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Journal of Accounting and Management JAM vol. 4, no. 1(2014)

Capital structure and the value of the firm: evidence from the
Nigeria banking industry

Adedoyin Isola LAWAL1

Abstract: Using data sourced from Nigerian commercial banks between the periods 2007 to 2012;
this study examined the factor that magnifies the value of a firm. We used OLS technique and White-
HAC heteroskedastcity test to infer the relationship between capital structure and the value of a firm
in Nigeria. It was observed that debt instrument play significant role in magnifying the value of
Nigerian banking firms, while equity role is partially significant. We suggest that bank managers as
well as regulators adopt measures that will promote leverage usage so as to maximise the overall
value of the firm.
Keywords: Debt, Equity, Value of a Firm, Capital Structure, Banks.

1 Introduction
The debate on the relationship between the capital structure of a firm and its
value began from Modighani and Miller theory of capital structure and firm
value. Hampton (1992) argues that a core objective of a firm is to maximize
its value. This can be achieved by examining its capital structure or financial
leverage decision based on its impact on the value of the firm (see Peltzman,
S. (1970), Marcus, A. J. (1983), Ogbulu and Emeni (2012)).
Capital structure represents the proportionate relationship between debt and
equity instruments on the capital outlay of a firm. The capital structure
decision is significant as its affects the costs of the capital and the market
value of the firm. A firm that has no debt in its capital structure is referred to
as unlevered firm, whereas a firm that has debt in its capital structure is
referred as levered firm. Capital structure decision of a firm do influences it
shareholders return and risk which in turn influences its market value
(Pandey (2004)). In capital structure theories, the most important decision of
the firm relates to the proportions of debt and equity to employ in order to
optimize the value of the firm and minimize the cost of capital (see Agliardi,
E. and Kousisi, N. (2013), De long, A., Kabir, R. and Nguyen, T. T (2008),
Margaritis, D. and Psillaki, M. (2010), Gersbach, H., (2013)).
Modighani and Miller (1958) argues that under the assumptions of perfect
capital market, given that no bankrupt cost, without taxes and capital
markets are frictionless, financial leverage is unrelated to firm value, but
when faced with tax deductible interest payments, a positive relationship
exist between the value of the firm and its capital structure. A modification
to this theory was propounded by M-M in 1963 which recognises the impact
of tax shield on the ground that debt can reduce tax to pay, thus the best

1
Department of Accounting and Finance, Landmark University, [email protected]

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Journal of Accounting and Management JAM vol. 4, no. 1(2014)

capital structure of a firm should be one hundred percent (100%) of debt

instruments. The core of M-M hypothesis centres on two propositions under
a perfect capital conditions viz: the value of the firm is independent of its
capital structure; the cost of equity for a leverage firm is equal to cost for an
unleveraged firm in addition to an added premium for financial risk (see
Joliet, R. and Muller, A. (2013), Agliard, E., Koussi, N., (2011)).
Subsequent theories such as Trade – off theory by Myers (1984) and
Agency Cost theory by Jensen and Meckling (1976) observed that in a
perfect capital market, if the capital structure decision is irrelevant, its
irrelevancy could be as a result of the imperfection that exist in the real
world (see Baxter (1967), Kraus and Litzenberger (1982), Kim (1998),
Jensen and Meckling (1976), De Angelo and Masulius (1980), Myers
(1984), Black and Cox (1976), Leland (1994), Horakimian, Opler and
Titman (2002), McConnel and Servaes (1990), Titman (1984), Robichek
and Myers (1965), Berger, A. N., Banaccorsi di Patti, E. (2006), Chien-
Chiang Lee and Meng-Fen Hsieh (2013)).
The essence of this paper is to find out whether the amount of equity and/or
debt used in financing Nigerian banks affects its market value, in other
words, does capital structure decision of Nigerian banks affects its value?
This paper will act as guide for the financial managers to design their
optimum capital structure so as to maximize the market value of the firm
and minimize the agency cost.
The rest of this paper is structured as follows: Section two provides the
literature review, section three deals with the methodology, section four
provides the findings and recommendations while section five provides the
conclusion.

2 Literature review
The debate on the relationship between the capital structure of a firm and its value
has been on since the emergence of M-M (1958) theory of capital structure.
Attention have been on whether there is an optimum capital structure for individual
firm or whether the rate of debt utilization is irrelevant or relevant to the value of a
firm (see Deesomsak, R., Paudyal, K., Pescetto, G., (2004), Shim, J. (2010)). A
number of theories have been used to examine the relationship between capital
structure and the value of the firm. Some of these theories will be briefly examined
in this section.
2.1 Capital structure theories
A number of theories have been used in examining the relationship between the
capital structure and value of a firm, these theories includes the Trade- off theory,
the Net Income Approach, the Net Operating Income Approach, the Modigliani
and Miller Hypothesis, the Pecking Order theory, the Asymmetric Information
Approach and the Market timing theory. Each of these theories will be briefly
examined here.

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Journal of Accounting and Management JAM vol. 4, no. 1(2014)

Modigliani and Miller Hypothesis (1958): This was among the pioneer work in the
theory of capital structure of a firm; the hypothesis is a behavioural justification of
the net operating income approach. Its argues that without taxes, the cost of capital
and market value of the firm remain constant throughout all levels of leverage.
They offered two strong propositions to support their hypothesis. They explained
that for firms in the same risk class, the total market value is independent of the
capital structure and is given by capitalizing the expected net operating income by
the rate appropriate to that risk class. If this proposition does not hold, then an
investor could buy and sell stocks and bonds in a way to exchange one income
stream for another stream, identical in all respects by selling at a lower price –
arbitrage. Base on the arbitrage process, they concluded that the cost of capital (or
market value of the firm) is not affected by any degree of leverage. This implies
that the capital structure (or financing decision) is irrelevant. The second
proposition of the M-M hypothesis explained that firms in the same risk-class, the
cost of equity is equal to the constant average cost of capital plus a premium for
financial risk which is equal to debt-equity ratio times the spread between the
constant average cost of capital and the cost of the debt.
The Net Income Approach: This approach explained that the value of the firm can
be increase or decrease its overall cost of capital by reducing or increasing the
proportion of debt security in the capital structure. It argues that leverage
significantly affects the overall cost of capital and that the value of the firm varies
with its leverage. This approach is based on the argument that debt can be
substituted for equity by issuing new debt and retiring existing equity. Under this
approach, as equity is replaced by more, lower debt, the overall cost of capital
declines.
Net Operating Income Approach: This approach argues that the market value of the
firm is not affected by the capital structure changes because the market value of the
firm depends on the Net Operating Income and cost of capital, which is expected to
be constant. The NOI submission rules out the possibility of leverage having any
effect on the overall cost of capital.
The Traditional View: This view represents a compromise between the Net Income
Approach and the Net Operating Income Approach as it argues that the value of the
firm can be increased or the judicious mix of debt and equity capital can reduce the
cost of capital. This implies that the cost of capital decreases within the reasonable
limit of debt and then increases with leverage. It thus, posits that optimum capital
structures exists and occurs when the cost capital is minimum or the value of the
firm is maximum (see Oloyede 2000).
The Trade-off theory: This theory explained that holding a firm’s investment plans
and assets constant, its optimal leverage ratio is obtained by trading off between the
tax benefits and the consequences of using debt instruments. According to this
theory, debt financing is attractive, in that, the benefits of tax saving from debt
payments shields a number of cost debt financing, thus high profit firms will have
higher benefits from debt financing accompany with lower level of financial
distress costs, this makes higher leverage attractive to higher profit making firms.
The Pecking Order theory: This theory provides an analytical description of the
sequence of firm’s financing decisions where retained earnings have a preference
over debt and debt is favoured over equity. According to Supa Tongkong (2012),
under pecking order hypothesis, firms prefer internal financing to external

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Journal of Accounting and Management JAM vol. 4, no. 1(2014)

alternatives such that if the firm issue securities, the firm favour debt over equity.
The implication is that profitability would be expected to explain the firm leverage
level such that more profit will connotes lesser use of debt instruments. This
contradicts the trade off theory submission that more profit attracts more leverage.
The Market Timing theory: this theory introduces the impact of timing on firm’s
financial decision making process. It explained that the choice between the use of
capital or equity is a function of manager’s ability to time the equity market, as
firms will prefer using equity so long the relative cost of equity is low, and if
otherwise preference will be on the use of debt instruments. Under this approach,
the stock market condition play crucial role in explaining the firm’s leverage
condition, for instance, during bullish equity market, firms prefer equity issuance
over debt financing (see Beck, T., Levine, R., (2004), Peura, S., Keppo. J., (2006),
Gropp, R. and Heider, F. (2010)).
2.2 Empirical literature
As earlier stated, works on the relationship between capital structure and the value
of a firm date back to the work of M&M (1958), ever since, a number of
contributions have been made to the subject matter with each authors addressing
several issues relating to capital structure composition. For instance, Chowdhury
and Chowdhury (2010) examined the impact of capital structure on firm’s value
using data from Bangladesh economy from the year 1997 to 2003 and observed
that maximizing the wealth of shareholders requires a perfect combination of debt
and equity. They explained that the cost of capital has a negative correlation from
the result, thus should be kept as minimum as possible (see also D. W., & Rajan, R.
G. (2000),).
Similarly, Supa Tongkong (2012) used multiple linear panel regression models to
examine the factors influencing capital structure decisions so as to maximize the
value of a firm, and a dynamic panel regression model using one-step and two-step
Arellano and Bond GMM estimation approach to determine the speed of
adjustment towards target capital structure, and observed that a positive
relationship exist between a firm’s debt and its median industry leverage. They also
observed that a positive relationship exists between firm size and growth
opportunity; and firm leverage, though a negative relationship exist between
profitability and leverage as stated in pecking order theory. They concluded that
the adjustment rate for restructuring of capital composition for the study area is
about 63 percent.
Using Nigeria data, Ogbulu and Emeni (2012) examined the impact of capital
structure on a firm’s value; they observed that in an emerging economy like
Nigeria, equity capital as a component of capital structure is irrelevant to the value
of the firm.
In a related development, Babalola (2012) examined the relationship between
Return on Equity (ROE) and the capital structure of a sample of 10 Nigerian firms
from year 2000 to 2009, and observed that a strong curvilinear relationship exist
between ROE and the debt-to-asset ratio. Their findings which is consistent with
the trade-off theory shows that at a reasonable parameter values, the financial
distress cost burn by debt do, infact provide a first-order counterbalance to the tax
benefit of debt and that firm’s performance is a quadratic function of debt ratio (see
Lei, A. C. H. and Song, Z. (2013), Yong Tan and Christos Floros (2013), ).

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Journal of Accounting and Management JAM vol. 4, no. 1(2014)

3 Data and Methodology

In this study, we used data from the individual financial statements (Balance
Sheets) of fifteen 15 publicly owned commercial banks in Nigeria between the
period 2007 to 2012. The variables used were adopted from existing literatures. We
used the Ordinary Least Square (OLS) techniques to examine the relationship
between the dependent variable – the value of the firm -; and the independent
variables – the debt and equity components. The OLS technique was adopted
because it is an appropriate technique since our focus was to test the relationship
between the firms’ value and their capital structure.
3.1 MODEL SPECIFICATION
3.1.1 Regression Analysis Model
In order to determine the factor that mostly influences the value of a firm, the
model is specified as follows:
FV = α0 + β1 Equity + β2 Debt +µt (1)
α0, β1, and β0 are parameters to be estimated
The a priori expectation is as follows
β1 > 0 and β2 > 0
Where FV is the Value of the firm, Equity represent the sum total of all equity
instruments, Debt is the summation of all the debt instruments used in financing a
bank and µt is the error term.
3.2 Heteroskedasticity Consistent Covariance (White)
We follow White (1980) to derive a formula to test for the heteroskedasticity, such
that
=T/T–K (2)
Where are the estimated residuals, T is the number of observations, k is the
number of regressors, and T/ (T-k) is an optional degree-of-freedom.

4 Data analysis and result

This study used the Ordinary Least Square (OLS) to examine the relationship
between the value of a firm and its capital structure. The results of the regression
analysis using Eview 7 are presented in Table 2 below. From the results, it can be
deduced that the value of our R2 at 0.979022 shows that about 98% variations in
firms value is explained by the interactions of debt and equity. It is also important
to state that with the value of R2 at 0.98, our sample regression line (SRC) shows
that our model is significant and is a good measure of fit. A priori , debt and equity
are expected to be positively related to the value of a firm, thus , our model
confirms to the theories of capital structure as both the coefficient of debt and
equity have positive signs.
A critical look at the (SE) standard error gives interesting information. A priori,
twice the SE should be less than the coefficient for the model to be significant,
looking at our debt variable, twice of 0.065797 equals 0.1315 which is far below
1.55970, this shows that the variable (debt) is significant. On the other hand, twice
of 0.612812 equals 1.22562 which is greater than 0.233615, this implies that equity
capital play a low significant role in magnifying the value of the firm.

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Journal of Accounting and Management JAM vol. 4, no. 1(2014)

When we use T- Statistics approach to examine the validity of our report, it is

evident that T- Statistics value for the debt instrument is far above 2, while that of
the equity instrument is far below 2. This also implies that debt instruments
contribute significantly in enlarging the value of firm (a priori, T- Statistics values
are expected to be greater than 2). Analysing each of the coefficients shows that
debt instruments increases the value of the firm with about 155% while equity
instrument contributes just about 23.4%.
The result of the heteroskedasticity test shows that both the F- and X2 (LM)
version of the test statistics give the same conclusion that there is no evidence for
the presence of heterscedasticity since the p- values are considerably are
considerably in excess of 0.05.
From the above, it can be deduced that debt instrument are the major components
that magnifies the value of a firm. Our finding is in line with existing theories such
as the Trade-off (see Myers and Majlufs (1984)). However, our result contradicts
pecking order theory that are of the view that debt instrument is independent of the
value of the firm, in that the value of the firm is an increasing function of leverage
due to tax deductibility of payment at corporate level.

5 Conclusion
This paper examined the capital structure theory and the value of a firm using data
from the Nigerian banking industry for the period 2007 to 2012. The M&M theory
which postulates that under the perfect capital market assumptions, given that there
is no bankrupt cost, capital markets are frictionless, without taxes etc the value of
the firm is independent of its capital structure formed the bedrock of debate on the
theory of capital structure.
Our findings suggest that capital structure decisions have various implications
which among other things influence the value of the firm.
Using regression analysis to analysis the annual published financial reports of these
banks, we observed that leverage or debt play significant role in maximizing the
value of the firm, while cost of capital have a minimum contribution towards
magnifying the value of the banking firm.
We therefore recommends that management of banks as well as the regulatory
institutions adopts policies that tends towards the use of debt instruments so as to
maximize the value of the firm, which will in turn maximize the shareholders
wealth.

6 References
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Babalola, Y. A. (2012): The effects of optimal capital structure on firms’ performances in Nigeria.
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133

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Beck, T. and Levine, R. (2004): Stock market, banks and growth: panel evidence. Journal of Banking
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Peltzman, S., (1970): Capital investment in commercial banking and its relationship to portfolio
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Appendix
Dependent Variable: FIRM_VALUE
Method: Least Squares
Date: 11/18/13 Time: 21:17
Sample (adjusted): 1 127
Included observations: 104 after adjustments

Variable Coefficient Std. Error t-Statistic Prob.

C -62779917 2.15E+08 -0.292147 0.0708

EQUITY 0.233615 0.612812 0.381218 0.0303
DEBT 1.559970 0.065797 23.70894 0.0000

R-squared 0.979022 Mean dependent var 4.00E+09

Adjusted R-squared 0.978607 S.D. dependent var 1.40E+10
S.E. of regression 2.04E+09 Akaike info criterion 3.74178
Sum squared resid 4.22E+20 Schwarz criterion 3.81806
Log likelihood -2375.572 Hannan-Quinn criter. 3.77268
F-statistic 2356.814 Durbin-Watson stat 2.00623
Prob(F-statistic) 0.000000

Table 3: Diagnostics test result.

Heteroskedasticity Test: White

F-statistic 0.380190 Prob. F(5,98) 0.8613

Obs*R-squared 1.978946 Prob. Chi-Square(5) 0.8521
Scaled explained SS 66.87724 Prob. Chi-Square(5) 0.0000

Test Equation:
Dependent Variable: RESID^2
Method: Least Squares
Date: 11/23/13 Time: 15:56
Sample: 1 127
Included observations: 104

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Journal of Accounting and Management JAM vol. 4, no. 1(2014)

Variable Coefficient Std. Error t-Statistic Prob.

C 7.60E+17 4.31E+18 0.176390 0.8604

DEBT -3.79E+09 4.63E+09 -0.818065 0.4153
DEBT^2 -0.064300 0.160090 -0.401650 0.6888
DEBT*EQUITY 1.942909 2.054571 0.945652 0.3467
EQUITY 4.53E+10 3.92E+10 1.156163 0.2504
EQUITY^2 -13.76406 11.96084 -1.150760 0.2526

R-squared 0.019028 Mean dependent var 4.05E+18

Adjusted R-squared -0.031021 S.D. dependent var 3.45E+19
S.E. of regression 3.50E+19 Akaike info criterion 92.89844
Sum squared resid 1.20E+41 Schwarz criterion 93.05101
Log likelihood -4824.719 Hannan-Quinn criter. 92.96025
F-statistic 0.380190 Durbin-Watson stat 1.210236
Prob(F-statistic) 0.861271

Table 3 List of Banks and their Debts, Equity and Value

FIRM
BANK YEARS DEBT EQUITY VALUE
STERLING 2007 128509070 28226786 156735855
2008 218405764 31441057 249846821
2009 200244609 21073556 221318165
2010 224122523 26118099 250240622
2011 463113119 41608399 504721517
2012 519529791 44532953 564062744
GTB 2007 436505430 47324118 486491079
2008 782080334 176996369 735692906
2009 879911544 193124102 1078177585
2010 947798681 214223531 1168052897
2011 1374644487 232006942 1608652646
2012 1451436740 282441120 1734877860
FIDELITY 2007 187818100 30101287 218332100
2008 398270325 136371740 535479544
2009 376561280 129418670 506267251
2010 343574000 134446000 478020000
2011 603158000 136350000 739508000
2012 365604480 30862080 396366560
ECO 2007 943754240 104281600 1048035840
2008 1143770240 185219520 1328989760
2009 1243353280 197690400 1441043680
2010 1467881760 206817600 1674699360
2011 2512412160 233493760 2745905920
2012 2843818080 348235520 3192053600

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Journal of Accounting and Management JAM vol. 4, no. 1(2014)

DIAMOND 2007 52774637 268175530 320950167

2008 486343532 116983008 603326540
2009 534346916 116544920 650891836
2010 431521401 116881159 548402560
2011 630443953 92522024 722965977
2012
SKYE 2007 433988000 12126000 446114000
2008 720889000 63989000 784878000
2009 534132000 88032000 622164000
2010 566310000 106937000 674064000
2011
2012
UBA 2007 937527000 164821000 1102348000
2008 1331938000 188155000 1520093000
2009 1213160000 187719000 1400879000
2010 1244902000 187730000 1432632000
2011 1485407000 170058000 1655456000
2012
STANDARD
CHATERED 2007 32097760000 3336160000 52779360000
2008 40983680000 3542400000 69610880000
2009 44573440000 4374400000 69864480000
2010 55232640000 6113920000 82646720000
2011
2012
ZENITH 2007 806341898 77599028 883940926
2008 1413153438 267148567 1680302005
2009 1419232556 301212546 162302287
2010 1439044000 350414000 1789458000
2011 1793845000 360868000 21547133000
2012
ACCESS 2007 3489081000 3489081000 6978162000
2008 862084772 171860655 1033945437
2009 525437890 168346048 693783938
2010 629453315 175370457 804823772
2011 1437704545 197042209 1634746754
2012
FIRST 2007 77351000 685530000 762881000
2008 900992000 264469000 1165461000
2009 1300466000 366956000 1667422000
2010 1693418000 269028000 1962444000

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2011 2192703000 270840000 2463543000

2012 2262650225 279479796 2542130021
UNION 2007 101751000 101049000 202800000
2008 795803000 53145 907074000
2009 1175140000 -253910 921230000
2010 981125000 -135894000 845231000
2011 664203000 179560000 843763000
2012
FCMB 2007 231837026 30968864 262805890
2008 132127473 333083428 465210901
2009 386951925 127457689 514409614
2010 395437666 134635822 530073488
WEMA 2007 139898800 25182700 165081500
2008 161521200 -32614700 128906600
2009 196774200 -44991300 150936200
2010 201215100 16368500 216984400
2011 215517000 6721000 222239000
2012
UNITY 2005 30420233 33179377 33179377
2006 100263887 131031671 114497777
2007 171194000 32040000 203234000
2008 18794270 345286564 364080834
2009 250776974 6911999 257936208
2010 261068700 44153233 305221933
2011 329349214 44510088 373859303
2012 344262498 51457682 395720180
STANBIC IBTC 2007 239420000 75563000 314983000
2008 270062000 80664000 350726000
2009 260010000 80480000 340490000
2010 300791000 83750000 384541000
2011 471419000 82806000 554225000
2012

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