e-sRC

CHAPTER ONE
INTRODUCTION
1.1 Background to the Study
The primary objective of every rational investor be it an institutional investor or
individual investor,is to maximize expected returns on their investments within an
acceptable level of risk. Thus, they prefer to invest their funds in shares of companies
with increasing prices that will eventually boost their wealth in the stock market.
Generally, most investors prefer persistent increase in the value of their shares in the
stock market in order to earn more return on their investments and maximize their
wealth.
However, in practice, the prices of stocks do not increase at all times in the stock
market. They could fluctuate and perhaps result in losses that could be detrimental to
the shareholders’ wealth. Therefore, the players in the financial market usually find it
difficult to obtain reliable information on market values of shares as these values
fluctuate quite frequently (Pandey, 2003). This fluctuation in the share values of
companies at the stock market has been a matter of great concern to investors, fund
managers and investment analysts globally and has attracted debates from financial
economists, corporate finance experts and scholars over the years (Almumani, 2014).
Limento and Djuaeriah (2013), Gharaibeh (2015) and Aliyu (2015) contend that
macroeconomic factors such as interest rate, gross domestic product, inflation rate,
money supply, and risk free rate also cause movement in the share prices of companies
in the stock market. On the other hand, it has also been argued that share value could
be influenced by microeconomic variables like dividend per share, dividend payout,
return on equity, earnings per share, book value per share, price earnings ratio,
profitability, firm size, and leverage (Stephen &Okoro, 2014, Taimur, Harsh, &Rekta,
2015, Zeeshan, Ali, Sohail&Sulaiman, 2015 and Adenugba, Ige&Kesinro, 2016).
It has been seen in many studies that the share price of a company is influenced by
financial leverage. For example, Buigut, Soi, Koskei and Kibet (2013) contend that the
ratio of total debt to total capital is one of the major factors causing movement in the
share value of a company. In the same vein, it has been argued by Hussain and Gul
(2011) that the company’s share price is affected by its interest coverage ratio as
investors perceive the company’s ability to cover its interest charges from profit as an
indication that the company is profitable.
Similarly, scholars like AlTroudi and Milhen (2013) and Stephen and Okoro (2014)
are of the view that the firm’s share price is strongly influenced by the retained
earnings ratio. They further posit that investors prefer companies that retain their
earnings for business growth rather than paying dividends. Conversely, Majanga
(2015) asserts that dividend coverage ratio is one of the factors that cause fluctuation
in the share value of a company. He added that investors prefer to invest their funds in
shares of companies that pay dividends.
Therefore, a critical analysis of these factors gives the investors insight knowledge on
whether the share price of a company is undervalued or overvalued in stock market at
a particular point in time. An understanding of the impact of various fundamental
variables on share price by investors helps them in making informed investment
decisions(Srinivasan, 2013). However, the dynamic nature of the stock market and
conflicting views held by scholars in the literature as regard the factors influencing
share price and persistent fluctuation in the prices of shares is still a crucial issue
facing investors, fund managers and investment analysts in the financial market
(Malhorta and Tandon, 2013) and (Almumani, 2014). These also pose a challenge
making the task of identifying those fundamental factors that could cause changes in
the share value and predicting future prices of shares complex.
Consequent upon the shock caused by the global financial crisis which had adversely
affected the prices of the equity shares of companies in Nigeria, most companies had
made strenuous efforts in raising funds to finance investments and projects in order to
recover and survive continually in business. In the same vein, and as part of the effort
to regain the confidence of their shareholders, companies had also adopted dividend
policies that would maximize the market values of their equity shares and boost the
shareholder’s wealth. Adamu (2009) contended that the companies in Nigeria that
were affected by the global financial crisis were mostly those in the oil and gas sector
and this has had a severe effect on the economy as revenue from the sector is the
major source of financing the Nigerian budget.
The sector has also suffered challenges posed by the fall and fluctuation in the price of
crude oil at the international market over the years, which affected the revenue base of
the sector in particular and the Nigerian economy in general (Adamu, 2015) and
(Ogochukwu, 2016). In the world today, crude oil is the major source of foreign
exchange and energy that powers the global economy and its industrialization
processes; and so fluctuation in the price of crude oil in the global market is expected
to have significant impact on both importing countries and the exporting countries of
the product (Abubakar and Umar, 2013 as cited in Inyiama&Ugah, 2015).
In 2015, the oil and gas sector had witnessed a fall in the price of crude oil at the
international market, which had affected the revenue in the sector and the nation’s
foreign exchange (Ogochukwu, 2016). This study therefore, intends to assess the
extent to which the debt financingdecision and choice of dividend policy by the oil
and gas companies in Nigeria during the global economic meltdown in 2007 and fall
in price of crude oil at the global market in 2015 affected the market values of their
equity shares in the stock market.
1.2 Statement of theResearch Problem
Several studies have been conducted for many decades in many developed and
developing countries on the issue of financial leverage, dividend policy and their
impact on share value.In Nigeria, many empirical studies have broadly attempted to
analyse the determinants of share price (Somoye, Akintoye&Oseni, 2009, Uwuigbe,
Olowe&Agu, 2012, Stephen &Okoro, (2014). Though some few studies have
attempted to analyse specifically the relationship between financial leverage and share
price (Oboh, Isa &Adekoya, 2012, Adenugba, Ige&Kesinro, 2016) or the relationship
between dividend policy and share prices of listed firms in Nigeria (Adelagan, 2009,
Okafor, Mgbame&Chijoke-Mgbame, 2011, Abubakar, 2012, Adaramola, 2012,
Adefila, Oladipo&Adeoti, 2013, Oyinlola&Ajeigbe, 2014, Ordu, Enekwe&Anyanwao,
2014), but to the best of the researcher’s knowledge, these studies employed virtually
the same explanatory variables such as dividend per share, dividend yield, dividend
payout ratio, and debt to equity ratio, while others used only one measure of financial
leverage or dividend policywhich cannot adequately explain the influence of financial
leverage or dividend policy on share value of quoted companies in Nigeria.
In addition, there is still no consensus among these scholars regarding the factors
determining the movement of share prices of companies in the Nigerian stock market.
This could be due to the fact that the impact of certain variables on stock prices varies
with the scope of the study, the periods covered in the study, the events that occurred
during the research period and the sector studied.
Relying on a single measure of financial leverage and dividend policy cannot
adequately explain the impact of debt financing and dividend policy on the movement
of share prices in Nigeria. Therefore, it is in this recognition that this study attempts to
employ other financial leverage measures like total debt to total capital ratio and
interest coverage ratio and dividend policy indicators like retained earnings ratio and
dividend coverage ratio to assess specifically how the level of financial leverage
employed and dividend policy deliberately adopted by the quoted oil and gas
companies in Nigeria had affected their share values during the periods which the
share prices of the companies suffered from the global financial crisis and fall in the
price of crude oil in the global market respectively (Jambawo, 2014, Hussain&Gul,
211, Majanga, 2015, and Malhorta&Tandon, 2013).
The oil and gas sector in Nigeria has suffered challenges posed by the fall and
fluctuation in the price of crude oil at the international market over the years, which
affected the revenue base of the sector in particular and the Nigerian economy in
general (Adamu, 2015) and (Ogochukwu, 2016). The choice of this sector is due to the
role it plays as the provider of the largest part of foreign exchange earnings and total
revenue required for economic and political development and growth in the Nigerian
economy (Akomolafe&Danladi, 2014) and (Ogochukwu, 2016).
Furthermore, the idea behind the study of the combined impact of financial leverage
and dividend policy on share value of the quoted oil and gas companies is based on the
fact that the firm’s decision on the amount of debt (financial leverage) to be included
in its capital structure and decision on the proportion of earnings to be retained
(dividend policy) are both primarily aimed at raising funds to finance the firm’s
investment opportunities and consequently maximize shareholders’ wealth and boost
share value, hence the need to assess how these two crucial financial management
decisions had jointly influenced the behavior of share prices of the oil and gas
companies in Nigerian Stock Market during the global economic meltdown and period
of global fall in the price of crude oil respectively.
1.3 Research Questions
From the forgoing, this study intends to proffer answer to the following questions:
i. To what extend doestotal debt to total capital ratio affect the share value of
quoted oil and gas companies in Nigeria?
ii. How does the interest coverage ratio influence the share value of quoted oil
and gas companies in Nigeria?
iii. What impact does retained earnings ratio have on share value of quoted oil and
gas companies in Nigeria?
iv. Does dividend coverage have any significant impact on the share value of
quoted oil and gas companies in Nigeria?