CHAPTER ONE
INTRODUCTION
1.1 Background of Study
The term capital structure is used to represent the
proportionate relationship between debt and equity. Equity includes paid-up
share capital, share premium and reserve and surplus (retained earnings)
(Pandey, 2010), while debt can be classified into bank debt, straight bond
debt, convertible bond debt, program debt (such as commercial paper), mortgage
debt, and all other debts (Rauh & Sufi, 2008). A firm can issue a large
amount of debt or a large amount of equity; hence it is important for a firm to
deploy the appropriate mix of debt and equity that can maximize its overall
market value. Utilization of different levels of equity and debt by managers is
one strategy used by firms to improve their financial performance (Gleason, Mathur
& Mathur, 2000).
Capital structure is important for agricultural firms,
lenders, and policy analysts because all of them need information about
financial structure of agricultural enterprises in order to make justified
decisions about farm viability (Nurmet, 2011). It is the most significant
aspect of company’s operations. Capital structure theories predict that
leverage level influences a firm’s performance (Orua, 2009). Maina and Ishmail
(2014) reported that there was evidence of a negative and significant
relationship between capital structure and all measures of performance. This
implies that the more debt the firms used as a source of finance they
experienced low performance. Capital structure decision is a vital decision
with great implications for the firm’s sustainability. The ability of the
organization to meet its stakeholders need is closely related to the capital
structure (Leon, 2013).
Agricultural credit is the present and temporary transfer of
purchasing power from a person who owns it to a person who wants it, allowing
the later opportunity to command another person’s capital for agricultural
purposes, but with confidence in his willingness and ability to repay at a
specified future date with or without interest (Nwaru, 2011). According to Akudugu
(2012), credit is a strategic empowerment tool that has the potential to change
the life of a person, family or community from a situation of abject poverty to
a more dignified life. It can transform self-image, unlock potential and boost
the productivity and well-being of the poor and vulnerable. Credit could bring
about higher productivity and profit in agricultural production (Ashaolu,
Mamioh, Philip & Tijani,2011) and may be financial or consist of goods and
services.
Access to agricultural credit has been positively linked to
agricultural productivity in several studies in Nigeria (Rahaman & Marcus
2004; Abu, Odoemenem,& Ocholi, 2010; Ugbajah, 2011), higher credit levels
are associated with higher input use (Satyasai, 2012). Access to credit by
small and medium agro enterprises is vital because the contributions which
small and medium scale enterprises (SMEs) make to the economic growth process
have been well documented (Mambula, 2002). Small and medium scale enterprises
(SMEs) generate more direct job per naira of investment than do larger
enterprises. They serve as a training ground for developing technical and
entrepreneurial skills and; by virtue of their greater use of indigenous
technological capabilities, they promote local inter-sectoral linkages and
contribute to the dynamism and competitiveness of the economy. Prior to the
1970s, the small and medium scale enterprises (SMEs) belonged to the past but
this view has since changed because the contributions of SMEs to industrial and
economic growth of countries have been recognised internationally (Nnanna,
2001). SMEs access to credit therefore will play an important role in enhancing
economic recovery. The extent to which firms can access external financing has
been shown to have an influence on the investment activity of the firm and the
ability of the firm to trade internationally (McCann, 2001). Unfortunately,
SMEs, the engine of economic growth and development in many developing
economies are still a shadow of themselves (McCann, 2001).
Ihyembe (2000), Eze (2007), Ike and Chidebelu (2003),
attributed several reasons for the poor performance of agro-based SMEs. Among
these is that they are operating under an environment of poor credit policy
support which does not provide opportunity for maximization of profit in a
competitive market. Ihyembe (2000) also reported that the absence of capital
could frustrate the taking off of any business and since personal savings or
contributions from family members and peer groups were not always enough, providing
bank credit to SMEs would enable the SMEs provide necessary capacity building,
infrastructure and raw materials to large scale industries. Due to diverse
financial as well as non-financial and behavioural factors, small and medium
scale enterprises rely more heavily on short term funding and this makes them
more prone to volatile economic situations. Under such circumstances, banks
have to request for more reliable collateral security to guard against loan
default.