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European Journal of Economic and Financial Research ISSN: 2501-9430 ISSN-L: 2501-9430 Available on-line at: http://www.oapub.org/soc Volume 2 │ Issue 5 │ 2017 doi: 10.5281/zenodo.897779 THE DEVELOPMENT OF DEBT TO EQUITY RATIO IN CAPITAL STRUCTURE MODEL: A CASE OF NIGERIAN MANUFACTURING FIRMS Hillary Chijindu Ezeaku1i, Anthony E. Ageme2, Izuchukwu Ogbodo3, Eze Festus Eze4 1&2 Department of Banking and Finance, University of Nigeria, Enugu Campus, Nigeria Department of Banking and Finance, Enugu State University of 3 Science and Technology, Enugu, Nigeria Department of Economics, University of Nigeria, Nsukka, Nigeria 4 Abstract: The arguments on the responsiveness of capital structure leverage to sets of its major determinants have dominated the corporate finance literature. There is however no consensus regarding the direction of effects of these determinants on debt to equity ratio. In contribution to existing literature, this study explored development of debt to equity ratio in capital structure in the Nigerian context, with aim of filling gaps in methodology which have been argued to undermine the credibility of previous findings. The method of estimation used is the Panel-Fully Modified Ordinary Least Squares (FMOLS). The Pedroni cointegration test was employed to test for long-run relationship. The descriptive statistics and the panel unit root test were the preliminary test. We ascertained that our data set are stable and normally distributed as precursor to determining if the variables are cointegrated. A more sophisticated method of panel estimation other than the traditional method was adopted which among other advantages purges the defects posed by heteroskendasticity prevalent in the conversional estimation method. We established that there is a long-run relationship between debt to equity ratio and tangibility, profitability, firm growth and firm size. The panel regression estimate confirmed the trade-off theory and the pecking order hypothesis in Nigeria as tangibility was found to have positive effect on corporate leverage. However, the finding with regards to growth and firm size supports the trade-off theory while discrediting the pecking order assumption. Profitability on the Copyright © The Author(s). All Rights Reserved. © 2015 – 2017 Open Access Publishing Group 1 Hillary Chijindu Ezeaku, Anthony E. Ageme, Izuchukwu Ogbodo, Eze Festus Eze THE DEVELOPMENT OF DEBT TO EQUITY RATIO IN CAPITAL STRUCTURE MODEL: A CASE OF NIGERIAN MANUFACTURING FIRMS other hand confirmed the pecking order theory for Nigeria and shows that profitability has negative effect on debt to equity ratio. The robustness and reliability of the findings was embedded on the controls for residual weaknesses and disturbances. JEL: L60, O14, D24 Keywords: capital structure, manufacturing firms, cointegration, panel FMOLS 1. Introduction The corporate finance literature has traditionally focused on the study of long-term financial decisions, particularly investments, capital structure, dividends or company valuation decisions. However, the key developments of capital structure with keen emphasis on debt to equity ratio need to be carefully analyzed. Gomez et al., (2012) state that if financing decisions are not right it will definitely affect the value of the firm. Supporting this assertion, Oino (2014) argues that bankruptcy is ultimately an outcome of high exposure to debt. The maximization of shareholders’ wealth remains the main objective of any profit-making organization. Ukaegbu & Oino (2012) highlight the need for finance managers to maintain the appropriate selection mix between debt and equity. In response to fewness of studies on this field, this study attempt to evaluate appropriate capital structure model from the perspective of the Nigerian manufacturing sector. Determining the optimal capital structure is often a daunting challenge for managers. Handoo & Sharma (2014) emphasise that in periods of credit expansion, firms find it very difficult to maintain an ideal liquidity level. When credit expands, liquidity contracts and firm, firms that mostly have do not have predictable cash flow rely on borrowing when usually translates to accumulation of excess debt. Gleason, Mathur & Mathur (2000) suggest that every firm has a specific strategy which is critical to improving the performance of a firm especially when the firm is facing diverse level of debt and equity integrated in the capital structure. Achieving the optimal mix of debt and equity is difficult to attain (Ukaegbu & Oino, 2014). Ramalho and Silva (2007) opine that variation in size has considerable influence in determining the capital structure compositions. Manufacturing firms have broad access to external financing and eventually they rely more on internally generated funds resulting from profitable operations compared to smaller firms like the SMEs (Uyar & Guzelyurt, 2015). Coleman (2000) supports this view and argued that small firms are normally unable to secure adequate sources of finance and this consequently results bankruptcy and failure. A few studies have actually attempted to determine the factors that determine capital structure. For instance, Anuar & Chin (2016), Hashemi (2013), AlNajjar & Taylor (2008) state that growth, firm size and profitability influence the European Journal of Economic and Financial Research - Volume 2 │ Issue 5 │ 2017 2 Hillary Chijindu Ezeaku, Anthony E. Ageme, Izuchukwu Ogbodo, Eze Festus Eze THE DEVELOPMENT OF DEBT TO EQUITY RATIO IN CAPITAL STRUCTURE MODEL: A CASE OF NIGERIAN MANUFACTURING FIRMS composition of debt in capital structure, while Gomez et al. (2001) and Ondieki, Gaster & Moraa (2013), and Saarani & Shahadan (2013) in their study suggest that liquidity is also a determinant of debt in capital structure. It is important to understand on how firms choose their financing choices by examining the relationship between capital structure and firm’s profitability and gauges the main attribute of capital structure that could influence on the firm’s profitability because long-term survivability of the firm heavily depends on its profitability and to know sound of capital structure decision made. Since interest is tax deductible in Nigerian tax systems, so that we expect that it will impact the capital structure decision made by the firm. Thus, study of capital structure would provide valuable insights on how strategic decision on implementing investments would affect firm values, which in return, used to determine the firm position in the market. The major contribution of this study to existing knowledge is in adopting dynamic analytical approach lacking in existing literature. The robustness of our parameters will be tested while a panel cointegrating association, which is rarely applied in panel estimation, will be determined. The panel dynamic OLS has been found a major breakthrough in panel data processing and will be employed in estimating our baseline linear function. The need to fill these gaps in knowledge is the major motivation for this study. For downloading the full article, please access the following link: https://oapub.org/soc/index.php/EJEFR/article/view/138 European Journal of Economic and Financial Research - Volume 2 │ Issue 5 │ 2017 3