1.1 Background to the Study
In corporate finance, the issue of funding has been given much prominence in the activities of the firm. Corporate financing is a global issue because without proper financing, organisations, globally, will find difficulty in conducting their businesses. Almeida and Campello (2010) stated that corporate managers in Europe and the United States have always claimed that maintaining „financial flexibility‟ is the primary objective of their firm‟s policies. Financial flexibility ensures the continued running of operations of an organisation; it brings sustainability, and continued growth for the firm, which is expected to create wealth and add value to shareholders and stakeholders of the organisation. Thus, funding is therefore very essential for the survival of a firm.
It is part of a mandatory role for companies in Nigeria to finance their businesses so that they may be able to add value, remain in business and grow over time. Once businesses are in operation, the general expectations are that profits will be generated which in turn would lead to the creation of wealth to both the shareholders and the organisation. The returns made are expected to be paid to the shareholders in the form of dividends. The continued existence of the business allows employment to be created and employees to be paid salaries thereby improving the standard of living of people. In addition, revenues to be generated for the government through taxes and levies, which if fully utilised effectively the stakeholders to also benefit both socially and economically. All these are expected to reduce the level of poverty in the country, create wealth for the economy, and increase economic growth and development for the country.
Corporate financing decisions can be a complex process and existing theories can at best explain only certain features of how diverse and complex financing choices can be. The complexity of the financing decisions resulted to the choices of determining which financing structure to adopt for the organisation and financing structure decisions informed the issue of firm characteristics. Characteristics of the firm consists of the combinations of debt, equity, fixed assets,total assets and turnover, which are used in financing decisions to bring about an optimum performance and firm value.
The relationship between financial performance of the firm and firm characteristics is a subject of considerable debate both theoretically and in empirical literature. An optimal characteristic is expected to achieve maximum firm value or market value, increase in profitability, decrease in risk, and lower the weighted average cost of capital. It therefore becomes a concern if organisations are unable to achieve maximum financial performance through optimum firm characteristics.
Arguments have been made on characteristics and how the financial performances of firms are affected. Area of conflict lies on which financing policy to adopt. Where the firm is heavily financed by debt, interest will be paid by the organisation which reduces the profit of the firm, dividends and also retained earnings. With fewer retained earnings, the firm will have fewer funds for investment and may decide to restructure and use more of internal financing. This is informed by the pecking order theory of capital structure as pioneered by (Myers, 1984). Another argument informed by Miller and Modigliani, (1958) is that capital structure has no relevance in determining the financial performance of the company, that performance is determined by factors none other than debt or equity.
The corporate sector in Nigeria is made up of firms operating in a competitive environment and this free market coupled with the widening and deepening of the financial markets created a basis for companies to optimally determine their characteristics. Salawu and Agboola, (2008) explained that financial freedom of Nigerian companies can be traced to as far back as 1987 when financial liberalisation gave more flexibility to the Nigerian financial managers in choosing the firm‟s characteristics. Despite this flexibility, finance is still a major constraint to businesses in Nigeria and with the lack of sufficient funds for operations, coupled with low levels of investment capital recorded in recent years have result in low capacity utilization of industries, thus affecting corporate performance.