity with an inverse association was confirmed with a long-term debt. Furthermore, the results showed a negative association between the ratio of total debt to total assets and profitability. On the contrary, Arowoshegbe and Idialu (2013) explored the relationship of capital structure to profitability of quoted firms in Nigeria for the period of 1996 – 2010 applying two panel regression models. The finding from the study revealed an inverse and significant association between capital structure and profitability of quoted companies in Nigeria. On the contrary opinion by Babalola (2014) found significant positive relationship between capital structure and Gusau Journal of Accounting and Finance, Vol. 2, Issue 1, April, 2021 5 financial performance in Nigeria using thirty-one (31) manufacturing firms for the period 1999 to 2012. More so, applying panel data by Akinleye and Akomolafe (2019) examined capital structure and profitability of manufacturing firms listed on the Nigerian stock exchange within the period of 2008-2017. Specifically, the study analyzed the impact of disaggregated variables of debt finance (Short term debt and long-term debt) and equity finance (share capital and share premium) on profit after tax. Findings established that short term debt has insignificant positive effect on profit after tax of manufacturing firms showing in specific term a coefficient estimate of 0.114985 (p=0.5890> 0.05) long term debt exerts significant positive impact on profit after tax, with specific coefficient estimate of 0.578290 (p=0.0001< 0.05) share capital exerts significant positive effect on profit after tax, with coefficient estimate of 0.784525 (p=0.0000< 0.05) share premium exerts insignificant negative effect on profit after tax, with coefficient estimate of - 0.000395 (p= 0.9924> 0.05). Mixed results recorded by Onaolapo, Kajola and Nwidobie (2015) examined the determinants of corporate capital structure using 35 listed firms on Nigerian Stock Exchange using as period 2006 – 2012. The study employed a pooled data OSL technique. From the result of the study, it was confirmed that leverage ratios as proxied for capital structure were inversely and significantly related with profitability. Also, it was confirmed from the study that asset tangibility and firm size were directly and significantly related to leverage. On the contrary, Nwosa (2018) analyzed the relative contribution of financial development on capital structure of ten selected manufacturing firms on the Nigerian Stock Exchange for the period 2002 to 2015. The study adopted panel pool data technique. The regression estimate showed that the ratio of stock market capitalization to gross domestic product (a measure of stock market development) had positive and insignificant effect on firms’ capital structure with the ratio of credit to the private sector to gross domestic product (a measure of banking sector development) had positive and significant effect on firms’ capital structure. This study adopted the pecking order theory as propounded in 1961 by Donaldson. The theory was regarded as the most influential theories that comprehensively explained the concept of capital structure. The theory posits that firm should finance its long-term investments from a well-defined order of preference with respect to the sources of finance it uses. According to Donaldson (1961) firm should only borrows when the internal finance available is insufficient to achieve the intended huge capital investment projects in which bank or corporate bonds should be the most preferably source of borrowing by the firm. Meanwhile, in a situation where internal finance, bank and corporate bonds borrowing is not available or exhausted firm should source for finance through issuing a new equity capital. According to Lawal, Edwin, Monica and Adisa (2014) the importance aspect of the theory is that it takes note of asymmetric information cost which deal with companies prioritize and the ways to finance them through internal finance, bank and corporate bonds borrowing. Also, Abdul, et al. (2019) reveals that the theory identifies how asymmetric information affect firm’s mispricing new securities, which posits that there is no well-defined target debt ratio. The pecking order theory suggests that firm’s managers are fully aware of price sensitive in the market than the investors. The representative of a firm facing the current production constraint is given below using the Cobb-Douglas (1928) production function as a hypothetical example: Y 0 = L a K b T ………………………………………………….…i Gusau Journal of Accounting and Finance, Vol. 2, Issue 1, April, 2021 6 Where Y 0 , L a , K b and T represent organization output, labour, available capital, and time or the rate of technological progress; also, a+b=1 In equation i above, increase could only occur in organization output (Y 0 ) when the insufficient internal finance available is supplemented by loan or equity or both (provided other factors affecting production is held constant). According to Donaldson (1961) firm should only borrows when the internal finance available is insufficient to achieve the intended huge capital investment. Capital structure is given below as follow; C = f(1+r0) …………………………………………………..…….. ii Where C, 1, and r0 are capital structure, loan and equity Equation i must increase by Iterating it to accommodate capital structure to have; Y i = L a K b T (1+r0) …………………………………………….… iii Equation iii implies that a firm could only increase organization output to Y i either through bank and corporate bonds borrowing or issuing a new equity capital. 3. Methodology and Data The selected manufacturing firms used in this study are the ones listed on Nigerian Stock Exchange market. The target populations were eight (8) manufacturing firms that include Cadbury Plc, Dangote Sugar Refinery, Unilever Nigeria Plc, Guinness Nigeria Plc, Nigeria Breweries, PZ Cusson, Nestle Plc, and Champion Breweries. The rationale for the selection of these population was because of the study main objective lied within the context of manufacturing industries. Also, the time frame was between 2005-2019 with data obtained from the yearly financial statement of the selected companies. The study adopted Generalized Method of Moments (GMM) techniques to examine the determinants of capital structure within the selected manufacturing firms. The rationale behind applying the techniques was to avoid the problem of endogeneity. According to Clark and Linzer (2015) the used of GMM help to overcome the problem of endogeneity. This study adopted Faiza, et al. (2013) model with little modification. Faiza, et al. (2013) basic model is given below as; Leverage ratio = (Profitability, Asset Tangibility, Growth, Firm Size)……. iv Where; In the above equation iv, leverage was used as proxy for capital structure and measured as the total debt divided by total assets, profitability as the net income divided by total assets, asset tangibility was the total gross fixed assets divides by total asset, growth as the annual percentage change in total assets, and firm size was obtained by natural logarithm of firms’ assets. The modified version of the Faiza, et al. (2013) model in equation iv is give below; LEV = f ( PROFIT, GROWTH, AUDCOM, LIQUID) … … ………….… v Where; LEV = Leverage ratio, PROFIT = Profitability, AUDCOM = Audit Committee, and LIQUID = Liquidity atio The rationale for modifying Faiza, et al. (2013) model was for two reasons. First, audit committee often determines the financial stands of an organization; therefore, gives information on the needs for either loan or equity or both for organization. For instance, the financial report presented by audit committee often shows organization growth and the need to expand operational capacity either through loan or equity or both. Also, audit committee was included in Gusau Journal of Accounting and Finance, Vol. 2, Issue 1, April, 2021 7 the variable because it was the core objective. Secondly, the other variables in the original model such as asset tangibility, and firm size were excluded from the modified model because they had been extensively discussed and identified in literature as determinants of capital structure in Nigeria. The econometric form of equation v is given below as; LEV =π0+ π1PROFIT + π2GROWTH + π3AUDCOM + π4LIQUID + µt … … ... vi Table 1: Measurement of Variables Variab les Measurement Source LEV Total debt divided by total assets Githira and Nasieku (2015), Faiza, et al. (2013) PROFI T Return on asset Faiza, et al. (2013) GRO WTH The annual percentage change in total assets Faiza, et al. (2013) AUDC OM This determines the size of the audit committee and consists the number of members who make up the Audit Committee Researcher’s compilation LIQUI D Ratio of current asset to current liability Researcher’s compilation Source: Researcher’s compilation, 2021 4. Empirical Results and Discussion Table 2: Correlation Matrix Variables LEV PROFIT GROWTH AUDCOM LIQUID LEV 1.000000 PROFIT 0.860528 1.000000 0.0000 GROWTH 0.988842 0.889106 1.000000 0.0000 0.0000 AUDCOM 0.448400 0.405858 0.413483 1.000000 0.0061 0.0141 0.0122 LIQUID -0.988949 0.889101 0.999989 0.413554 1.000000 0.0000 0.0000 0.0000 0.0122 Source: Researcher’s compilation from Eview-9, 2021 In the above table 2, the result of leverage ratio followed the Pearson’s correlation assumption that states that a perfect strong correlation must be confirmed when a variable (say, Xi) is estimated against itself (say Xi). The implication of this finding is that change that occurred in the ratio of selected listed manufacturing firm’s total debt (loan capital) to the value of the sum of non-current and current assets is completely (100%) influence by itself. For profitability and leverage, a positive relationship was confirmed between the duo with the coefficient value of 0.8605 and p-value of 0.000. This shows that indeed increase in profitability ratio led to increase in leverage ratio with a strong degree association. The implication of this Gusau Journal of Accounting and Finance, Vol. 2, Issue 1, April, 2021 8 finding is that change that occur in total debt to total asset due to change in return on asset in the selected listed manufacturing firms was high. The relationship between firm growth and leverage was strong and high with a coefficient value of 0.99 and p-value less than 0.005. This therefore, shows that a positive relationship occurred between the duo with firm growth having high effect on leverage of the selected firms. The inference of this finding is that when change occur in net income or total asset or both of manufacturing industries on Nigerian stock exchange, it has high effect on capital structure. The coefficient value of the degree of association between audit committee and leverage was moderate with a value approximate of 0.45 and p-value less than 0.05. This therefore, shows that a direct relationship occurred between the duo with audit committee having little effect on leverage. The implication of this finding is that when change such as oversee and disclosure occurred as part of audit committee’s function, it has little moderate effect on capital structure of the firms. In addition, an inverse association was confirmed between liquidity and leverage with a strong degree association and p-value less than 0.05. This inference that indeed ratio of current asset to current liability of the selected listed manufacturing firm’s caused change in capital structure. Table 3: Generalized Method of Moments (LEV dependent Variable) Variable Coefficient Std. Err t-Statistic Prob. C -0.3030 0.1238 -2.4458 0.0218** PROFIT 0.1918 0.1019 1.8821 0.0692* GROWTH 0.7071 0.2881 2.4549 0.0417** AUDCOM 0.0063 0.0032 1.9643 0.0585* LIQUID -0.8851 0.8510 -1.0296 0.3112 (J-statistic) = 1.10622; Prob. (J-statistic)=0.063452 ** & * indicate statistically significance @ 0.05 &0.1 , t0.05= 1.962 & t0.1= 1.645 for two-tails Source: Researcher’s compilation from Eview-9, 2021 The results of GMM estimated revealed that profitability was positive with a significant p-value less than 0.1 at the conventional level. Also, judging from the t-value, the profitability value had an estimated co-efficient value of 0.1918 and the t-statistic (1.8821) greater than the student t- value (t0.1= 1.645) at 0.1 significance level. This finding infers that in the selected manufacturing firms on Nigerian stock exchange, the ratio of a company's debt (loan capital) to the value of the sum of non-current and current assets is often influenced by return on assets. The finding confirmed with the a priori expectation. The significance implication of the result on capital structure of the selected manufacturing industries is that most of them are established with the sole aim of adding utility to unfinished product for the purpose of making profit; therefore, any additional loan acquires by them must be backed up by a feasibility study that such loans would increase return on assets. Also, studies like Akinleye and Akomolafe (2019) and Ezenwakwelu, et. al (2019) confirmed a direct and significant relationship between the duo, Akinleye and Akomolafe (2019) established that long term debt exerts significant positive impact on profit after tax. On the contrary, Olajide, et al. (2017) revealed that a negative relationship existed between capital structure and firms’ performance across African countries, with relatively high Agency costs among the firms. Gusau Journal of Accounting and Finance, Vol. 2, Issue 1, April, 2021 9 The p-value for firm growth was statistically significant with p-value less than 0.05 with an estimated coefficient value of 0.7071. Also, the estimated t- statistics (2.4549) was greater than the student t-value (t0.05= 1.962) at 0.05 significance level. This finding confirmed that firm growth was significant at 0.05 significance level with a direct effect on leverage. The implication of this finding was that increase in organization assets such as fixed capital, raw material, space and facilities and number of employees conjointly influence capital structure. The significance and direct effect of firm growth on capital structure could be attributed to the fact that manufacturing industries produce consumable goods that often have season demand; therefore, provision of more goods above the available within organization’s inventory during the season could result in financing such either by equity or debt or both (capital structure). From the study, it was confirmed that in Nigerian manufacturing sector increase in productivity does increase capital structure (debt/equity). Given this, Gharaibeh (2015) and Akinyomi (2013) identified firm growth as one of the significant and robust determinant factor of capital structure. Also, judging from the p-value and t-statistics, it was confirmed that audit committee was significance. For the p-value, it was significance at 0.1% with a p-values less than 0.1 and t- statistics was greater than t-value at 0.1. For audit committee, it implication on leverage as proxy for capital structure in the selected listed manufacturing industries in Nigeria was that overseeing and disclosure of the financial reporting by committee saddle with the responsibility had importance influence on equity and debt. The significance nature of audit committee on capital structure could be attributed to two reasons. First, audit committee in an organization comprises of both internal and external that are saddle with the purpose of achieving shareholders’ returns on investment and maintain the integrity of the corporation; thereby, recommends and justify the need to increase organization’s equity and debt. Secondly, when audit committee members comprise of people with sound financial knowledge, it creates public confidence. Therefore, enable organization especially manufacturing companies to raise more equity for their firms. For instance, Nwaiwu and Joseph (2018) remark that increase in revenue generation of quoted firms in Nigeria is determined by corporate governance. Additionally, the liquidity ratio was non-significant judging from a p-value greater than 0.05 and 0.1 conventional level. Also, from the estimated coefficient value liquidity ratio had a negative association with leverage; therefore, negated the formulated a priori expectation. The non – significance of liquidity ratio could be attributed to two factors. First, majority of the manufacturing industries are seasonal in term of high demand for their sales. For instance, the selected manufacturing industries in this study like Guinness Nigeria Plc, Nigeria Breweries, and Champion Breweries often have high safe during festival period and yuletide seasons. Due to this, most of them may not increase their loan or equity profile during the off sale period. Therefore, reduce or have infinitesimal effect on leverage. Secondly, liquidity was proxy by ratio of current asset to current liability which indicates when current asset is greater than current liability, it reduces the need for capital structure. This therefore, supported the adopted pecking order theory as propounded in 1961 by Donaldson that assumes that firm with high profitability ratio level display little dependence on debt with the belief that a firm should only borrows when the internal finance available is insufficient to achieve the intended huge capital investment projects. Gusau Journal of Accounting and Finance, Vol. 2, Issue 1, April, 2021 10 5. Conclusion and Recommendations Based on the findings, it was concluded that audit committee, profitability, and firm growth were the major determinants of capital structure among the listed manufacturing firms in Nigeria. The study therefore, recommends that Nigerian manufacturing industries especially the quoted firms should consider the feasibility study as carried out by audit committee before deciding on their choice of debt or equity on both, since both proved to positively influenced return on assets. The industries should embrace pecking order theory as propounded by Donaldson during the off- season period to reduce the severity of loan due to unforeseen circumstance. Since the finding established a direct and significant relationship between growth and capital structure, thus the industries should use more of the loan and equity secured to finance fixed capital assets. Also, both debt and equity set aside for the business must be ensured that such funds increase firm growth through annual assessment of such capital on executed projects. References Abdul, K., John, A., & Idachaba, O. I. (2019). Effect of capital structure on the profitability of listed insurance firms in Nigeria. 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