Study Of Business Companies In Colombo Stock Exchange

Capital structure is most significant discipline of company’s operations. The Study attempts to identify the impact of Capital Structure on Companies Performance. The analyze has been made Financial year from 2005 to 2009 (05 years) financial year of Business companies in Sri Lanka. The results shown the relationship between the capital structure and financial performance is negative association at -0.114.. F and t values are 0.366, -0.605 respectively. It is reflect the insignificant level of the Business Companies in Sri Lanka. Hence Business companies mostly depend on the debt capital. So that, they have to pay interest expenses much.

1. Introduction

To understand how companies finance their operations, it is necessary to examine the determinants of their financing or capital structure decisions. Company financing decisions involve a wide range of policy issues. At the private, they have implications for capital market development, interest rate and security price determination, and regulation. At the private, such decisions affect capital structure, corporate governance and company development (Green, Murinde & Suppakitjarak, 2002). Knowledge about capital structures has mostly been derived from data from developed economies that have many institutional similarities (Booth 2001). It is important to note that different countries have different institutional arrangements, mainly with respect to their tax and bankruptcy codes, the existing market for corporate control, and the roles banks and securities markets play.

Capital structure refers to a mixture of a variety of long term sources of funds and equity shares including reserves and surpluses of an enterprise. The historical attempt to building theory of capital structure began with the presentation by Modigliani & miller (MM)(1958). They revealed the situations under what conditions that the Capital structure (CS) is relevant or irrelevant to the financial performance of the listed companies. most of the decision making process related to the CS are deciding factors when determining the CS, a number of issues e.g. cost, various taxes and rate, interest rate have been proposed to explain the variation in Financial Leverage across firms (Van Horne,1993; Hampton,1998; Titman & Wessels,1998).these issues suggested that the depending on attributes that caused the cost of various sources of capital the firm’s select CS and benefits related to debt and equity financing

The relationship between capital structure and financial performance is one that received considerable attention in the finance literature. How important is the concentration of control for the company performance or the type of investors exerting that control are questions that authors have tried to answer for long time prior studies show that capital structure has relating with corporate governance, which is the key issues of state owned enterprise. To study the effects of capital structure or financial performance, will help us to know the potential problems in performance and capital structure.

2. Literature Review

Modigliani and Miller(M & M)(1958) wrote a paper on the irrelevance of capital structure that inspired researchers to debate on this subject. This debate is still continuing. However, with the passage of time, new dimensions have been added to the question of relevance or irrelevance of capital structure. M&M declared that in a world of frictionless capital markets, there would be no optimal financial structure (Schwartz & Aronson, 1979). This theory later became known as the "Theory of Irrelevance'. In M & M's over-simplified world, no capital structure mix is better than another. M & M's Proposition-II attempted to answer the question of why there was an increased rate of return when the debt ratio was increased. It stated that the increased expected rate of return generated by debt financing is exactly offset by the risk incurred, regardless of the financing mix chosen.

Brander and Lewis (1986) and Maksimovic (1988) provide the theoretical framework that links capital structure and market structure. Contrary to the profit maximization objective postulated in industrial organization literature, these theories are similar to the corporate finance theory in that they assume that the firm's objective is to maximize the wealth of shareholders. Furthermore, market structure is shown to affect capital structure by influencing the competitive behavior and strategies of firms.

Firms in an oligopolistic market will follow the strategy of maximizing their output in favorable economic conditions to optimize profitability (Brander & Lewis 1986). The theory also holds in unfavorable economic conditions; firms would take a cut in production and reduce their profitability. Shareholders, though, while enjoying increased wealth in good periods, tend to ignore a decline in profitability in bad times. This is due to the fact that unfavorable consequences are passed in to lenders because of shareholders' limited liability status. Therefore, the oligopolistic firms, in contrast to firms in competitive markets, would employ higher levels of debt to produce more when opportunities to earn higher profits arise. The implied prediction of the output maximization hypothesis is that capital structure and market structure have a positive relationship. In corporate finance, the agency costs theory supports the use of high debt, and it is consistent with the prediction of the output maximization hypothesis.

Jensen and Meckling (1976) argue that the shareholders-lenders conflict has the effect of shifting risk from shareholders and of appropriating wealth in their favor as they take on risky investment projects (asset substitution). Hence, shareholders, and managers as their agents, are prompted to take on more borrowing to finance risky projects. Lenders receive interest and principal if projects succeed, and shareholders appropriate the residual income; however, it is the lender who incurs the loss if the project fails. It is difficult and costly for debt holders to be able to assess and monitor

Huson, and Nazrul Hisyam. (2008) examined that the relationship between ownership structure and company performance has been issue of interest among academics, investors and policy makers because of key issue in understanding the effectiveness of alternative governance system in which government ownership serve as a control mechanism. Therefore, this study examines the impact of alternative ownership/control structure of corporate governance on firm performance among government linked companied (GLCs) and Non-GLC in Malaysia. It is believed that government ownership serve as a monitoring device that lead to better company performance after controlling company specific characteristics. We used Tobin's Q as market performance measure while ROA is to determine accounting performance measure. This study is based on a sample of 210 firms over a period from 1995 to 2005. We use panel based regression approach to determine the impact of ownership mechanism on firm's performance. Findings appear to suggest that there is a significant impact of government ownership on company performance after controlling for company specific characteristics such as company size, non-duality, leverage and growth. The finding is off significant for investors and policy marker which will serve as a guiding for better investment decision.

Mohammed Omran (2001) evaluates the financial and operating performance of newly privatized Egyptian state-owned enterprises and determines whether such performance differs across firms according to their new ownership structure. The Egyptian privatization program provides unique post-privatization data on different ownership structures. Since most studies do not distinguish between the types of ownership, this paper provides new insight into the impact that post-privatization ownership structure has on firm performance. The study covers 69 firms, which were privatized between 1994 and 1998. For these newly privatized firms, these study documents significant increases in profitability, operating efficiency, capital expenditures, and dividends. Conversely, significant decreases in employment, leverage, and risk are found, although output shows an insignificant decrease following privatization. The results also show that Egyptian state-owned enterprises, which were sold to anchor-investors and employee shareholder associations, seem to outperform other types of privatization, such as minority and majority initial public offerings.

B.Nimalathasan and Brabete (2010) pointed out that Dept equity ratio is positively and strongly associated to all profitability ratios in Listed Manufacturing Companies.

3. Conceptual Frame Work

Based on the Litteratures, the following conceptual model is constructed. It shows that hypotgesized the relationship between capital structure and Performance of listed Business companies in Sri Lanka

Debt Equity

CS

GP NP

FP

ROE

ROI

4. Objectives

The main objective is to find out the impact of Capital Structure on Financial Performance of the Business companies in Srilanka.

To achieve the above objective the following sub objective are considered

To identify the relationship between capital structure and performance

To determinants of a capital structure

5.0 Hypotheses

The following hypothesis is formulated for the study

H1:- The capital structure has significant impact on financial performance.

H2:-Capital structure is significantly correlated with financial performance

6.0 Methodology

To produce the above mentioned research objective, the data for this study was gathered from the financial statements as published by Business Companies. In addition, another source of data was through reference to the review of different articles, papers, and relevant previous studies. For this purpose, collecting data of Business firms is used which are listed on Colombo Stock Exchange.. All firms are taken for the study representing the period of 2005-2009, and the average values of each item was considered for the purpose of ratio computation and analysis.

6.1 Mode of Analysis

1.Capital structure

Role of debt and equity

Debt ×100

equity

Debt ×100

Total funds

Total funds

2.Financial Performance

Gross profit

Gross profit ×100

Net Sales

Net Sales

Net profit Net profit

Net profit ×100

Sales

ROA

PAIT ×100

Assets

ROI/ROCE

Investment

PBIT ×100

Equity

7. Results and Discussions

7.1 Correlation Analysis

Correlation is concern describing the strength of relationship between two variables. In this study the correlation co-efficient analysis is under taken to find out the relationship between capital structure and financial performance. It can be said that the what relationship exist among variables

Capital structure correlated with

R value R2 value

Gross profit 0.360 0.1296

Net profit - 0.110 0.0121

ROI -0.104 0.0108

ROA -0.196 0.0384

Performance -0.114 0.0129

7.1.1 Capital structure and Gross profit

Table I

Variables

Capital structure

Gross profit

Capital structure

1

0.360

Gross profit

0.360

1

It shows the relationship between gross profit and capital structure variables. There is a weak positive relationship between two variables. The correlation is 0.360. significant level is 0.01. the co-efficient of determination is 0.1296. that is only 12.96% of variance in the capital structure is accounted by the gross profit.

So, There is a weak positive relationship between capital structure and gross profit

7.1.2 Capital structure and Net profit

Table II

Variables

Capital structure

Net profit

Capital structure

1

-0.110

Net profit

-0.110

1

It illustrates the relationship between net profit and capital structure variables. There is a weak negative relationship between two variables. The correlation is -0.110. Significant level is 0.01. The co-efficient of determination is 0.0121. That is only 1.21% of variance in the capital structure is accounted by the net profit.

7.1.3 Capital structure and ROI

Table III

Variables

Capital structure

ROI

Capital structure

1

-0.104

ROI

-0.104

1

It indicates the relationship between ROI and capital structure variables. There is a weak negative relationship between two variables. The correlation is -0.104. Significant level is 0.01. The co-efficient of determination is0.0108. that is only 1.08% of variance in the capital structure is accounted by the ROI.

7.1.4 Capital structure and ROA

Table IV

Variables

Capital structure

ROA

Capital structure

1

-0.196

ROA

-0.196

1

It shows the relationship between ROA and capital structure variables. There is a weak negative relationship between two variables. The correlation is -0.196 significant level is 0.01. the co-efficient of determination is 0.0384. that is only 3.84% of variance in the capital structure is accounted by the ROA.

7.1.5 Capital structure and Financial performance

Table V

Variables

Capital structure

Financial performance

Capital structure

1

-0.114

Financial performance

-0.114

1

It illustrates the relationship between performance and capital structure variables. There is a weak negative relationship between two variables. The correlation is -0.114. Significant level is 0.01. The co-efficient of determination is 0.0129. that is only 1.29% of variance in the capital structure is accounted by the performance.

7.2 Regression Analysis

Regression analysis is used to test the impact of financial performance on capital structure of the listed companies traded in Colombo stock exchange

7.2.1 Capital structure and Gross profit

Table VI

Model

R

R Square

Adjusted

R Square

Std.Error of the Estimate

1

0.360a

0.129

0.098

0.32306

The above table shows the weak positive correlation between the capital structure and gross profit.

Table VII

Model

Un standardized

Coefficients

Standardized

Coefficients

t

sig

B

Std.Error

Beta

1(constant)

Capital structure

0.187

0.047

0.073

0.023

0.360

2.556

2.039

0.016

0.051

The above table indicates the coefficient of correlation between the capital structure and gross profit. multiple r2 is 0.1296. only 1.29% of variance of gross profit is accurate by the capital structure. But, remaining 98.21% of variance with gross profit is attributed to other factors.

7.2.2 Capital structure and Net profit

Table VIII

Model

R

R Square

Adjusted

R Square

Std.Error of the Estimate

1

0.110a

0.012

-0.023

0.36514

The above table shows the weak negative correlation between the capital structure and net profit.

Table IX

Model

Un standardized

Coefficients

Standardized

Coefficients

t

sig

B

Std.Error

Beta

1(constant)

Capital structure

0.124

-0.015

0.083

0.026

-0.110

1.498

-0.584

0.145

0.564

The above table indicates the coefficient of correlation between the capital structure and net profit. Multiple r2 is 0.012. Only 1.2% of variance of net profit is accurate by the capital structure. But, remaining 98.8 % of variance with net profit is attributed to other factors

7.2.3Capital structure and ROI

Table X

Model

R

R Square

Adjusted

R Square

Std.Error of the Estimate

1

0.104a

0.011

-0.025

115.19484

The above table shows the weak positive correlation between the capital structure and ROI.

Table XI

Model

Un standardized

Coefficients

Standardized

Coefficients

t

sig

B

Std.Error

Beta

1(constant)

Capital structure

31.283

-4.563

26.050

8.250

-0.104

1.201

-0.553

0.240

0.585

The above table indicates the coefficient of correlation between the capital structure and ROI. Multiple r2 is 0.011. Only 1.1% of variance of ROI is accurate by the capital structure. But, remaining 98.9% of variance with ROI is attributed to other factors

7.2.4 Capital structure and ROA

Table XII

Model

R

R Square

Adjusted

R Square

Std.Error of the Estimate

1

0.196a

0.039

0.004

0.10866

The above table shows the weak positive correlation between the capital structure and ROA.

Table XIII

Model

Un standardized

Coefficients

Standardized

Coefficients

t

sig

B

Std.Error

Beta

1(constant)

Capital structure

0.099

-0.008

0.025

0.008

-0.196

4.020

-1.060

0.000

0.298

The above table indicates the coefficient of correlation between the capital structure and ROA. multiple r2 is 0.039. only 3.9% of variance of ROA is accurate by the capital structure. But, remaining 96.1% of variance with ROA is attributed to other factors

7.2.5 Capital structure and Financial performance

Table XIV

Model

R

R Square

Adjusted

R Square

Std.Error of the Estimate

1

0.114a

0.013

-0.022

0.98395

The above table shows the weak positive correlation between the capital structure and performance.

Table XV

ANOVA

b

.354

1

.354

.366

.550

a

27.109

28

.968

27.463

29

Regression

Residual

Total

Model

1

Sum of

Squares

df

Mean Square

F

Sig.

Predictors: (Constant), Capital_structure

a.

Dependent Variable: Performance

b.

Table XVI

Model

Un standardized

Coefficients

Standardized

Coefficients

t

sig

B

Std.Error

Beta

1(constant)

Capital structure

0.704

-0.043

0.223

0.070

-0.114

3.162

-0.605

0.004

0.550

The above table indicates the coefficient of correlation between the capital structure and performance. multiple r2 is 0.013. only 1.3% of variance of performance is accurate by the capital structure. But, remaining 98.7% of variance with performance is attributed to other factors.

8. Concluding Remarks

Correlation analysis explains, there is a weak positive relationship between gross profit and capital structure (0.360).at the same time, there is a negative relationship between net profit and capital structure (-0.110).it reflects the high financial cost among the firms. ROI and ROA also has negative relationship with capital structure at -0.104, -0.196 respectively.

It is focused on the overall point of view of the relationship between the capital structure and financial performance. There is a negative association at -0.114. Co-efficient of determination is 0.013. F and t values are 0.366, -0.605 respectively. It is reflect the insignificant level of the Business Companies in Sri Lanka.

Business companies mostly depend on the debt capital. Therefore, they have to pay interest expenses much.

8.1 Testing of Hypotheses

Statistical Techniques Results

Correlation -0.114

Co –efficient of determination -0.0129

Based on the empirical results of this study, H1this hypothesis come false .Because in this study the empirical results shows that there is a insignificant negative relationship

H2: “There is a positive relationship between the capital structure and firm’s financial performance?.

At the first step of testing the hypothesis(H1), hypothesis (H1) was considered and tested for its validity. It has the following result between the capital structure and firm’s financial performance measured by performance measures such as ROA , ROI ,Net profit margin and etc. Based on the above evidence gathered, the H2 was rejected. Because research result is negative relationship between the capital structure and firm’s financial performance.

H0: “there is a negative relationship between the capital structure and firm’s financial performance?.

After the rejection of H1, the Null hypothesis (H0) was tested for its validity. H0 was accepted based on the above evidence gathered. it has been provided that there is a negative relationship between the capital structure and firm’s financial performance(-0.114).

9.0 Suggestions and Recommendations

The following suggestions are recommended to increase the Company’s financial performance based on capital structure.

Performance standards should be established and communicated to the investors. This will help investors to achieve the standard and take better investment decisions.

Identifying weaknesses of investment may be best one to improve the firm’s financial performance, because it indicates the area which decision should be taken.

Motivating the investors to help to achieve the high level of firm’s financial performance..

Political changes are very important factor in the share market. It is also determine the firm performance. Therefore, political should possible to increase the financial performance of the listed companies.

Inflation and exchange rate also affect the listed company’s performance. So, government should consider the economic growth to control the inflation.