EFFECT OF FIRM SPECIFIC CHARACTERISTICS ON FINANCIAL LEVERAGE OF QUOTED DIVERSIFIED COMPANIES IN NIGERIA

CHAPTER ONE

INTRODUCTION

1.1         Background to the Study

The genesis of the use of external financing by firms can be traced back to the period of micro trade by barter which was bedeviled by so many problems, including absence of a standard unit for measurement. This served as a barrier to lending and borrowing. The introduction of money as a medium of exchange facilitated the development of other forms of business such as sole proprietorship and partnership which were mainly sustained through internal financing. However, after the industrial revolution of the 1830s, the nature of business ownership and financing evolved, partnerships were formed, which lead to the emergence of joint stock companies. As a result of the formation of large joint stock companies which can take greater risks in business opportunities, internal sources of finance became insufficient for further expansion and growth, thus, necessitating business ventures to resort to external financing in order to boost their efficiency and productivity.

Moreover, expanding into new line of businesses and the possible increase in the number of their division/ subsidiaries became one of the reasons that necessitated the need for external source of funding in form of loans, or new equity from creditors, lenders, shareholders and other debt providers. These could come in form of debenture and loan usually termed as financial leverage with a fixed rate of charges attached to it in form of interest payment needed for such expansion. This gives raise to the concept of capital structure or debt/equity mix often referred to as leverage.

Companies spend a lot of time in trying to fashion out how to finance a project or an operation using  the  most  appropriate  source  of  financing  at  the  right  time.  Project  financing  may sometimes be achieved through the combination of both internal and external source of finance which entails the use of debt or issuance of equity or combination of both (Suleiman, 2012). Thus, optimum financing decision from the best source is very vital to the success and survival of a firm as it helps in determining financing, investment, liquidity and dividend decision which in turn helps in maximizing the shareholder’s wealth

Furthermore, several hypotheses and theories have been postulated with a view to explaining how capital combination of a firm affects its value. These include the pioneering work of Modigliani and Miller (1958) which proposed the irrelevancy theory based on the perfect market assumption. In 1963, Modigliani and Miller relaxed one of their earlier assumptions on corporate tax, thus making debt financing more advantageous than equity financing. Further development to the theory was made in 1977 when Modigliani and Miller added personal income tax into their previous hypotheses and found out that, tax shield can be offset by personal income tax.

EFFECT OF FIRM SPECIFIC CHARACTERISTICS ON FINANCIAL LEVERAGE OF QUOTED DIVERSIFIED COMPANIES IN NIGERIA