CHAPTER ONE

INTRODUCTION

1.1 Background to the Study

Capital structure, also called financial structure, is the mix of debt, equity and hybrid securities that a firm uses to finance its assets. The subject goes back to Modigliani and Miller (1958), and recent reviews of the theory and the evidence show that it remains an active area of research (Brusov & Filatova, 2023; John & Joseph, 2025; Kruk, 2021). How a firm is financed matters to managers and providers of funds alike, because an unsuitable mix of debt and equity can threaten both the performance and the survival of the business. This study contributes to the debate on the relationship between capital structure and firm performance, using data from the Nigerian foods, beverages and tobacco sector, and it asks whether capital structure affects the financial performance of firms.

An efficient economic system needs reliable mechanisms for allocating resources among competing uses. In a market economy, much of this allocation is the result of private decisions, and capital investment and financing decisions are among the most important. At firm level, they affect operations, profitability, growth and survival. At national level, poorly allocated capital lowers the productivity of labour and materials and limits the economy's potential output.

Scholars have not agreed on whether an optimal capital structure exists. Modigliani and Miller (1958) showed that, in a perfect capital market, firm value is independent of capital structure, so that debt and equity are perfect substitutes. Once their restrictive assumptions are relaxed, financing choices begin to matter. Later theories explain these choices through the trade-off between the tax benefits and the distress costs of debt, through information asymmetry between managers and outside investors, which gives rise to the pecking order of financing (Myers & Majluf, 1984), and through the agency conflicts between managers, shareholders and creditors (Jensen & Meckling, 1976). Recent studies continue to test these theories. A meta-analysis by Dao and Ta (2020) finds that corporate performance is negatively related to leverage, which is consistent with the trade-off model with agency costs and with the pecking order theory, and that the industry in which firms operate is a significant moderator of the relationship. Ronoowah and Seetanah (2024) further examine the moderating and mediating roles of agency cost in the link between capital structure and firm performance.

The choice of financing mix is therefore a critical decision, because it affects the cost of capital, the risk borne by shareholders and the ability of the firm to compete. Firm characteristics also matter. In the Nigerian consumer goods sector, Oluwatuyi and Obafemi (2023), using data for 2011 to 2020, found that firm size is positively associated with profitability and that firm age is negatively associated with it, and Garba (2026) investigates the effect of firm size and age on the profitability of listed consumer goods firms. Performance is commonly measured with accounting indicators, such as return on assets, return on equity and earnings per share, and with market indicators, such as the price–earnings ratio and market capitalisation. Financial ratios help to standardise this information so that analysts, managers and investors can compare firms and assess their strengths and weaknesses.

Recent Nigerian studies reach different conclusions. Abdullahi et al. (2026), using fixed-effects panel regression on listed Nigerian food and beverage firms for 2020 to 2024, report that the debt-to-equity ratio is significantly and negatively related to return on assets and return on equity, while firm size and asset growth are positively related to performance. Umar (2025), analysing 21 consumer goods firms listed on the Nigerian Exchange Group for 2014 to 2023, found a significant overall relationship between capital structure and financial performance, although the individual leverage measures he tested did not show a statistically significant effect on their own. Uwasomba and Boniface (2024), in a study of the capital structure of British American Tobacco Nigeria, found that liquidity has a positive and significant effect on the debt-to-equity ratio, while total assets and profitability have negative and significant effects, which is consistent with the pecking order and agency theories. Aghaebe and Oranefo (2024) also examined the capital structure and financial performance of listed consumer goods firms. Because these results differ, the foods, beverages and tobacco sector merits further critical analysis.

1.2 Statement of the Problem

The link between capital structure and firm performance has been debated for decades without a clear resolution. Researchers have not agreed on how, or how far, capital structure affects firm value and performance. The theoretical literature offers competing predictions, and the empirical literature has produced positive, negative and insignificant results depending on the country, sector, period and measure of performance. Dao and Ta (2020) synthesise this controversial evidence in a meta-analysis and identify industry as one of the sources of the inconsistency, which supports the case for sector-specific studies.

In practice, the optimal capital structure is difficult to identify. Theory suggests that, in a world with taxes and bankruptcy costs, the optimal structure is the one that minimises the weighted average cost of capital and so maximises firm value, but no formula identifies it decisively. Different views also exist on which source of funds is most suitable. The trade-off perspective stresses the tax advantage of debt, while the pecking order perspective argues that, because of information asymmetry, firms prefer internal funds, then debt, and only last equity (Myers & Majluf, 1984). The agency perspective adds that debt can discipline managers, but that excessive debt creates conflicts between shareholders and creditors (Jensen & Meckling, 1976). Raising capital in Nigeria is made harder by its cost and risk, and many managers and investors pay little attention to how the financing mix affects performance.

Evidence specific to the foods, beverages and tobacco sector remains limited and inconclusive. Studies of Nigerian firms typically cover mixed groups of firms or single companies, and their results differ (Abdullahi et al., 2026; Umar, 2025; Uwasomba & Boniface, 2024). Umar (2025) also observes that earlier Nigerian studies often examined only some components of debt financing, which limits what can be concluded about the financing mix as a whole. Corporate managers in the sector therefore do not have clear guidance on which sources of finance to use, or on how much of each, to achieve efficient performance. This study investigates the effect of capital structure on the performance of manufacturing firms in the Nigerian foods, beverages and tobacco sector, in order to address that gap.

1.3 Objectives of the Study

The main objective of the study is to analyse critically the effect of capital structure on the performance of manufacturing firms in the Nigerian foods, beverages and tobacco sector. The specific objectives are to determine:

1. whether the capital structure of the firms under study has a significant positive effect on their performance;
2. the relationship between firm size and capital structure; and
3. the relationship between firm age and capital structure.

1.4 Research Questions

In line with the objectives, the study answers the following questions:

1. To what extent does capital structure affect financial performance?
2. What is the relationship between firm size and capital structure?
3. What is the relationship between firm age and capital structure?

1.5 Research Hypotheses

The following hypotheses, stated in null form, guide the study:

H₀₁: Capital structure has no significant positive effect on the financial performance of firms in the foods, beverages and tobacco sector.

H₀₂: There is no significant relationship between firm size and capital structure.

H₀₃: There is no significant relationship between firm age and capital structure.

1.6 Scope of the Study

The study is limited to the analysis of the capital structure of listed manufacturing firms in the foods, beverages and tobacco sector of the Nigerian economy. It examines how their financing mix relates to their financial performance and to firm characteristics, namely size and age.

1.7 Significance of the Study

The study is significant in three main ways. First, it provides evidence that managers of manufacturing firms can use in applying sound principles of capital structure management and in judging how much debt and equity to employ. Second, it adds to the evidence on capital structure and performance in a developing-country setting and in a specific sector, which helps to address the inconsistency that meta-analytic work attributes partly to differences between industries (Dao & Ta, 2020). Third, it provides a reference for students, researchers and other stakeholders in manufacturing and finance who wish to study the subject further.

References

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Aghaebe, V. C., & Oranefo, P. C. (2024). Capital structure and financial performance of consumer goods firms listed in Nigeria. Journal of Global Accounting, 10(1), 33–61.

Brusov, P., & Filatova, T. (2023). Capital structure theory: Past, present, future. Mathematics, 11(3).

Dao, B. T. T., & Ta, T. D. N. (2020). A meta-analysis: Capital structure and firm performance. Journal of Economics and Development, 22(1), 111–129. https://doi.org/10.1108/JED-12-2019-0072

Garba, M. S. (2026). Impact of firm size, firm age on the profitability of listed consumer goods firms in Nigeria. FUDMA Journal of Accounting and Finance Research, 4(1), 104–117. https://doi.org/10.33003/fujafr-2026.v4i1.293.104-117

Jensen, M. C., & Meckling, W. H. (1976). Theory of the firm: Managerial behavior, agency costs and ownership structure. Journal of Financial Economics, 3(4), 305–360.

John, N., & Joseph, K. S. (2025). A systematic literature review on the impact of capital structure on corporate financial performance. Review of Professional Management. https://doi.org/10.1177/09728686251404428

Kruk, S. (2021). Impact of capital structure on corporate value—Review of literature. Journal of Risk and Financial Management, 14(4), 155. https://doi.org/10.3390/jrfm14040155

Modigliani, F., & Miller, M. H. (1958). The cost of capital, corporation finance and the theory of investment. American Economic Review, 48(3), 261–297.

Myers, S. C., & Majluf, N. S. (1984). Corporate financing and investment decisions when firms have information that investors do not have. Journal of Financial Economics, 13(2), 187–221.

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