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PROJECT TOPIC: THE IMPACT OF CAPITAL STRUCTURE AND PERFORMANCE ON THE PETROLUEM SECTOR

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CHAPTER ONE

INTRODUCTION

1.1      BACKGROUND OF THE STUDY The theory of capital structure is an important reference theory and perhaps, one of the most puzzling issues in corporate finance. The determination of optimal capital structure which maximizes firm’s value has frustrated theoretician for decades. The early works made numerous assumptions in other to simplify the problem and assumed that both the cost of debt and cost of equity were independent of capital structure and that the relevant figure for consideration was the net income of the firm. However a closer look suggests that the costs of debt and the cost of equity are important and relevant figure for consideration. Pandey (1999) defines capital structure to mean a mix of long term sources of funds, such as debentures long term debt, preference share capital, and equity share capital including reserves and surplus (i.e. retained earnings). Pandey goes further to say that some companies do not plan their capital structure and it develops as a result of the financial decision taken by the financial manager, but ultimately, they may face considerable difficulties in raising funds to finance their activities. Also with unplanned capital structure, these companies may fail to economize the use of their funds. In order to fortify the firm against these severe consequences, it is being increasing realized that a company should plan its capital structure. Anup and Pual (2010). Debt provides tax shield benefit to firms. Capital structure planning is also advisable to be able to maximize the use of funds and to adapt easily to changing economic conditions. Capital structure simply means an enterprises mixture of debt and equity financing. Debt and equity is probably the reason why Brounen and Elchholts (2001), make the assertion that the announcements of season equity offerings cause negative price reactions, whereas the news of an additional debt issue is followed by an increase in stock prices whether or not the structure of capital has an impact on performance is one of the most complex and important issues in corporate finance. A number of assertions have been made on this very issue. Chen (2001) examines the relationship between ownership structure and firm value in the case of China. The result shows that there is a strong positive relationship between concentrated ownership and corpora value. Earlier, it was asserted that ownership structure plays an important role in a firm, particularly in determining the directions and goals of the firm which influence performance, and in turn, affects shareholder’s wealth as well as stakeholders’ benefits (Porter, 1990; La Portal et al, 1998; and Jensen, 2000).


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