ASSESSING THE IMPACT OF CAPITAL STRUCTURE ON PROFITABILITY OF MANUFACTURING INDUSTRY IN GHANA: A CASE STUDY AT SELECTED FIRMS BY: DUAH AWUAH-AGYEMAN A THESIS SUMMITED TO THE DEPARTMENT OF ACCOUNTING AND FINANCE, KWAME NKRUMAH UNIVERSITY OF SCIENCE AND TECHNOLOGY IN PARTIAL FULFILMENT OF THE REQUIREMENT FOR MASTERS IN BUSINESS ADMINISTRATION SCHOOL OF BUSINESS COLLEGE OF HUMANITIES AND SOCIAL SCIENCE AUGUST, 2015 DECLARATION I hereby declare that this is my own work and that, to the best of my knowledge it contains no material previously published by another person nor materials which have been accepted for the award of any degree in this or any other University, except where due acknowledgement has been made in the text. Duah Awuah-Agyemen …………………..……… …………….…… Student Name Signature Date (PG 9610613) Certified Mr. Gideon Boako …………………..……… …………….…… Supervisor: Signature Date Certified Dr. K. O. Appiah …………………..……… …………….…… (Head of Department) Signature Date ii ACKNOWLEDGEMENT I would like to give praise and thanks to the Almighty God for His guidance and protection throughout my life and also seeing me through my studies. I express my sincere gratitude to my supervisor Mr. Gideon Boako who took time to read and made the necessary criticisms, suggestions and corrections in the course of writing this thesis. I also thank Dr. Oteng Abayie of the Economic Department for his help on the regression model for my analysis. I am extremely grateful to my brother Mr. Kwasi Awua and my friends Mr. Cudjoe Ahetoe and Mr. Tei Muno who assisted me financially in pursuing this program. To Mr. Eric Achindiba, the Chief Accountant of Naja David Company, I am grateful for helping me to get data for this work. My gratitude also goes to my wife and children for their support and understanding throughout my study period. Finally to all my course mates, especially, Josephine Duodu (Mrs), Tony Gyapong, Isaac Danso and my friend Ebenezer Duut, I thank you all for your various assistance and advice. iii DEDICATION I dedicate this work to my wife, Pat and the children. iv ABSTRACT This research was done to assess the impact of capital structure on profitability of manufacturing industry in Ghana using some selected firms as the case study for a period of eight (8) years: 2005-2012. Fifteen (15) firms were selected from different sub-sectors of the manufacturing industry. Thirteen (13) of them were firms listed on the Ghana Stock Exchange (GSE) whilst the other two were from the private sector. Data for the study were obtained from the audited financial statements of the selected firms from the GSE and the individual firms‟ websites or obtained with permission. Return on equity (ROE) or profit after interest and tax was used to representing profitability, whilst capital structure was represented by the natural logarithms of short term debt (STD), long term debt (LTD) and equity (EQ). Panel data regression method, using both the fixed –effects and the random –effects, was used for the data analysis. Descriptive statistics and correlation analysis were also employed in the study. The result shows that STD and LTD were negatively related to profitability but the effect of the LTD was insignificant. whilst EQ was positively related to profitability. This was consistent with previous empirical studies and also with literature. The study recommends that manufacturing firms in Ghana should use equity such as retained earnings to expand their business instead of debt. Where debt has to be taken it is recommended that it has to be a long term debt. For future research, it is recommended that a study should be done by considering increasing the sampled firms to cover other manufacturing sectors; by considering more firms in the private sector and also looking at the effect of total debt on profitability in the manufacturing industries. v TABLE OF CONTENT DECLARATION.......................................................................................................... ii ACKNOWLEDGEMENT ..........................................................................................iii DEDICATION............................................................................................................. iv ABSTRACT .................................................................................................................. v TABLE OF CONTENT .............................................................................................. vi LIST OF TABLES ...................................................................................................... ix LIST OF APPENDIX .................................................................................................. x CHAPTER ONE .......................................................................................................... 1 INTRODUCTION........................................................................................................ 1 1.0 Introduction .............................................................................................................. 1 1.1 Background of the study .......................................................................................... 1 1.2 Statement of problem, .............................................................................................. 4 1.4 Research Questions .................................................................................................. 5 1.5 Relevance of the Study. ........................................................................................... 5 1.6 Scope of the Research .............................................................................................. 6 1.7 Limitations of the Study........................................................................................... 7 1.8 Organization of the Work. ....................................................................................... 7 CHAPTER TWO ......................................................................................................... 8 LITERATURE REVIEW ........................................................................................... 8 2.1 Introductions ............................................................................................................ 8 2.2 The concept of capital structure ............................................................................... 8 2.3 Capital Structure Theories. ...................................................................................... 9 2.3.1 The Trade-off Theory ........................................................................................... 9 2.3.1.1 Tax ................................................................................................................... 11 2.3.1.2 Contracting costs .............................................................................................. 12 2.3.1.3 Bankruptcy Cost............................................................................................... 13 2.3.1.4 Agency Cost ..................................................................................................... 14 2.3.1.5 Information Asymmetry Cost .......................................................................... 16 2.3.1.6 Transaction Cost .............................................................................................. 17 2.4. Pecking Order Theory. .......................................................................................... 18 vi 2.4.1 The Signaling, or Asymmetric Information Theory ........................................... 19 2.4.2 The Market Timing Theory ................................................................................ 20 2.5. Determinants of Capital Structure. ....................................................................... 21 2.5.1 Profitability ......................................................................................................... 21 2.5.2 Size of a firm ....................................................................................................... 22 2.5.3 Asset structure ..................................................................................................... 22 2.5.4 Growth ................................................................................................................ 23 2.5.5 Firm risk .............................................................................................................. 24 2.5.6. Taxation ............................................................................................................. 24 2.5.7 Firm‟s Age. ......................................................................................................... 25 2.6. Relationships between Firms Leverage and Profitability ..................................... 26 2.6.1 Positive association between leverage and firm profitability. ............................ 26 2.6.2 Negative association between capital structure and company‟s profitability. .... 27 2.7. Brief Historical Overview of Manufacturing firms in Ghana. .............................. 28 2.7.1 Current view of manufacturing in Ghana ........................................................... 30 2.7.2 Challenges in Manufacturing in Ghana. ............................................................. 31 CHAPTER THREE ................................................................................................... 34 METHODOLOGY .................................................................................................... 34