ABSTRACT
The central objective of this study is to assess the effect of capital structure on performance of OMCs in Ghana. The data sample consists of six oil marketing companies that have been in continuous existence from 2010-2015. The study employed panel regression models to examine the relationship between capital structure and performance of OMCs in Ghana.
The results of this study show that the analysis of leverage and firm performance relationship produces mixed outturns. The leverage has a positive relationship with return on equity but relates inversely with return on asset. These findings found support for both the bankruptcy cost and tax benefits arguments.
The study results also suggest that the size of the firm has positive and significant effects on return on assets (ROA) and return on equity (ROE). The larger firms have easier access to external funds and are most likely able to meet their investment needs thus increasing their profitability. The results of the regression analysis show that the liquidity ratio produces negative effects on return on asset. This finding confirms the liquidity and profitability trade off theory.
CHAPTER ONE INTRODUCTION
Background of Study
Capital structure can be described as the blend of debt and equity which constitutes the aggregate capital of firms (Gatsi & Akoto, 2010). In broad terms, the capital structure of a firm constitutes its net worth, that is its total assets less the amount owed to its creditors (Abor, 2005; Onaolapo & Kajola, 2010). In company law, capital represents a firm’s issued or paid up capital. The ability to select the right mix or proportions of equity and debt can assist the firm in solving some of the difficulties it faces as it seeks to maximize its stakeholder returns (Detthamrong, Chancharat, & Vithessonthi, 2017). But the extent of debt to equity adopted by corporate managers remains a strategic choice (Gatsi & Akoto, 2010). Ever since the seminal works of Modigliani and Miller (1958), literature within the framework of capital structure, both in developed and developing countries, has gained a lot of attention and/or discussion.
For instance, Abor (2005), in his study of Ghanaian firms suggested that decisions relating to capital structure are vital for any business enterprise with the intention of ensuring maximum returns to the various parts of the organisation. He further explained that capital structure decision is important because it gives firms the capability to deal with its competitive market situations. The debt of a company consists of an amount borrowed either from the government, statutory financial corporations, banks and individuals, and other financial institutions which are repayable over a period of time with an associated cost. Equity consists of ordinary share capital, share premium, reserves, undistributed profits, preference shares and discretionary provision or contingency fund.
In Ghana, companies within the non-financial firms require capital mostly to establish or procure production facilities, property and equipment to enter into new business ventures (Amidu, 2007a). Funds are also required to finance their working capital requirements, pay a dividend as well as make provision for other expenses. For these investments and expenses to maximize the firm value, the appropriate capital structure choice must be strategically made.
Onaolapo and Kajola (2010) argue that capital structure decisions are very important to both managers of firms and financiers. This is on account of the basis that, if a wrong mix of funds is utilized, the performance and survival of the business enterprise might be extremely influenced. This implies that in arranging the capital structure of firms either at the initial or subsequent stages managers need to consider the interest of investors and other bodies. To understand how non-financial firms in developing countries fund their operational activities in order to maximize their market worth, it is vital to ascertain the impact of capital structure decisions on firm performance. Gowthorpe (2003) asserts profitability ratios as the best measure of a company’s financial performance.
To develop any economy, be it at the micro or macro level, a lot depends on how well both the financial and non-financial sectors in the economy are able to improve their productivity capacity so as to contribute to the overall well-being (GDP) of the economy. Therefore, how the non-financial companies in Ghana finance their operations is of great importance to researchers and policy makers. Hence the essence of this present study is to empirically study capital structure decisions and its effect on the financial performance of non-financial firms, particularly Oil Marketing Companies (OMCs) in Ghana.
Problem Statement
It is important to note that, numerous research works have been carried out on the profitability of financial and non-financial firms in Ghana. Remarkable among them includes Abor (2005) on the profitability of listed companies in Ghana. Another study by Abor and Biekpe (2005) assessed the determinants of capital structure of companies in Ghana. In regard to banks, Amidu (2007b) concentrated on the capital structure determinants of banks in Ghana. Likewise, Gatsi and Akoto (2010) examined capital structure and profitability of banks in Ghana while Etu-Menson and Enyamful (2011) considered capital structure and profitability of rural banks in Ghana. With regard to insurance, Boadi, Antwi & Lartey (2013) focused on performance determinants of firms in the insurance industry in Ghana.
Despite the many empirical studies carried out in Ghana, the issue of capital structure and profitability within the non-financial industry, particularly the oil marketing industry, still remains under-researched, although same cannot be said of other industries.
Most of the studies focused on listed financial firms or both listed financial and non-financial firms. Clearly, very little consideration has been directed towards the investigation of capital structure and profitability of oil marketing companies (OMCs). With a growing oil and gas economy, the role of OMCs in the success of local content policy and the ultimate growth of the economy cannot be overlooked, hence the need for the assessment of their profitability. It is against this backdrop that the current study is being carried out to look at specifically the relationship between leverage and profitability of selected Oil Marketing Companies in Ghana.
Research Objectives
This study aims:
- To examine the effect of short-term debt on profitability of selected oil marketing companies in Ghana.
- To determine the relationship between long-term debt and profitability of oil marketing companies in Ghana.
- To ascertain the effect of total debt on profitability of oil marketing companies in Ghana.
Research Questions
This study is driven by the following questions:
- What effect does short-term debt have on the profitability of oil marketing companies in Ghana?
- What is the relationship between long-term debt and profitability of oil marketing companies in Ghana?
- How does total debt impact the profitability of oil marketing companies in Ghana?
Significance of Study
The significance of this study can be seen in three areas: research, policy and practice.
In terms of research, the results would expand the current knowledge in the area of capital structure from the Ghanaian perspective. It would also help policy developers in their decision- making process on matters that affect the business environment and cost of capital in Ghana.
