The Choice between Equity and Debt in Nigerian Quoted Companies: Some Empirical Tests of the Capital Structure Theory.


The study of capital structure attempts to explain the mix of securities and financing sources used by corporations to finance real investment. Most of the researches are on industrialized economies and evidence on developing countries like Nigeria remain scanty.

This study, which attempts to fill the void or contribute to filling it, investigates and empirically analyses the application of the capital structure theory to the Nigerian situation.

capital structure models,  such as the pecking order and trade-off theories, were specifically applied using data from annual financial reports of sixty quoted firms over a ten-year period, 1996 to 2005, as well as the Nigerian Stock Exchange (NSE) publications.

The study utilized correlation and regression analyses as well as an autoregressive distributive lag (ADL) model to test for capital structure adjustment and other related issues.

The study showed that market leverage is a decreasing function of marginal tax rate, growth options, capital market conditions, collateral, profitability and earnings volatility; and an increasing function of size and profitability attained Statistical significance with meaningful theoretical explanation.

The cross-sectional behaviour of most of the explanatory variables was unstable over time. Overall, the empirical evidence obtained confirms the theoretical predictions of the pecking order and trade-off models though more evidence exists to validate the former theory.

Further, we find that the tax benefits of debt are about 14.6 per cent of firm value. The implications of these results are discussed.

In particular, managers of firms seem to be concerned about the value of tangible assets, firm size and profitability in their financing decisions. Finally, our results confirmed the targets-adjustment hypothesis of capital structure:

Nigerian quoted firms engage in dynamic rebalancing of capital structure toward their target debt ratios. The major contribution of this study is the applications of our theory, a modified version of the standard pecking model.

Table Of Contents

Title page                                              i

Approval page                                   ii

Certification                                      iii

Dedication                                      iv

Acknowledgements                            v

Abstract                                             vi

List of Tables                                  vii

List of Figures                              viii

List of Appendixes                         ix


  • Background of the Study 1
  • Statement of Research Problem 5
  • Objectives of the Study 6
  • Research Questions 7
  • Research Hypotheses 7
  • Significant of the Study 8
  • Scope of the Research 8
  • Limitations of the study 9
  • Definition of Terms 9

References                    13


  • Introduction 18
  • Value of the Firm giving Corporate taxes only 19
  • Value of the firm with both personal and corporate

Taxes                                22

  • Merton Miller’s Equilibrium 22
  • De Angelo And Masulis Theory 23
  • The Separability of Investment and Financing

Decisions                            25

  • Nature and Characteristics of Debt and Equity Capital 26
    • Benefits of Equity capital over Debt capital 27
    • The Maturity Structure of Debt 28
  • Possible reasons for an optimal capital structure 30
    • Bankruptcy costs 30
    • Signaling Hypotheses 36
  • Capital Structure Theories 38
    • Trade-OFF 38
    • Pecking Order Theory 39
    • Agency costs and capital Structure 43
    • Option Pricing Implications for Capital 48
  • Empirical Evidences On Capital Structure 50
  • Determinant of Capital 54
    • Taxes 55
    • Firm size 56
    • Growth Opportunities 58
    • Profitability 59
    • Capital Market Conditions 61
    • Tangible Assets 61
    • Risk of Financial Distress 62
    • Inflation 63
    • Existing Financial Structure 63
  • Evidence Based On Exchange Offers And Swaps 64
    • Times Series Studies; Announcement 66
  • Nigerian Corporate Environment: The Capital Market 70
  • Chapter summary 72

References                     74


  • Introduction 85
  • Research Design 85
  • Population of the Study 85
  • Sample Size 86
  • Specification of Models 87
    • Dependent Variable 87
    • Independent Variable 87
    • Determinant Of Debt Ratio 89
    • Proposed Regression 91
  • Nature and Sources of Data 92
  • Techniques of Analysis 93
  • Evaluation of Coefficients 95
  • Limitations of the Methodology 98

References                              99


  • Introduction 101
  • Estimates of Debt Ratio Parameters for Individual Firms 108
  • Cross Sectional Result 110
  • Results of Market Leverage 113
  • The Tax Benefits of Debt 117
  • Debt and the Financing Deficit 122
  • Capital Structure and the Target Adjustment Model 127
  • Empirical Results and Research Questions 130
  • Empirical Results and Research Hypotheses 131
  • Chapter Summary 132

References                              134


  • Introduction 136
  • Major Findings 138
  • Discussion of Findings 138
    • Pecking Order Theory 140
    • Debt and Taxes 141
    • The Trade-Off Theory 141
    • Impact Of Capital Market
    • Debt, Collateral, Growth Options, size and Earnings Volatility 143
    • The Target Adjustment of Capital Structure 144

References                                       147


6.0    Introduction                          148

  • Major Contributions of the Outcomes of the Study to Knowledge 152
  • Conclusion 153
  • Recommendations 155
  • Recommendations for Future Research 157

References                 159

Appendix                           160

Bibliography                               163


Background of Study

The modern theory of capital structure began with the celebrated paper of Modigliani and Miller (1958). They propose that all mixes of capital structure produce the same financial result in a perfect capital market.

In other words, the optimal capital structure is irrelevant to creating shareholders’ wealth. After the 1958 paper of Modigliani, and Miller (MM) concluded irrelevance under stringent assumptions, subsequent works have added many potential explanations for capital structure policies in firms.

Much emphasis has been placed on relating the assumptions made and in particular taking into account taxes (the importance of which MM themselves recognized. (MM, 1963).

Capital structure has generated great interest among financial researchers (Harris and Raviv, 1991; Myers, 2003). With respect to the theoretical studies, three main theories currently dominate the capital structure debate namely; trade off theory, pecking order theory and agency theory.

According to static trade off theory, the optimal capital structure does exist. A firm is regarded as setting a target debt level and gradually moving towards it.


Allayannis, G.,Brown,G. and Klapper,L.F. (2003), ˝ Capital Structure and Financial Risk: Evidence from Foreign Debt Use in East Asia,” Journal of Finance, 58, (6): 2667-2709

Beck, T. Demirguc – Kurt,A. and Maksimovic, V. (2005), “Financial and Legal Constrains on Growth: Does Firms size Matter?” The Journal of Financial, 60(1) 235-316.

Booth, L., Aivazian,V., Demirguc-Kunt ,A.and Maksimoric,V. (2001) ,“Capital Structure in Developing Countries,” Journal of Finance, 56, (1):87-130.

Butter, A., Grullon,W.G. and Weston,J.P. (2005), “Can managers Forecast Aggregate Market Returns”, Journal of Finance, 60, (2): 963-986.

Easley, D. and Hara,M.O. (2004), “Information and Cost of Capital, Entrenchment, “American Economic Review, 86, (5): 1197 – 1215

Faulkender, M. and Wang,R. (2006),” Corporate financial policy and the value of cash”,Journal of finance, 61(4):1957-1990.

By admin

Leave a Reply

Your email address will not be published. Required fields are marked *