Seminar on Determinants of Corporate Investment in Nigeria (1981-2018)
INTRODUCTION
Corporate investment decisions are shown to be directly related to financial factors. The investment decisions of firms with high creditworthiness (according to traditional financial ratios) are extremely sensitive to the availability of internal funds; less creditworthy firms are much less sensitive to internal fund availability. This large sample evidence is based on an objective sorting mechanism and supports the results of Kaplan and Zingales (1997) who also found that investment outlays of the least constrained firms are the most sensitive to internal cash flow. Early applied research stressed the significance of financing constraints in business investment. Since the mid-1960’s, however, most applied work isolated real firm decisions from purely financial factors. This shift in approach can be attributed to the seminal work of Modigliani and Miller in 1958. This demonstrated the irrelevance of financial structure and financial policy for real investment decisions under certain conditions. Thus, a firm’s financial structure would not affect its market value in frictionless capital markets.
If their assumptions were satisfied, “real” firm decisions (e.g. fixed investment) motivated by maximization of shareholders’ claims would be independent of financial factors such as liquidity, leverage, or dividend payments. Applied to capital investment, this boils down to the neoclassical theory of investment in which the firm’s choice of optimal capital stock could be determined irrespective of financial factors. The q theory approach pioneered by Tobin (1969) and extended to models of investment, assuming convex costs of adjusting the capital by Hayashi (1982) offered another formulation of the neoclassical model. Investment opportunities could be summarized by the market valuation of the firm’s capital stock, and, under certain assumptions, the ratio of the market value of the capital stock to its replacement cost is the basic variable explaining investment demand.
CHAPTER TWO
LITERATURE REVIEW
Conceptual review
Concept of Corporate investment in Nigeria
The corporate long-term capital structure and its optimization are continuously discussed by both academics and financial managers. The basic question formulated by Myers (1984) “How do firms choose their capital structure?”, however, still remains unanswered despite an extensive research concerning corporate investment decisions. Corporate investment decision is a complex multi-criterion process. The individual criteria operate often against each other, and the chosen financing strategy depends on a particular company. Long term financing in the Czech Republic is generally based on the continental system of corporate financing where companies get additional capital primarily from banks.
The modern theory of the capital structure was established by Modigliani and Miller
(1958). Since then many various theories concerning corporate financing have been introduced. There are generally two groups of these theories, the static theories search for the optimal debt-to-equity ratio, whereas the dynamic theories declare that there is no defined target capital structure and they are primarily based on the assumption that each firm continually optimizes its financial decisions according to changing specific conditions. Several studies have already examined empirical relevance of these theories. One of the most extensive works focused on corporate financial management approach was done by Graham and Harvey (2001). The study was conducted on a sample 392 CFOs of the U.S. companies. Respondents indicated that in the field of capital planning and budgeting the most often used methods were the internal rate of return (IRR), the net present value (NPV) and surprisingly also the payback period, despite all its often discussed shortcomings. To determine the cost of capital, the most frequently used methods were capital asset pricing model (CAPM), multi-beta capital asset pricing model, average historical return and dividend discount model. Part of the research was devoted also to empirical verification of the trade-off and the pecking order theories of the capital structure.
The study of Bancel and Mittoo (2004) tested the capital structure of companies from 16 European countries (Austria, Belgium, Greece, Denmark, Finland, Ireland, Italy, France, Germany, the Netherlands, Norway, Portugal, Spain, Switzerland, Sweden and the United Kingdom) on the basis of almost the same questionnaire as Graham and Harvey. It offers the opportunity to compare conclusions regarding the capital structure of U.S. firms with European companies. The research is based on responses from 87 CFOs from industrial sectors (about 37%), technology (about 18%) and financial sector (about 18 %). Due to the limited sample size, the authors do not present results as country specific. The authors confirm that businesses mostly set their target debt ratio (about 75 % of respondents) which supports the trade-off theory of capital structure. Inquiry concerning the determinants of capital structure identified the financial flexibility, the average cost of capital, and the interest rates as the most important factors. The importance of interest tax shield, profit and cash-flow volatility and a potential financial distress cost support the trade-off capital structure theory.
CHAPTER THREE
METHODOLOGY
The study used data from Annual Report of companies quoted in the Nigeria stock exchange. This is because the estimation of the model to be employed in the study requires the use of data in the form of financial information. These data were obtained from the annual reports and accounts of the companies for the period 1981 to 2018.
The variables used to determine investment are cash flow, capital structure, firm size and dividend payout with three control variables which are firm growth, Firm age and effective tax rate. The data presented were analyzed using descriptive statistic and regression analysis. The result of the analysis are presented in chapter four.
The statistical application that was utilized in this study is the Ordinary Least Squares (OLS) method. A linear relationship between corporate investment decision and its determinants is assumed, therefore, a model of the following form is formulated.
CHATER FOUR
Results presentation and Discussion
The result presents the various data on the determinants of investment in quoted manufacturing firms in Nigeria. The variables used to determine investment are cash flow, capital structure, firm size, dividend payout and the control variables are firm growth, firm age and effective tax rate. The data presented are analyzed using descriptive statistic and regression analysis.
CHAPTER FIVE
CONCLUSION AND RECOMMENDATIONS
This study was carried out on the determinants of corporate investment in Nigeria (1981-2018). The result of analysis has shown that the overall power of the explanatory variables is significant in explaining investment decision of manufacturing firms in Nigeria. However, one variable that stands out among the others is cash flow. Cash flow has statistical significance for all the sub-sectors and also in the overall pool result. The reason for this is that firms cannot naturally invest when there is no stream of income. The result is in line with the earlier finding of Ramesh (2010), Adelegan and Ariyo (2008), Mathias and Ibrahim (2001) and Kaplan and Zingales (1997).
Based on the analysis done in this study, it was found out that the major determinants of investment decision by manufacturing firms in Nigeria are cash flow and effective tax rate. A firm needs to generate enough cash to enable it channel some into investment, thus the finding is in line with a priori expectation. It is also through effective tax rate that a company determines its investment decisions. This result indicates that effective tax rate is also a major determinant of investment decision. It is therefore recommended that while cash flow can affect the investment decision of firms, it is also important that firms in this sector take into consideration the type of capital structure they have before embarking on investment. A firm that is largely financed by debt capital will need to borrow more to carry out further investments which could consequently result in total control by outsiders.
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