CORPORATE GOVERNANCE MECHANISMS AND CAPITAL STRUCTURE OF

LISTED FOODS AND BEVERAGES FIRMS IN NIGIRIA

ABSTRACT

This paper examines Corporate governance mechanisms and capital structure

of listed foods and beverages firms in Nigeria. The population of the study

consists of all listed companies in thw Nigerian stock exchange. A sample of

16 companies whose data for 4 years from 2014-2018 was selected. Analysis

was done using multivariate regression in a panel data framework. The result

shows that board size is negatively related with debt to equity ratio, the

percentage of independent directors is negatively related to capital structure.

Government ownership is positively related to capital structure. However,

managerial ownership is negatively related to capital structure which

indicates that increased managerial ownership align the interest of manager

with the interest of outside shareholders and reduces the role of debt as a tool

to mitigate the agency problems.

The positive relationship between institutional shareholding and debt to

equity ratio indicate that firms with larger percentage of institutional

shareholding use debt as a tool to reduce agency problem and, are also able to

negotiate more debt at a lower cost. It can also be argued that institutional

investors enforce good corporate governance structure hence they get better

recognition from the debt market. Firms with large percentage of government
shareholding are viewed as less risky by the debt providers and in the event of

financial distress, they normally have state bail out and therefore they will

continue to get more external recognition from debt providers.

Firms with larger board size, more independent directors and managerial

shareholding have a negative relationship between debts to equity ratio, this is

because as the board size, percentage of independent director and managerial

shareholding increases, they tend to bring down a firms debt to reduce risk

and bankruptcy cost. Therefore it can be expected that listed companies

striving to lower their debt to equity ratio can use board size, percentage of

independent directors and managerial shareholding as a tool to achieve the

objective. The study recommends that future research could also be

undertaken on large un-listed companies in Kenya and also on the listed

financial institutions so as to understand how corporate governance and

capital structure relate to each other in the whole economic set-up.

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CHAPTER ONE

INTRODUCTION

1.1 Background of the study

Corporate governance has received greater attention from regulators,

professionals and academics following a series of corporate scandals that had

happened in large companies around the world. The issue of corporate

governance has attracted the attention of both business market leaders and

regulatory authority around the globe, aiming to minimize the scandals rate in

companies (Ebrahim, Abdullah and Faudziah 2013).

The concepts of corporate governance encompass problems such as

measure of management, degree of control as well as way of relationship

between the great and small shareholders. Corporate governance spells out the

delivery of rights and duties among diverse players in the establishment; the

board, managers, shareholders as well as other stakeholders. It also stipulates

the techniques for making decisions on corporate affairs. In this fashion, it

offers the framework whereby the organisation’s goals are established and

strategy for reaching those goals and monitoring performance (Kaola, 2008).

According to Aganga (2011), the issue of corporate governance is

comparatively fresh in Nigeria, on account of several cases of corporate

1
misconduct. The shift in Nigeria system of government from military era to the

democratic dispensations with a policy to catch the attention of new and

environmentally friendly foreign investments entailed the requirement for

corporate governance reform. This results in a recognized commission to

evaluate the presence, adequacy and corporate governance relevance in Nigeria

relative to global best practices as a reaction to the New International

Economic Order. Considering the importance linked to the organization for

efficient corporate governance, the Nigerian government, via its numerous

agencies, has constituted several institutional arrangements to safeguard the

investors’ valuable investment from disingenuous management/directors of

company in Nigeria (Aganga, 2011). Despite all the efforts and mechanism put

in place by government, there are cases of crises, collapses, inefficiencies, and

eventual distress among the firms in Nigeria. This may be the consequence of

management-shareholder conflict or agency conflict especially while

shareholders want long term maximization of their compensation and power.

In Nigeria, financial constraints and insider abuse have been the major factors

affecting corporate firms’ performance. According to Salawu and Agboola

(2008), the move towards a free market, coupled with what they called

widening and deepening of various financial markets has provided the basis for

the corporate sectors to optimally determine their capital structure. The overall

target of this is to improve corporate performance for the benefit of the

2
stakeholders. Firm performance generally is an important concept that relates

to the way and manner in which financial resources available to an

organization are judiciously used to achieve the overall corporate objective. It

aims at keeping the organization in business and creates a greater prospect for

future opportunities.

According to Kyereboah-Coleman (2007), capital structure refers to the amount

of equity and debt that is utilized to finance the organization’s operations.

There is need to comprehend the different funding sources for organizations

and what affects the decision on the capital structure that a firm should select .

Adam & Mehran, (2003) argued that corporate governance is an operation that

involves structures and processes which lead to the creation of shareholder’s

value by managing the corporate affairs. The corporate affairs should be

managed to ensure protection of the collective and individual interest of the

company’s stakeholders. The decisions on capital structure are one of the most

imperative issues that the management of firms has to tackle. The

organization’s capital structure is dependent on the decision of the board of

director. The board of directors should adhere to the code of best practices in

corporate governance. Various studies by (Berger et al., 1997; Abor, 2007; Wen

et al., 2002; Friend and Lang, 1988) have identified that corporate governance

has an impact on the firm’s capital structure decisions. The role of the board of

directors is to manage the overall operations of the organization.

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Capital structure, sometimes known as financial plan, represents the

proportionate relationship between the various long-term form of financing,

such as debentures, long-term debt, preference capital and common share

capital, including reserves and surpluses (retained earnings). In other words,

capital structure in financial term means the way a firm finances its assets

through the combination of equity, debt, or hybrid securities (Saad, 2010). How

an organisation is financed is of paramount importance to both the managers

of firms and the providers of funds. This is because if a wrong mix of finance is

employed, the performance and survival of the business enterprise may be

seriously affected. Consequently, it is being increasingly realized that a

company should plan its capital structure to maximize the use of the funds,

improve performance and to be able to adapt more easily to changing

conditions (Hovakimian et al, 2004; Margaritis and Psillaki, 2010).

From the extant literature, corporate financing decisions are quite complex

processes and existing theories can at best explain only certain facets of the

diversity and complexity of financing choices. It has been emphasized in some

literature for instance that the separation of ownership and control in a

professionally managed firm may result in managers exerting insufficient work

effort, indulging in perquisites, choosing inputs or outputs that suit their own

preferences or otherwise failing to maximize firm value (Fama and Jensen,

1983; Demsetz and Villalonga, 2001 and Frijns et al, 2008). There is however, a

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general consensus that the structure of corporate ownership matters because it

determines the incentives and motivation of shareholders related to all

activities and decisions occurring in the firm. It is against this background that

this study intends to examine corporate governance and capital structure of

listed food and beverages firms in Nigeria.

1.2 Research Problem

The relationship between corporate governance and capital structure is

imperative when considering the role the two principles play in generation and

distribution of value (Bhagat and Jefferis, 2002). The capital structure is

capable of creating value through the interaction of corporate governance

instruments, by creating ways in which the value that has been generated can

be distributed (Zingales, 1998).

Studies conducted about corporate governance and capital structures have

ended up with mixed results. Ganiyu and Babalola (2012) in a different

perspective, examined the interaction between corporate governance

mechanisms and capital structure decisions of Nigerian firms by testing the

corporate and capital structure theories using sample of ten selected firms in

the food and beverage sector listed on the Nigerian Stock Exchange during the

periods of 2000-2009. The results show that corporate governance has

important implications on the financing decisions. They noted that corporate

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governance can greatly assist the food and beverages sector by infusing better

management practices, effective control and accounting systems, stringent

monitoring, effective regulatory mechanism and efficient utilization of firms’

resources resulting in improved performance if it is properly and efficiently

practiced.

In the same line, Uwuigbe (2013) examined the effects of board size and CEO

Duality on the capital structure of listed firms in Nigeria. A total of 40 listed

firms listed in the Nigerian stock exchange were used for the study, covering a

period of 2006 to 2011. The study among others finds that there was a

significant negative relationship between board size and the capital structure of

the selected listed firms. The study also observed that there was a significant

positive relationship between CEO duality and the capital structure of selected

listed firms in Nigeria. The study concludes that firms having smaller board

size, due to weaker corporate governance tend to use more amount of debt to

reduce agency problems

Rehman and Raoof (2010) carried out a research to determine the relationship

between capital structure and corporate governance of 19 banks in Pakistan

from the year 2005 to the year 2006. It was found out that there exist a positive

relationship between the corporate structure and capital governance. The same

positive relationship was identified by Rajendran (2012) in the study carried

out for the manufacturing firms in Sri Lanka. However, Saad (2010) reported
6
contradictory findings by indicating that there is a negative relationship

between corporate governance and capital structure in a study that included

126 public listed companies in Malaysia.

Fosberg (2004) argued that firms that have a separate CEO and chairman use

the optimal debt level in the capital structure. Therefore, it was identified that

companies that have different CEO and chairman have a high financial

leverage. According to Abor and Biekpe (2004), evidence revealed that there

exist a positive relationship between the duality of the CEO and the gearing

level of the firm. In addition, according to Wen (2002), there exist a positive

relationship between the structure of capital and the size of the board. He

argued that boards of directors that are large have a high level of gearing which

is aimed at enhancing the value of the company. On the other hand, Berger et

al, (1997) argued that companies with large board of directors have a low level

of gearing. Berger et al, (1997 also found that a large boards exerts more

pressure on the managers since they are required to enhance the firms

performance while maintaining lower level of gearing.

It is for those studies and gaps thereon that the study wished to address by

examining corporate governance and capital structure of listed food and

beverages firms in Nigeria.

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 1.3 Objectives of the Research

The objectives of this study are:

a) to examine the nature of corporate board of listed firms

b) to examine the financing pattern of listed firms

c) to examine the influence of corporate board characteristics

and corporate ownership on the capital structure decisions of

listed firms in Nigeria

1.4 Research questions

The following questions are relevant

a) What is the nature of corporate board of listed firms?

b) What is the financing pattern of listed firms?

c) What is the effect of board Characteristics and ownership

structure on capital structure decisions of listed firms?

1.5 Significance of the study

This study seeks to explore the linkage between corporate governance

and capital structure of listed food and beverages firms in Nigeria.

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The study is expected to advance knowledge on the impact of

corporate practice in an organization on the capital formation of food

and beverage industries in Nigeria. This area has attracted little

attention of empirical researchers in Nigeria for the obvious reason of

non-availability of data in an organized form and also in terms of

proper econometric modelling. It will also add to the existing body of

knowledge. It also throws more insight on the findings of previous

empirical works in Nigeria.

1.6 Scope of the study

The study focuses on corporate governance and capital structure of

listed firms covering in Nigeria during the periods between 2014 -

2018. It also examines corporate governance practices, and

ownership structure of the the listed firms.

1.7 Limitations

The study limitation was on non availability of data. Though the study

uses secondary data, the annual reports for some periods were not

available. The selection of firms was therefore based on the

availability of data.
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1.8 Chapter disposition

This study is organized into five chapters.

Chapter 1 is the introduction of the study. It includes the background

of the study, problem statement, objectives of the study, research

questions, significance, scope, limitation and the organization of the

study.

Chapter two reviews the relevant literature on corporate governance,

capital structure, the theoretical framework for the research.

Chapter three discusses the methodology of the study; data design

and data collection.

Chapter four is data analysis, presentation and the discussion of

findings.

Chapter five deliberates on summary of findings, conclusion and

recommendations

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CHAPTER TWO

LITERATURE REVIEW

2.1 Introduction

This chapter presents a review of literature on the relationship between capital

structure and corporate governance of a firm. The chapter focuses on studies

undertaken by various scholars and theories that reflect corporate governance

and capital structure decisions. First a theoretical review on corporate

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governance and capital structure is presented followed by an empirical review;

lastly, a summary chapter is presented where research gap is identified.

2.2 Conceptual Review

2.2.1 Corporate Governance

Corporate governance is a system of processes, practices, and laws that are

used by a company to direct and control its operations. According to a

definition adopted by Malaysia’s Finance Committee (2004), corporate

governance refers to the structure and process utilized to manage and direct

the affairs and business of a firm towards ensuring corporate accountability

and business prosperity. The main objective of corporate governance is to

realize long- term value of the shareholder together with the interest of

stakeholders of the firm. Tricker (2010) found that corporate governance is a

complex subject matter with many facets and that involves not only regulation

and legislative but also good practices, which entails mind-set, corporate

culture, and education. In addition, corporate governance focuses on the way

power is exercised over the entities that are corporate. Firms that have a

corporate structure require proper governance; be they wholly owned

subsidiaries, listed companies, family companies, not-for-profit firms, joint

ventures, and any other.

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Corporate governance as defined by the Cadbury Committee is “the

system by which companies are directed and controlled” (Cadbury,

1992). It is a system through which the interests of all stakeholders

are satisfied. The classical concept of corporate governance was to

mitigate agency problem. But the financial fraud of the early 1990s

and the late 2000s, involving Enron, WorldCom and other large

companies have emphasized disclosure, transparency and

accountability. The concept of corporate governance has now evolved

to entail broader issues from the ownership structure through to the

processes and procedures of the firm. Thus corporate governance

should be seen to involve the relationship among the firm, its staff, it

creditors and the environment in which it operates. It must go beyond

financial disclosure and agency problem mitigation to encompass

employee compensation, resolving grievances, proper records,

conformance to standards and compliance to regulatory requirements.

Al-Najjar (2010), describes corporate governance as a set of

relationships between a company‟s management, its board, its

shareholders, and other stakeholders. Al-Najjar identifies two sets of

governance factors that affect management activities. Internal

corporate governance, that relate to the interaction among the

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management, board, shareholders and other stakeholders. And the

other has to do with the support and encouragement of good corporate

governance. These factors include laws, regulations, and appropriate

oversight by government or other regulatory bodies such as central

banks or security exchanges. Abor (2007) argued that corporate

governance can be thought of as compliance with regulations and the

mechanisms for establishing the nature of ownership and control of

organizations within an economy. According to La Porta, Lopez-de-

Silanes, Shleifer, & Vishny, (2000), corporate governance can be

thought of as a system through which outside investors protect

themselves against expropriations by insiders (managers and

controlling shareholders). Again The high level finance committee

Report on Corporate Governance (1999, p.10), defined corporate

governance as, “…the process and structure used to direct and

manage the business and affairs of the company towards enhancing

business prosperity and corporate accountability with the ultimate

objective of realizing long-term shareholder value, …” Saad, (2010). In

Kyereboah-Coleman & Biekpe (2006), corporate governance has to do

with the supervision and accountability of those who direct and

control the management of the firms. La Rocca (2007) defined

corporate governance as how decision making power is distributed

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within the firm as well as how investors are protected from

entrepreneurial opportunism.

Corporate governance is important to all businesses whether small or

big, family owned or not, listed or not. For small and non listed firms,

the infusion of corporate governance at an early stage will instill

discipline in the managerial team and assist in obtaining external

financing (Abor & Adjasi, 2007) and as the business grows, and

owners and managers become separate, corporate governance

mechanisms can effectively deal with the agency problem (Boubakari,

2010) while increasing the firms‟ value. In family businesses

corporate governance avoids mismanagement problems and ensures

transferability and continuation of the business. It also mitigates the

agency problem between shareholders and managers as well as

between controlling shareholders and external financiers.

Corporate Governance involves holding a balance between social and economic

goals and between communal and individual goals. The framework of corporate

governance is aimed at encouraging the efficient utilization of resources and,

therefore, it requires accountability to safeguard the resources of the firm. The

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proper governance of organizations is as essential as the proper governance of

a country. The purpose of corporate governance is to align as much as possible

the individuals’ interest, society’s interests, and corporations’ interest

(Gatamah, 2004).

To analyze the impact effects that corporate governance has on the different

corporate performance measures, commercial providers and academics have

utilized variables such as ownership structure, and board independence or

have tried to construct various measures of the practices of corporate

governance. Despite considerable efforts, sophisticated methods, and

measures, the results that have been achieved are surprisingly quite

contradictory and misleading (Bhaghat et al., 2008). Most importantly, it has

been difficult to prove that the measures used by companies to determine the

quality corporate governance are capable of predicting the future performance

of the business.

2.2.2 Capital Structure

Capital structure refers to the combination of equity and debt capital that is

utilized by organizations to finance the long-term operations. According to

Brealey and Myers (2003) capital structure is the combination of various

securities that are used to finance a firm’s investment. Also, Brealey and Myers

(2003) observed that an organization can give various security using different

16
combinations but the best combination is the one that maximizes the value of

the market. Akram and Ahmad (2010) argued that capital structure of the

company includes the debt and equity component used to finance the

business. Equity financing is usually provided by the people who buy the

shares of the firm. The holders of equity finance have a stake in the firm which

is denominated by the number of shares. The shareholders of the firm share

the risk involved in carrying out the business and also entitled to the share of

business profit. The value of the company is dependent on the streams of

expected earnings and the rate that is utilized to discount the earnings. The

required rate of return and the cost of capital are utilized to discount the

earnings of the company. The decision on the firm’s capital structure can have

an impact on the value of the entity by either changing cost of capital or the

expected earnings (Pandey, 2002).

Pandey (2002) found that the optimal capital structure can be obtained by

combining the equity and debt in a way that maximizes the value of the firm.

The total value of the company is the combination of the debt value and equity

value. The optimal structure is also aimed at ensuring that the weighted cost of

capital has been maintained at a lower level. Capital structure refers is the

combination of financial resources that are made available to ensure business

success (Myers, 2003). Capital structure of the entity was also defined as the

17
 components of debt and equity that are used as sources of financing

(Brockington, 1990).

The theoretical framework on the relationship between performance and capital

should be considered while determining the components of the capital

structure. The relationship between performance and capital depends on the

leverage market values. The leverage market value is difficult to achieve and,

therefore, the accounting measures are essential in determining the value. The

choice of the measure used by firms is dependent on the objectives of the

analysis (Rajan and Zingales, 1995). A case in point, the ratio of firm’s total

liabilities to total assets should be used to determine the value of shareholders

after the firm has been liquidated. However, the ratio is not a good measure of

identifying the risk of default in the future. The amount of leverage can also be

overstated since the total liabilities of the firm include the accounts payable

that are not considered as sources of financing. According to Pandey (2002),

the measure of identifying risk can be enhanced by subtracting the liabilities

and accounts payable from total assets of the firm. The research will utilize the

debt to equity ratio to measure the capital structure of an organization.

2.2.3 Determinants of Capital Structure

The relation between capital structure and corporate governance becomes

extremely important when considering its fundamental role in value generation

18
and distribution (Bhagat and Jefferis, 2002). Capital structure has become an

instrument of corporate governance; not only the mix between debt and equity

and their well-known consequences as far as taxes go must be taken into

consideration. Through its interaction with other instruments of corporate

governance, firm capital structure becomes capable of protecting an efficient

value creation process, by establishing the ways in which the generated value

is later distributed (Zingales, 1998).

2.2.3.1 Risk

The volatility in income is a measure of operating risk that has been argued by

several authors to have a negative impact on firm leverage (Myers, 1984; Wald,

1999; Fama and French, 2002). Myers (1984) argues that, ceteris paribus,

risky firms ought to borrow less since a higher variance rate in net income

increases the probability of default. Firms with volatile earnings are given

incentives not to fully utilize the tax benefits of debt since they are more likely

to be exposed to agency and bankruptcy costs. On the other hand, several

counter-hypotheses have been presented (e.g. Castanias and DeAngelo, 1981;

Jaffe and Westerfield, 1984; Bradley et al., 1984). Empirical evidence by Titman

and Wessels (1988) and Cassar and Holmes (2003) fail to find a statistical

relationship for neither SMEs nor large firms. In addition, Wald (1999) finds

contradictive results since the impact seems to be country-dependent. More

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surprisingly, the limited research on SMEs rather suggests a positive

relationship between risk and leverage (Jordan et al., 1998; Michaelas et al.,

1999).

2.2.3.2 Size of the firm

A substantial number of authors have suggested a positive relationship

between firm size and leverage (Fama and French, 2002). Warner (1977) and

Ang et al. (1982) argue that as the value of the firm increases, the ratio of direct

bankruptcy costs to the firm value decreases. The impact of these expected

bankruptcy costs might be negligible for large firms’ borrowing decisions, which

enable them to take on more leverage (Rajan and Zingales, 1995). Smaller firms

on the other hand face a different reality in procuring long-term debt. This is

not mainly due to information asymmetry, but to the strong negative

correlation between firm size and the probability of bankruptcy (Berryman,

1982; Hall et al., 2004). A possible explanation is that relatively large firms

tend to be more diversified and consequently are less prone to insolvency

(Titman and Wessels, 1988). However, Fama and Jensen (1983) suggest that

transaction costs for large firms are reduced since they struggle with less

asymmetric information problems. This should increase larger firms’ preference

for equity relative to debt compared to smaller firms.

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Smaller firms often find it relatively more costly to disperse asymmetric

information and as a consequence are offered less or significantly more

expensive capital from financiers and lenders (Ferri and Jones, 1979).

2.2.3.3 Age of the firm

Age should affect capital structure both in the context of the static trade-off

theory and the pecking order theory. According to the former, an older firm has

a track record on which longterm lenders can base their lending decisions on.

As a result young firms, which are typically SMEs and not large firms, will have

to depend on short-term financing (Johnsen and McMahon, 2005). The pecking

order theory lends support to this hypothesis since an older firm is more likely

to have accumulated internally generated funds, thus reducing the need for

external lending in the short-term (Petersen and Rajan, 1994).

Since the marginal effect of an additional year of track record should decline

with age, we use the natural logarithm of age to control for the possibility of

non-linearity. Based on the preceding arguments, we expect age to be positively

related to long-term debt and negatively related to short-term debt.

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2.2.3.4 Asset Structure

The type of assets owned by a firm should be an important determinant of

capital structure according to most capital structure theories. Depending on

the extent to which a firm’s assets are tangible and generic, the liquidation

value of the firm will be affected (Titman and Wessels, 1988; Harris and Raviv,

1991). A relatively larger proportion of tangible assets will increase the

liquidation value of the firm since the values of the tangible assets can be

assessed more easily. As a result, tangible assets are more likely to be accepted

as collateral compared to intangible assets.

By collateralizing debt, funds provided to the borrower are restricted to a

specific project. If no such guarantee exists for a project, the creditors may

require more favorable terms, potentially forcing the firm to use equity

financing instead. Using tangible assets as collateral also prevents risk shifting

since the firm will find it difficult to shift investments to riskier projects (Myers,

1977). Therefore, a relatively larger fraction of tangible assets should increase

the willingness to supply financing by lenders and increase firm leverage (Rajan

and Zingales, 1995). This conclusion seems to be the general consensus and is

supported by a number of authors (Jensen and Meckling, 1976; Storey, 1994;

Berger and Udell, 1998).

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For large firms, the theoretical arguments in favor of a positive relationship

between asset structure and firm leverage are supported by empirical evidence

(e.g. Rajan and Zingales, 1995). The much less comprehensive research on

SMEs suggests, while not conclusive, that there might be a similar positive

relationship between asset structure and firm leverage. On a decomposed

leverage level the relationship between asset structure and long-term debt still

shows signs of a positive relationship while there seems to be a negative

relationship to short-term debt (Van der Wijst and Thurik, 1993; Chittenden et

al., 1996; Jordan et al., 1998; Michaelas et al., 1999).

2.2.3.5 Profitability

Myers and Majluf (1984) states in their pecking order theory that firms prefer

internal financing over debt, and debt over equity. Since a more profitable firm

has access to more internal finance it will use less external financing to fund

its operations and investment opportunities, ceteris paribus. The negative

relationship between profitability and leverage has been tested empirically by

several authors and remains almost unambiguously uncontested both for

SMEs and large firms (Friend and Lang, 1988; Jordan et al., 1998; Coleman

and Cohn, 1999; Mishra and McConaughy, 1999; Michaelas et al., 1999; Fama

and French, 2002). In fact, Wald (1999) finds that profitability has the single

largest negative effect on a firm’s debt to asset ratio.

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On the other hand, there are a few conflicting theoretical predictions on the

effect of profitability on firm leverage (Jensen, 1986; Williamson, 1988). Jensen

(1986) presents a model where firms with high profitability, will likely be

subjects of takeovers and increased leverage. As a result, profitable firms which

have been acquired should have higher debt to assets ratio, implying a positive

relationship between profitability and firm leverage.

2.2.4 Relationship between Capital Structure and Corporate Governance

The choice of capital structure of a firm is an imperative factor in the practices

of corporate governance. The company’s financial policies are mainly the real

issues in the process of making decisions. The company’s financial policies of a

firm remain a subject of interest among many organizations across the globe.

Also, the capital structure of corporate firms is one of the controversies in the

modern theories of corporate finance. Most of the debates are mainly focused

on achieving a capital structure that is optimum even though individual firms

may not consider the relevance of optimum capital structure. Chevalier &

Rokhim (2006) found that the target ratio is not considered by individual firms

as important. Since information asymmetry is found in capital markets,

companies prefer the retained earnings to debt as a source of funding the long-

term investments. Chevalier & Rokhim (2006) argued that some of the

24
renowned theories that dominate the capital structure of the entity are; the

pecking-order analysis, free cash-flow theory, and the agency theory.

According to Lipton and Lorsch (1992), a significant relationship exists between

the size of the board and the capital structure of the firm. Berger and Lubrano

(2006) argued that companies that have a large membership in the board have

low debt ratio or leverage. The assumptions are that board sizes that are large

in size instill more pressure for the managers to use less debt while financing

the long-term investments of the firm. The findings of Berger and Lubrano

(2006), indicated that are highly monitored use more debt to finance the

business to raise the value of the business. Berger et al (1997) suggest that

companies that have a higher debt ratio have many directors in the board while

companies that have a low debt ratio have lower debt ratio.

The company’s capital structure depends on the decision of the board of

directors and the company’s compliance of best practices stipulated in the code

of corporate governance. According to Hart (1995), a negative relationship

exists between the capital structure and the board size of the firm. Also, there

exists a positive relationship between the duality of CEO and leverage since the

CEO adopts a high debt policy since he is the board’s chairman. Jensen (1986)

explains the relevance of debt in minimizing the free cash flow cost in instances

where the company. However, if a firm generates huge free cash flows there

25
exist a conflict of interest between the managers and the shareholder of the

firm. Use of debt acts as a bond since it reduces the level of cash flow that is

available to the managers of a firm. The level of debt increases the efficiency of

managers since managers are required to perform to get enough funds to repay

debts. It was also observed that the CEOs who are entrenched tend to avoid

debt financing for long-term projects (Berger et al., 1997).

If the managers do not have discipline that results from control mechanism

and corporate governance, managers prefer low leverage since they do not

prefer the pressure that results from repaying debts and interest. Some of the

mechanism that instills discipline to the managers include threats of dismissal,

monitoring by the board, and performance based compensation.

Berger (1997) found that companies that have many board of directors lower

debt than equity in their capital structure. A large board of directors has more

pressure set upon the managers to perform and lower the gearing level of the

firm. According to Abor (2007), the relationship between capital structure and

corporate governance was examined for Small and Medium Enterprises (SME)

in Ghana by utilizing multivariate regression analysis. The results of the

analysis indicated that there exist a negative relationship between the leverage

ratios and the size of the board. Also, the SMEs that have a larger board have a

gearing level that is low.

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2.3 Theoretical Review

This section contains review of theories relevant to the study. A theoretical

review on corporate governance and capital structure is presented by an

explanation of three theories that help us understand how capital structure

and corporate governance of a given entity relate to each other. The three

theories narrated here are; the Agency theory, the Pecking order theory and the

Free cash flow theory.

2.3.1 Agency Theory

Agency theory is the fundamental reference in corporate governance as the

ownership structure of an organization will have an impact on the governance

structure adopted. This ‘Berle-Means

Hypothesis’ developed in the 1930’s was based on studies done on the

development of the modern corporation which lead to the separation of

ownership and management (Berle and

Means, 1932). In the 1970’s, work carried out by Jensen and Meckling (1976)

resulted in a theory for understanding the implications of the separation of

ownership from control. This separation of ownership and management led to

the development of agency theory. The owners contract agents to manage the

business on their behalf.

27
Kyereboah-Coleman (2007) interrogates the identification of an optimal capital

structure and its explanatory variables. The author starts by asking what

motivates the selection of a debt and equity mix. As a result, the agency theory

is proposed and explained as when managers have the information regarding

the prospects of the company, use that information for their own interests

which are different from those of shareholders. Subsequently, firms use more

debt in their capital structure especially when management is pressurized by

the shareholders to use funds efficiently so as to be able to pay out future cash

flows (for example dividends) (Kyereboah-Coleman, 2007).

In summary, agency theory suggests that there are several ways in which debt

can help mitigate agency conflicts between shareholders and managers.

Holding constant the manager’s absolute investment in the firm, increase in

the fraction of the firm financed by debt increases the managers share of the

equity, there by bringing the manager’s and shareholders interest into better

alignment. Moreover, Jensen (1986) argued that since debt commits the firm to

pay out cash, it reduces the amount of free cash flow available to managers to

engage in excessive perquisite consumption. Corporate governance is put in

place specifically to ensure that managers act in the best interest of

shareholders.

28
2.3.2 Pecking Order Theory

Pecking Order Theory, states that capital structure is driven by firm's desire to

finance new investments, first internally, then with low-risk debt, and finally if

all fails, with equity. Therefore, the firms prefer internal financing to external

financing (Myers and Majluf, 1984). This theory is applicable for large firms as

well as small firms. Since the quality of small firms’ financial statements vary,

small firms usually have higher levels of asymmetric information. Even though

investors may prefer audited financial statements, small firms may want to

avoid these costs (Pettit and Singer, 1985). Therefore, when issuing new

capital, those costs are very high, but for internal funds, costs can be

considered as none. For debt, the interest costs are also high. As a result, firms

prefer first internal financing (retained earnings), then debt and they choose

equity as a last resort (Pettit and Singer, 1985).

Myers & Majluf (1984) contrasting the static trade-off theory, discusses the

rationale of the Pecking Order model (POT) of corporate leverage, which was

later supported by amongst others Chen (2004). The model is explained by

what has been observed in companies, which is the tendency of not issuing

stock (shares) and instead, holding large cash reserves. Myers & Majluf

conclude that this is unnecessarily holding financial slack as a consequence of

possible conflict of interest by managers as well as between old and new

29
shareholders. Chen’s (2004) view is that only when forced by circumstances, do

companies resort to external financing, using debt before equity.

Kyereboah-Coleman (2007) explains the pecking order theory to be suggesting

that the profitability of a firm does influence its financing decisions. The study

elaborates the contention that firms which have not predetermined their debt

and equity mix prefer internal to external financing. An observation is that the

pecking order framework tends to overlap the asymmetric information and the

agency cost theories.

2.3.3 Free Cash Flow Theory

According to free cash flow theory of capital structure innovated by Jensen

(1986), leverage itself can also act as a monitoring mechanism and thereby

reduces the agency problem hence increasing firm value, by reducing the

agency costs of free cash flow. There are some consequences derived if a firm is

employing higher leverage level. Managers of such firms will not be able to

invest in non-profitable new projects, as doing so, the new projects might not

be able to generate cash flows to the firm, hence managers might fail in paying

the fixed amount of interest on the debt or the principal when it’s due. It also

might cause in the inability to generate profit in a certain financial year that

may result in failing to pay dividends to firm shareholders.

30
Furthermore, in employing more leverage, managers are forced to distribute the

cash flows, including future cash flows to the debt holders as they are bonded

in doing so at a fixed amount and in a specified period of time. If managers fail

in fulfilling this obligation, debt holders might take the firm into bankruptcy

case. This risk may further motivate managers to decrease their consumption

of perks and increase their efficiency (Grossman and Hart, 1982).

This statement has been supported by Jensen (1986) which states that from

the agency view, the higher the degree of moral hazard, the higher the leverage

of the firm should be as managers will have to pay for the fixed obligation

resulting from the debt. Hence, it will reduce managers’ perquisites. Extensive

research suggests that debt can act as a self-enforcing governance mechanism;

that is, issuing debt holds managers’ “feet to the fire” by forcing them to

generate cash to meet interest and principle obligations (Gillan, 2006).

2.4 Empirical Literature Review

Ganiyu and Babalola (2012) in a different perspective, examined the

interaction between corporate governance mechanisms and capital structure

decisions of Nigerian firms by testing the corporate and capital structure

theories using sample of ten selected firms in the food and beverage sector

listed on the Nigerian Stock Exchange during the periods of 2000-2009. The

results show that corporate governance has important implications on the

31
financing decisions. They noted that corporate governance can greatly assist

the food and beverages sector by infusing better management practices,

effective control and accounting systems, stringent monitoring, effective

regulatory mechanism and efficient utilization of firms’ resources resulting in

improved performance if it is properly and efficiently practiced.

In the same line, Uwuigbe (2013) examined the effects of board size and CEO

Duality on the capital structure of listed firms in Nigeria. A total of 40 listed

firms listed in the Nigerian stock exchange were used for the study, covering a

period of 2006 to 2011. The study among others finds that there was a

significant negative relationship between board size and the capital structure of

the selected listed firms. The study also observed that there was a significant

positive relationship between CEO duality and the capital structure of selected

listed firms in Nigeria. The study concludes that firms having smaller board

size, due to weaker corporate governance tend to use more amount of debt to

reduce agency problems.

Bodaghi and Ahmadpour (2010) in a different dimension examined the effect of

corporate governance and ownership structure on capital structure of Iranian

listed companies. Measures of corporate governance employed are board size,

board composition, and CEO/Chair duality. The impact of shareholding on

financing decisions was also examined by using institutional shareholding.

Similarly, influence of controlled variables like firm size and profitability on

32
firm’s financing mechanism was also investigated. Results revealed that board

size is significantly negatively correlated with debt to equity ratio. Corporate

financing behavior however was found not to significantly influence by

CEO/Chair duality and the presence of non-executive directors on the board.

The study, however noted that control variables like firm size and return on

assets have significant effect on capital structure. Based on the results, they

concluded that corporate governance variables like size and ownership

structure play important role in determination of financial mix of the firms.

Daraghma and Alsinawi (2010) examined the effect of board of directors,

management ownership and capital structure on the financial performance of

the corporations listed in Palestine Securities Exchange. Twenty eight (28)

Palestinian corporations were selected within four years 2005 to 2008. The

results of their study indicated that the chief executive officer CEO-Chairman

separation does not have any significant impact while the CEO-Chairman

duality has a significant impact on the financial performance. The results also

showed that management ownership has positive effect on the financial

performance. The study also concluded that the debt financing has no

influence on the profitability of Palestinian corporations.

Latif et al (2013) in their study examined the impact of corporate governance

mechanisms – Board size, Board composition, and CEO/Chairman duality on

firm performance ( represented by Return on Asset) in sugar industry of

33
Pakistan collected from 12 listed Sugar mills of Pakistan from 2005 to 2010.

The results revealed that there is a significant impact of corporate governance

on firm performance. Secondly, results show that there is a significant impact

of board size, CEO/Chairman duality on ROA, whereas there is insignificant

impact of Board composition on ROA. This is similar to the earlier work done

by Hassan and Butt (2009) that revealed board size and shareholding being

significantly negatively correlated with debt ratio, but noted that corporate

financing behavior is not significantly influenced by CEO/Chair duality and

the presence of non-executive directors on the board.

Decisions on capital structure are one of the most important issues considered

by financial managers. Maina and Sakwa (2012) conducted a study on

understanding financial distress among listed firms in Nairobi stock exchange

and took a quantitative approach using the z-score multidiscriminate financial

analysis model. The results clearly indicated that the financial health of the

listed companies needed to be improved. In addition, a disjoint was noted in

the correlation between what is expected of the listed companies in terms of

financial performance and the benefits to be accrued from CMA surveillance on

them.

Wambua (2011) conducted a study on the effects of corporate governance on

savings and credit co-operatives (Sacco’s) financial performance in Kenya and

34
found that good corporate governance aims at increasing profitability and

efficiency of organizations and their enhanced ability to create wealth for

shareholders, increased employment opportunities with better terms for

workers and benefits to stakeholders. Indicators of Good Corporate Governance

identified in the study include; independent directors, independence of

committees, board size, split chairman/CEO roles and the board meetings. He

concluded that better corporate governance is correlated with better operating

performance and market valuation. Corporate governance mechanisms assure

investors in corporations that they will receive adequate returns on their

investments. Evidence suggests that corporate governance has a positive

influence over corporate performance.

Mang’unyi (2011) conducted a study on ownership structure and corporate

governance and its Effects on Performance and took a Case of Selected Banks

in Kenya. The study revealed that there was no significant difference between

type of ownership and financial performance, and between banks ownership

structure and corporate governance practices .This study recommends that

corporate entities should promote corporate governance to send a positive

signal to potential investors. The Central Bank of Kenya (CBK) should continue

enforcing and encouraging firms to adhere to good corporate governance for

financial institutions for efficiency and effectiveness. Finally, regulatory

35
agencies including the government should promote and socialize corporate

governance and its relationship to firm performance across industries.

Ebaid (2009) in his study on the emerging market economy of Egypt find that

the selection of capital structure mix has a very weak relationship with the

performance. He found that the relation among capital structure variables

including short term, long term and total debt to total assets has insignificant

relationship with performance measured by ROE (return on equity). Whereas,

the relation of short term debt and total debt to total assets is negative and

statistically significant with the performance. A negative insignificant relation

exists for the long term debt with return on assets. Further, the relation of the

capital structure with performance measured by the gross profit margin is also

insignificant.

36
37
CHAPTER THREE

RESEARCH METHODOLOGY

3.1 Introduction

This chapter contains review of literature of research design, population,

sample and data analysis. Research methodology is the architecture or the

layout of the research framework. According to Polit and Hungler (2003)

methodology refers to ways of obtaining, organizing and analyzing data.

3.2 Research Design

This study employed descriptive survey design. Descriptive survey is conducted

to describe the present situation, what people currently believe, what people

are doing at the moment and so forth (Baumgartner, Strong and Hensley,

2002). According to Kothari (2004), descriptive survey design includes surveys

and fact finding enquiries of different kinds. The major purpose of descriptive

research design is description of the state of affairs as it exists at present

(Kothari, 2004).

38
3.3 Population

Burns and Grove (2003) describe population as all the elements that meet the

criteria for inclusion in a study. Population is therefore the entire group of

individuals, events or objects having a common observable characteristic. The

population of this study consist of all the companies listed on the Nigerian

Stock 180 Exchange (NSE). The companies listed are classified into twelve

industrial sectors, and each 181 sector comprises of homogenous companies.

3.4 Sampling technique

According to Polit and Beck (2003), a sample is a proportion of population to be

researched, while Kothari (2004) defines a sample as the selected respondents

representing the population.

The sample size of the study was selected based on Nigerian Stock Exchange

classification of the listed companies into industrial stratum of homogeneous

companies of same or similar characteristics, which the food and beverage

industry forms a strata. This sector comprises sixteen (16) listed companies,

(Big treat Plc, 7-up Bottling Company Plc, Dangote Flour Mills, Cadbury

Nigeria Plc, Dangote Sugar Refinery Plc, Ferdinand Oil Mills Plc, Flour Mills

Nigeria Plc, Foremost Dairies Plc, National Salt Co. Nigeria Plc, Nestle Foods

Nigeria Plc, Nigerian Bottling Company Plc, Northern Nigeria Flour Mills Plc, P

39
S Mandrides & Co. Plc, Tate Industries Plc., Union Dicon Salt Plc. UTC Nigeria

Plc.), selected for the study for over a period of five years (2014-2018).

3.5 Measures of Corporate Governance

To measure corporate governance quality, the study employed the governance

standards provided by the Institutional Shareholder Services (ISS). The ISS

governance standards include 51 factors encompassing eight corporate

governance categories: audit, board of directors, charter/bylaws, director

education, executive and director compensation, ownership, progressive

practices, and state of incorporation.

The ISS governance standards are the most all-inclusive data on corporate

governance ever collected. Corporate governance has been identified in

previous studies (Berger et al., 1997; Friend and Lang, 1988; Wen et al., 2002;

Abor, 2007) to influence the capital structure decisions of firms. The existing

literature identified the main feature of corporate governance to include board

size, board composition, board independence and CEO duality. The board of

directors is charged with the responsibility of managing the firm and its

operations.

3.6 Measures of Capital Structure

40
This research applied two measures of Capital structure: Total Debt to Total

Assets, Total Debt to Equity. Further, the first selected measure of capital

structure was broken down and also used Short Term Debt to Total Assets and

Long Term Debt to Total Assets. The choice of these as measures of capital

structure was motivated by four main drivers. Firstly, was the recommendation

from literature (Rajan and Zingales, 1995) that Total Debt to Capital ratio is

probably the best representation of past financing decisions. Secondly, was the

fact that Total Debt to Total Assets ratios was the second best (Rajan and

Zingales, 1995).Thirdly, was the fact that this information was readily available

whilst the information for the other measures of capital structure was not

readily available. Lastly, the reason for breaking down further Total Debt to

both Short Term Debt and Long Term Debt comes from the fact that developing

counties tend to shun away from Long Term Debt and favour Short Term Debt

as observed by Diamond (1991) and Caprio and Demirguc-Kunt (1998).

3.7 Data Collection

Seondary data was used for this study. It was adopted from the audited

financial statements of the listed food and beverages companies in the Nigerian

Stock Exchange (NSE), for the

period of year 2014 – 2018. This study also made use of Nigerian Stock

Exchange Fact Book

41
2018 for the company’s ownership structure and CBN bulletin 2018. Most of

the yearly

reports that were inaccessible in the NSE fact book were obtained from the

corporate offices

of concerned food and beverages companies and were also downloaded from

their corporate. The study mainly depended on secondary data which was

collected from the Nigerian Securities Exchange Handbooks, the IPO

prospectuses as well as Annual Accounts.

Long term debt to asset ratio (LTDA), Short term debt to asset ratio (STDA),

Debt equity ratio (DE), and Total debt to asset ratio (TD) as dependent

variables. Data on the leverage, board size, size of the firm, liquidity of firm,

proportion of non-executive directors, CEO-duality, board independence,

institutional shareholding, as well as managerial shareholding, was sourced

from the general information about the company’s directors, chairman, chief

executive officer and company’s annual financial reports for the year 2008-

2012.

3.8 Diagnostic tests

The evaluation of diagnostic tests comprises a very broad and complex set of

research questions and considerations. This is used to determine the frequency

42
with which something occurs or with which it is associated with something

else. After fitting a regression model, it is important to determine whether all

the necessary model assumptions are valid before performing inference. If there

are any violations, subsequent inferential procedures may be invalid resulting

in faulty conclusions. Therefore, it is crucial to perform appropriate model

diagnostics. In constructing the regression model, the assumption is that the

response y to the explanatory variables are linear in the β parameters and that

the errors are independent and identically distributed normal random variables

with mean 0 and constant variance σ2.

Model diagnostic procedures involve both graphical methods and formal

statistical tests. These procedures allow to explore whether the assumptions of

the regression model are valid and decide whether subsequent inference results

can be trusted. The tests for the linear regression assumptions include: Test for

linearity, homoscedasticity test, multicollinearity test and testing for normality.

An important assumption for this multiple regression model is that

independent variables are not perfectly multicollinear.

3.9 Data Analysis

This study employed a multivariate regression analysis in a panel data

framework to measure the dependence of capital structure on corporate

governance variables. The panel data analysis helps to explore cross-sectional

43
and time series data simultaneously. Pooled regression was used with an

assumption of constant coefficients. Constant coefficient model assumes

intercept and slope terms are constant. The Significance of beta values at 5%

was interpreted using the T-test of significance. In addition, the model was

tested for significance using the F statistic. Coefficient of determination (R)

derived from the regression analysis was used to show the amount of variation

explained by the independent variable.

3.9.1 Analytical Model

The general form of model is given as:

LEVit = β + β1(Log BZ) it + β2(% NED) it + β3(%INSTSH)it + β4(MANGSH) it +

β5(DUALITY) it + β6(%GOVTSH) it +εt

Where LEV= Ratio of total debts to total Equity

BZ = Board size

NED= Non-Executive Directors calculated as the proportion of non-executive

directors to total number of directors.

INSTSH = Institutional Shareholding measured as percentage of shares held by

institutions

44
 MANGSH = Managerial Shareholding measured as percentage of shares held by

members of board disclosed in annual financial reports

DUALITY= CEO/Chair Duality taken as 1 if CEO is chairman; otherwise it is

taken as 0 GOVTSH = Government Shareholding measured as percentage of

shares held by government

ε= Error Term

β0 = Intercept of the equation

βi = marginal effect of variable on debt to equity ratio.

3.9.2 Tests of significance

This study employed t-test to determine if betas β1, β2, β3……. β6 were

individually significant and f-tests to test whether the whole model was

significant. Analysis of variance (ANOVA) for the regression model was also

used to determine whether the model was statistically significant.

3.10 Validity of Instrument

Validity is to check whether the measuring instrument measures what it

intends to measure. The validity of the study will be in terms of the content.

Content validity implies the degree to which the test measures what it was

45
designed to measure. The instruments used for the study are among the

instruments adjudged by experts in the field as suitable.

3.11 Reliability of Instrument

Reliability of instrument has to do with the consistency or reproducibility, the

degree to which the instrument consistently measures what it intends. The

study made use of secondary data; published audited annual financial

statements of the firms. The process of preparing the audited financial

statement had followed the stringent accounting standard both national and

international. The financial statements are published documents, which were

examined and verified to ensure its objectivity, comparability; consistency,

availability, and approved by the Corporate Affairs Commission and Nigeria

Stock Exchange before publishing. This ensures the consistency of the data

over time as the information therein could not be altered, thus the assurance of

the reliability of the data.

46
 CHAPTER FOUR

DATA ANALYSIS, RESULTS AND DISCUSSION

4.1 Introduction

This chapter presents the data analysis and interpretation of the results.

Section 4.2 provides the descriptive statistics, section 4.3 provides the analysis

of variance for the regression model and the multivariate regression analysis,

section 4.4 provides correlation Matrix and Section 4.5 the interpretation of the

findings.

4.2 Descriptive Statistics

The descriptive statistics for the outcome variable and the predictors were as

shown in table 1 below.

Table 1: Descriptive Statistics for Predictors Ratio of Total Debts to Total

Equity

Standard

Mean Deviation

Leverage 1.051326 0.8568544

47
Proportion of Non-

Executive Directors 0.7823 0.12107

% of Institutional

Shareholding 59.8551 26.40432

Managerial Shareholding 7.7320 15.33598

% of Government

shareholding 13.58421 22.3213

Board size 8.6503 2.34426

Results reveal that average size of the board in Kenya listed non-financial

companies is 8. 65. Non-executive directors constitute 78.2% of the board

which shows on average listed nonfinancial companies complies with the CMA

requirement on board composition. However, for most companies, it is not

clearly stated in their annual report whether all the non-executive directors are

also all independent directors or what percentage of Non-executive directors

constitute independent directors.

The average institutional shareholding stands at 59.85% implying that a

greater percentage of shareholding in listed companies are under both local

and foreign institution. The average government shareholding is at 13.59% and

management shareholding is at 7.73%. The lower level of average government

48
shareholding is due to the fact that even though the government shareholding

is high in the few companies that they control, majority of the listed companies

do not have government shareholding.

4.3 ANOVA for the regression model

Table 2: ANOVA for the regression model.

Sum of Degree of Mean Fstatisti

Model Squares Freedom Square c Significance

Regression 17.131 5 3.426 5.566 0

Residual 70.788 115 0.616

Total 87.919 120

From the ANOVA table it can be concluded that overall the model was

significant as shown by the .000 value in the significance column which is

below .05

49
4.4 Correlation Matrix

The strength of correlation between the dependent variable and each predictor

variable was tested using Pearson’s moment correlation coefficient. The results

were as summarized in table 4 below. Table 4: Correlations between

Variables in the Regression Model

% % of % of % Board size

LEV NED INSTSH MANGSH GOVTSH (BZ)

Leverage 1.000

% NED -0.192 1.000

% of

INSTSH 0.258 -0.347 1.000

% of

MANGSH -0.146 0.096 -0.053 1.000

% of

GOVTSH 0.051 0.217 -0.112 0.254 1.000

Board

size (BZ) -0.287 0.365 -0.180 0.067 0.378 1.000

50
4.5 Multivariate Regression Analysis

Table 3 presents a summary of the regression model that includes the four

predictors namely proportion of non-executive directors to total number of

directors, percentage of shares held by institutions, percentage of shares held

by board members, percentage of shares held by government and board size as

well as the outcome variable which was ratio of total debts to total equity.

The model for the predicator variable will thus be:

LEVit = 2.888 - 2.193(Log BZ)it - 0.330( % NED)it + 0.005(%INSTSH)it

-.008(MANGSH)it +

.010(%GOVTSH)it +εt

Table 3: Standard Multiple Regression for Predictors of Capital Structure.

Unstandardized Standardized T-

Model coefficients Coefficient Statistic Significance

Standard

Beta error Beta

Constant 2.888 0.730 3.903 0

-0.330 0.666 -0.048 -0.508 0.613

proportion

51
of NED

% of

INSTSH 0.005 0.0025 0.198 2.208 0.029

% of

MANGSH -0.008 0.005 -0.164 -1.892 0.061

% of

GOVTSH 0.010 0.004 0.255 2.711 0.008

Log of BZ -2.193 0.640 -0.328 -3.428 0.001

4.6 Interpretation of the Findings

The study shows that the relationship between Non-executive directors and the

ratio of debt to equity is negative; this is partly because a higher percentage of

external directors on the board lead to lower leverage, due to their superior

control, monitoring and also due to the fact most listed companies have a

higher percentage of institutional shareholding and that external directors are

generally representative of the institutional shareholders. The result of the

finding is consistent with Wen et al. 2002. However, the relationship between

government shareholding and the ratio between debt to equity is positive

indicating that firm with higher percentage of government ownership have the

ability to force management to use optimal level of debt and also, they reinforce

52
recognition from external stakeholders thereby enhancing the ability of

company to raise external funds. The weak correlation could be due to the fact

that the number of government owned firms as a percentage of all the listed

companies is relatively lower. This relationship is significant at α = 0.05

There is a negative relationship between managerial shareholding and debt to

equity ratio, this is because as managers shareholding increases they tend to

bring down the size of the firms debt to reduce risk and the cost of bankruptcy,

the negative correlation can also be explained by the fact that increased

managerial ownership align the interest of manager with the interest of outside

shareholders and reduces the role of debt as a tool to mitigate the agency

problems. This observation is consistent with the findings in Friend and Lang

(1988). Board size is also found to be negatively correlated with debt to equity

ratio indicating that larger board size generally translates into strong pressure

from the corporate board to make managers pursue lower leverage to increase

firm performance. This relationship is significant at α = 0.05.

CEO/Chairman duality was removed from the model because in Kenya, the

CMA requires that all listed companies have the position of the chairman

separated from that of the CEO of the company. All the companies surveyed

complied with this requirement and hence this variable remained zero and

constant throughout the observation.

53
The study shows that ownership structure defined by institutional

shareholding, government shareholding and management shareholding

produces mixed results. Higher institutional shareholding bears a positive

relationship with the level of debt used by firms. The higher the percentage of

institutional investor shareholding, the higher the level of debt, this result is in

line with the findings of some of the earlier studies. Jiraporn et al., (2008) and

Fosberg (2004), the positive relationship could be because institutional

shareholders, due to their large economic stake, have a strong desire to watch

over management closely, making sure that management do not engage in

activities that are detrimental to the wealth of the shareholders and thus would

mostly likely push management to employ more debt to maximize the value of

the firm and reduce agency problem. This relationship is significant at α = 0.05

CHAPTER FIVE

SUMMARY, CONCLUSION AND RECOMMENDATIONS

5.1 Introduction

This chapter provides various sections, Section 5.2 include summary of the

study, section 5.3 includes conclusion, section 5.4 presents the limitation of

the study and finally section 5.5 presents recommendations for further

research

54
5.2 Summary

The study found out that board size negatively correlated with debt ratio

suggesting that larger boards translates into strong pressure from the

corporate board to make managers pursue lower leverage to increase firm

performance. Managerial ownership is negatively related to the long term debt

ratio.

The negative relation between Non- executive directors and capital structure

indicate that board with more independent directors take on less debt on

favorable terms due to effective monitoring and superior control. It is also

worth noting that most listed companies have a higher level of institutional

shareholding and therefore most of the non-executive directors are expected to

be their representatives

Government ownership is positively related to capital structure indicating that

firms with higher percentage of government ownership have the ability to force

management to use more debt than equity and also, they reinforce recognition

from external stakeholders thereby enhancing the ability of the company to

raise funds. However, managerial ownership is negatively related to capital

structure which indicates that increased managerial ownership align the

interest of manager with the interest of outside shareholders and reduces the

55
role of debt as a tool to mitigate the agency problems. The percentage of

Institutional shareholding is positively correlated with debt to equity ratio.

5.3 Conclusions from the Study

The study analyzed the relationship between corporate governance

mechanisms and capital structure of listed foods and beverages firms in Nigeria

for the period 2014 – 2018 by using multivariate regression analysis.

Board size and Non-executive directors is negatively correlated with debt level

and in overall board independence and managerial shareholding are not

important factors in determining choice of financial mix. However most listed

firms with government ownership however few they seems to be, tend to have a

higher level of debt than equity. This could be because higher government

shareholding imposes confidence from external stakeholders to grant debt to

the listed firms.

The negative relation between Non- executive directors and capital structure

indicate that boards with more independent directors take on less debt on

favorable terms due to effective monitoring and superior control. Managerial

shareholding has a negative relationship with the debt indicating that

concentration of ownership induces managers to lower the gearing level;

however the relationship is statistically insignificant. Institutional shareholding

56
is positively correlated with debt level this may be due to the fact that in Kenya,

the larger proportion of firms’ shareholding are under institution and therefore

institutional shareholder may be putting management under pressure to utilize

more debt to maximize firm value and also reduce free cash flow problems.

Another possible reason could be, firms with larger institutional shareholding

have more confidence from debt providers than firms with more individual

shareholdings.

5.4 Limitations of the Study

One of the major limitation of the study is the un availability of data on all the

variables for the five years for all the listed companies, secondly some listed

companies do not clearly disclose the distinction between independent

executive directors and non-executive directors on their annual report and

therefore it is very difficult to determine among the executive directors, what

proportion is independent.

Another limitation is that not all data has been extracted from one source.

Where there were gaps, these have had to be filled from other sources or

estimated or inferred using different ratios. This therefore means that for some

firms, data has not been uniformly sourced and that therefore there may be

issues of uniformity. Additional biases may be created by accounting non-

compliance. The search for data from more than one source may skew the

57
results as such data depends on the integrity and intentions from the different

data sources.

Additionally the 33 companies sampled do not represent all Kenyan companies,

but since no data is publicly available for the other majority of firms in Kenya, l

was forced to use the companies listed in the Nairobi Stock Exchange. This is a

common problem experienced by other studies on determinants of capital

structure in developing countries including in Booth et al., (2001)

The study had also intended to investigate the effect of CEO/Chairman duality

on capital structure of firms; however the variable was removed from the model

because it remained constant throughout the observation and added no value

to the model.

5.5 Suggestions for Further Research

The study covered active food and beverages companies listed on the Nigerian

Stock Exchange for the period 2014 – 2018. Looking at Board size, proportion

of non-executive directors, proportion of Institutional Shareholding, percentage

of Managerial Shareholding, CEO/Chair Duality and percentage of Government

Shareholding, However, although negative relationship was found between

institutional shareholding and capital structure, a further study can also be

58
done separating foreign institutional shareholding and local shareholding in

the model.

Secondly the study could also be undertaken for the same period but using

large un-quoted firms in Nigeria and finally a study can also be done but

separating data from multiple sectors of the listed firms of the Investment and

Securities Exchange Commission and comparing the results and findings

among the sectors. This may provide evidence on the influence of Industry on

debt to equity ratio.

59
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