Effect of Financial Leverage on Firm Value: Evidence From Selected Firms Quoted on the Nigerian Stock Exchange

Umar Abbas Ibrahim ,Abdul Qudus Isiaka

doi:10.7176/ejbm/12-3-16

Abstract

This study examined the effect of financial leverage on firm value with evidence from a sample of selected companies quoted on the Nigerian Stock Exchange. The study adopts a panel data analysis using secondary data obtained from the financial statements of the selected companies over the period 2014-2018. The sample of 18 firms studied was selected through the convenient sampling technique. The level of financial leverage was denominated by long term debt to equity ratio. This work is the first Nigerian study to utilize the Tobin’s q ratio as a proxy of firm value. Other variables proven in literature to be of importance when considering firm value such as Total Asset, Return on Asset and the Number of years for which the firm has been in operation, were utilized as control variables in presenting the Tobin’s Q model of firm valuation. Data obtained were analyzed by E-VIEWS to determine the extent of the causal and correlational relationships between the dependent variable and the regressors. The study determined the degree of causality using the Pooled Ordinary Least Squares (POLS), Random Effect Panel Data Model(REM) and Fixed Effect Panel Model(FEM) estimation techniques. The correlation coefficients were estimated using the pairwise correlation matrix to determine the extent to which financial leverage can predict firm value In line with the findings of Akani & Kenn-Ndubuisi (2017); the regression results showed that financial leverage has a significantly negative effect on firm value while the result of the pairwise correlation showed that there is no significant linear relationship between leverage and firm value. The Management of these companies were advised to take less long term debts and instead such firms should consider issuing more equity to reduce the level of financial leverage to thereby attain the optimal capital structure. Financial leverage has proven to be a weak predictor of firm value; hence the management should not rely on the levels of financial leverage to predict future firm value. Future studies may consider the use of a larger sample and a random sample selection method which will group the firms based on their level of capitalization into mid, low and high-capitalization companies so which will help to ascertain the average optimal capital structure for each of the three classes. Finally, future studies can consider a longer time span. Keywords : Firm value, Tobin’s q, Financial Leverage, REM JEL Classification: G11; G32; M21 DOI : 10.7176/EJBM/12-3-16 Publication date: January 31 st 2020

Highlights

The growing levels of corporate debt profiles and issue of corporate debt instruments has made it an imperative to understand what the key drivers of a geared capital structure are, as well as its implications for the financial performance and value of such firms
4.2 Regression Results Hypothesis One: Financial leverage has no significant effect on firm value Table 4: Regression Results (Using Random effect model (REM), Pooled Ordinary Least Squares (POLS) and Fixed Effects Panel Data Model (FEM)) Source: Researcher’s Computation
Like previous studies like Jaisinghani et al (2017) this work sought to determine whether the firms on the stock exchange had an optimal capital structure or not

Summary

Introduction

The growing levels of corporate debt profiles and issue of corporate debt instruments has made it an imperative to understand what the key drivers of a geared capital structure are, as well as its implications for the financial performance and value of such firms. The theoretical position on the effect of financial leverage and capital structure on the value of firms is well known and has been discussed extensively by researchers like Arosa, Richie and Schumann (2014); Lee, Su, & Lin, (2012). As Eldomiaty, Choi and Cheng (2007) noted that capital markets in developing economies are largely inefficient when compared to those of advanced economies because of the information asymmetry. It is not likely that inferences drawn from data obtained from advanced economies would be applicable to a developing economy such as Nigeria. When a firm embarks on a financing decision, there are basically two alternatives available to the management to choose from namely debt and equity

Methods

Results

Conclusion