Introduction:

In the realm of corporate finance, capital structure is a fundamental determinant of a firm's financial performance and sustainability. Capital structure refers to the proportion of debt, equity, and other financial instruments used by a firm to finance its operations and growth (Olokoyo, 2012). The choice between debt and equity financing has significant implications for a firm's cost of capital, financial risk, and potential return on investment. In emerging economies like Nigeria, where financial markets are evolving, capital structure decisions become critical due to various factors, including high-interest rates, inflation, currency volatility, and limited access to long-term financing.

Nigerian deposit money banks (DMBs) are crucial to the country's economy, serving as financial intermediaries that mobilize savings and provide credit to individuals and businesses. Their performance has direct implications for economic growth, employment, and overall financial system stability (Olayemi & Fakayode, 2021). However, the banking sector in Nigeria faces unique challenges, including regulatory constraints, fluctuating interest rates, and an unpredictable economic environment. Consequently, the capital structure decisions made by these banks can significantly influence their ability to generate profits and manage financial risks.

This paper investigates the impact of capital structure on the financial performance of quoted deposit money banks in Nigeria, focusing on how long-term debt and equity affect key performance metrics such as Return on Equity (ROE) and Profit After Tax (PAT). By analyzing data from 2012 to 2021, this study aims to provide insights into how Nigerian banks can optimize their capital structure to enhance their financial outcomes. The findings will contribute to the existing literature on capital structure theory, particularly in the context of emerging markets, where financial instability and market imperfections are more pronounced.

Objectives of the Study:

The primary objectives of this study are as follows:

1. To examine the effect of long-term debt on Return on Equity (ROE) of quoted deposit money banks in Nigeria.
2. To determine the impact of equity on ROE of quoted deposit money banks in Nigeria.
3. To assess the influence of equity on Profit After Tax (PAT) of quoted deposit money banks in Nigeria.
4. To evaluate the effect of long-term debt on PAT of quoted deposit money banks in Nigeria.
5. To provide empirical evidence that can guide bank managers in making optimal capital structure decisions.

Research Questions:

The study aims to answer the following research questions:

1. What is the effect of long-term debt on ROE of quoted deposit money banks in Nigeria?
2. What is the impact of equity on ROE of quoted deposit money banks in Nigeria?
3. How does equity influence PAT of quoted deposit money banks in Nigeria?
4. To what extent does long-term debt affect PAT of quoted deposit money banks in Nigeria?

Research Hypotheses:

The study formulates the following null hypotheses:

1. H01: Long-term debt has no significant effect on ROE of quoted deposit money banks in Nigeria.
2. H02: Equity has no significant impact on ROE of quoted deposit money banks in Nigeria.
3. H03: Equity has no significant influence on PAT of quoted deposit money banks in Nigeria.
4. H04: Long-term debt has no significant effect on PAT of quoted deposit money banks in Nigeria.

Conceptualization of Terms:

To ensure clarity and understanding, key terms used in this study are defined as follows:

Capital Structure: The mix of a firm's long-term debt, short-term debt, common equity, and preferred equity used to finance its operations. This study focuses on the components of long-term debt and equity as capital structure variables.

Return on Equity (ROE): A financial ratio that measures a firm's profitability by comparing net income to shareholders' equity. It is a key performance indicator used to assess how effectively a bank uses its equity to generate profits.

Profit After Tax (PAT): The net profit a company has left after all taxes have been paid. It is a key measure of a firm's profitability and is used in this study to evaluate the overall financial performance of banks.

Long-term Debt: Debt that is due for repayment after more than one year. In this study, long-term debt refers to the portion of a bank’s total debt obligations that have a maturity period of more than one year.

Equity: The ownership interest held by shareholders in a bank. This includes common stock, retained earnings, and other reserves, representing the bank’s internal financing sources.

Literature Review:

Conceptual Framework of Capital Structure:

The concept of capital structure involves the mix of a firm's long-term debt, short-term debt, common equity, and preferred equity used to finance its operations and growth (Olufemi et al., 2021). The structure of this mix determines a firm's cost of capital and its overall financial risk profile. Various theories have been developed to explain the relevance and implications of capital structure decisions for firm performance.

One of the foundational theories in corporate finance is the Modigliani-Miller Theorem (1958), which argues that in a world without taxes, bankruptcy costs, or transaction costs, the value of a firm is independent of its capital structure. However, in the real world, market imperfections such as taxes, bankruptcy risks, and asymmetric information make capital structure decisions crucial to firm value. The introduction of corporate taxes into the Modigliani-Miller framework later showed that firms could benefit from debt financing due to the tax shield provided by interest payments.

The Trade-off Theory posits that firms balance the benefits of debt (primarily the tax shield) against the potential costs of financial distress, including bankruptcy. This theory suggests that firms should seek an optimal capital structure where the marginal benefit of debt equals its marginal cost (Olufemi et al., 2021). In emerging markets like Nigeria, where the cost of debt is relatively high due to high-interest rates and inflationary pressures, firms must be careful in their use of leverage.

The Pecking Order Theory, introduced by Myers and Majluf (1984), suggests that firms prefer internal financing over external financing. If external financing is necessary, firms opt for debt over equity due to lower information asymmetry and lower flotation costs. This theory implies that firms with higher profitability are more likely to finance their operations with retained earnings, while firms with less profitability may rely on debt.

Capital Structure in Emerging Economies:

In emerging markets like Nigeria, firms face additional challenges in determining their optimal capital structure. Economic volatility, high inflation rates, currency instability, and underdeveloped capital markets make it difficult for firms to access affordable long-term debt or raise equity (Mahmud & Musa, 2016). Additionally, government regulations, such as capital adequacy requirements for banks, further constrain the capital structure decisions of firms in these economies.

Studies in emerging markets have shown that capital structure decisions have a significant impact on financial performance. For instance, Nwaolisa and Chijindu (2016) found that Nigerian firms with higher levels of debt performed worse than those with lower debt levels, primarily due to the high cost of debt in Nigeria's economic environment. Conversely, Ajibola et al. (2019) demonstrated that moderate levels of long-term debt could positively impact financial performance, as firms could benefit from the tax shield provided by interest payments.

Empirical Evidence on Capital Structure and Financial Performance:

Numerous empirical studies have explored the relationship between capital structure and financial performance, yielding mixed results. In developed markets, studies like those of Frank and Goyal (2009) found that firms with higher leverage tend to have higher profitability, especially in industries where the tax benefits of debt outweigh the costs of financial distress. However, in developing markets, the results are less clear.

In the Nigerian banking sector, Olayemi and Fakayode (2021) found that banks with higher debt levels generally reported higher ROE, but they also faced greater risks of financial distress, particularly during periods of economic downturn. Chechet and Olayiwola (2014) noted that while debt financing could enhance profitability through leverage, excessive reliance on debt could undermine firm value, especially in an unstable economic environment.

Research conducted by Akinwumi and Akintoye (2018) on the impact of capital structure on the performance of banks in Nigeria found that the optimal capital structure significantly influences profitability. Their study indicated that banks with higher leverage exhibited higher financial performance due to the benefits of debt tax shields but warned against excessive leverage, which may lead to financial instability.

The existing literature underscores that the relationship between capital structure and financial performance is complex and context-dependent. In Nigeria, the interplay of high-interest rates, economic uncertainty, and regulatory constraints further complicates these dynamics, suggesting that a one-size-fits-all approach to capital structure management may not be appropriate.

Theoretical Framework for the Study:

This study is anchored in two main theories: the Trade-off Theory and the Pecking Order Theory. The Trade-off Theory provides a basis for understanding how firms weigh the benefits of debt against its risks. In the context of Nigerian banks, this theory is pertinent as it reflects the need to find an optimal level of debt that balances tax benefits and bankruptcy costs.

The Pecking Order Theory complements this by highlighting the preference for internal financing, suggesting that banks with strong internal cash flows may prioritize equity over debt financing. This is particularly relevant in Nigeria's banking sector, where access to capital markets may be limited due to economic instability and regulatory frameworks.

Methodology:

Research Design

This study adopts an ex-post facto research design to analyze historical data and determine relationships between capital structure variables and financial performance indicators of quoted deposit money banks in Nigeria. The focus is on banks listed on the Nigeria Exchange Group (NGX) over the period from 2012 to 2021. The study employs two main performance indicators: Return on Equity (ROE) and Profit After Tax (PAT).

Population and Sampling:

The target population for this study includes all deposit money banks listed on the Nigeria Exchange Group. A purposive sampling technique was employed to select ten banks that consistently provided complete financial reports over the specified period. This selection ensures that the data analyzed are relevant and reliable for drawing conclusions about capital structure impacts.

Data Collection:

Secondary data were gathered from the audited annual financial statements of the selected banks. The data set includes:

Long-Term Debt: Total liabilities due after one year.

Equity: Total shareholders’ equity, including common stock and retained earnings.

Return on Equity (ROE): Calculated as Net Income divided by Shareholders' Equity.

Profit After Tax (PAT): The net profit reported after all tax obligations have been settled.

This data was sourced from the banks' annual reports, which are publicly available and accessible through the Nigeria Exchange Group’s website and the banks' investor relations sections.

Data Analysis:

The collected data were subjected to regression analysis to assess the relationships between capital structure components (long-term debt and equity) and financial performance indicators (ROE and PAT). The regression model can be expressed mathematically as:

Y = β0 + β1LTD + β2EQ + ϵ

Where:

YYY represents financial performance ROE or PAT,

β0​ is the constant term,

β1 is the coefficient for long-term debt (LTD),

β2​ is the coefficient for equity (EQ),

ϵ is the error term.

The analysis was conducted using SPSS software, and a significance level of 5% was adopted for hypothesis testing. The regression results were interpreted to understand the impact of capital structure on the financial performance of Nigerian banks.

Results and Discussion

Descriptive Statistics:

The descriptive statistics provide an overview of the key variables used in the study. The data summary is presented in Table 1.

The average ROE for the sampled banks was found to be 13.5%, indicating moderate profitability in the banking sector during the study period. The average PAT of ₦45.8 billion reflects a strong earnings capacity, suggesting that Nigerian banks can sustain operations effectively despite the economic challenges. Long-term debt accounted for 45% of the capital structure on average, showing a reliance on debt financing, while equity made up 55%, indicating a balanced approach.

Regression Analysis Results:

Table 2: presents the results of the regression analysis conducted to determine the impact of long-term debt and equity on ROE and PAT.

The results indicate a positive and statistically significant relationship between long-term debt and ROE (p < 0.05), suggesting that banks with higher levels of long-term debt tend to experience higher returns on equity. This finding is consistent with the trade-off theory, which posits that moderate levels of debt can enhance profitability through leverage benefits. However, it is crucial to note that excessive debt can increase the risk of financial distress, particularly in a high-interest-rate environment like Nigeria's.

Similarly, equity has a positive and significant effect on both ROE and PAT. This indicates that a stronger equity base is essential for maintaining profitability and financial stability in the banking sector. The results align with the pecking order theory, which emphasizes the importance of internal financing and suggests that banks should prioritize equity financing to avoid the risks associated with excessive debt.

Discussion of Findings:

The findings of this study highlight the importance of balancing debt and equity in the capital structure of Nigerian banks. Long-term debt, when utilized judiciously, can significantly enhance profitability by providing the necessary leverage for growth. However, the high cost of debt in Nigeria necessitates careful management to avoid financial distress.

Equity financing offers banks financial stability and flexibility, enabling them to navigate financial challenges effectively. The significant relationship between equity and both ROE and PAT underscores the need for banks to maintain a strong equity position to support long-term growth and performance.

These findings contribute to the ongoing discourse on capital structure management in Nigeria's banking sector. Policymakers and financial managers should recognize that optimal capital structure decisions are essential for enhancing profitability while minimizing risks associated with high leverage. Moreover, given the economic volatility in Nigeria, a cautious approach to debt financing is warranted to protect against potential financial crises.

Conclusion:

This study provides empirical evidence on the relationship between capital structure and financial performance in Nigerian deposit money banks. The findings suggest that both long-term debt and equity significantly impact key performance indicators such as Return on Equity (ROE) and Profit After Tax (PAT). Long-term debt positively influences ROE, indicating that banks can benefit from leveraging debt to finance growth and enhance profitability. However, excessive debt can lead to financial distress, particularly in a volatile economic environment like Nigeria's.

Equity also plays a crucial role in financial performance, providing banks with the stability and flexibility needed to manage financial challenges. The positive relationship between equity and both ROE and PAT suggests that banks should focus on strengthening their equity base to support their long-term growth and sustainability.

The study emphasizes the importance of optimizing capital structure to enhance financial performance in the Nigerian banking sector. Policymakers and financial managers should concentrate on maintaining a balanced mix of debt and equity to ensure profitability while minimizing financial risks.

Recommendations:

Based on the findings, the following recommendations are made:

Nigerian banks should aim to maintain an optimal balance between debt and equity, ensuring that they do not over-leverage while maximizing the benefits of debt.

Banks should manage their debt levels carefully, particularly in light of Nigeria's high-interest-rate environment, to avoid financial distress and ensure long-term sustainability.

Banks should prioritize building a strong equity base, which will provide the financial flexibility needed to absorb shocks and maintain profitability.

Financial institutions should develop robust policies to guide capital structure decisions, focusing on risk assessment and management.

Future research should explore the impact of short-term debt and liquidity management on the financial performance of Nigerian banks. Additionally, studies can investigate the effects of economic conditions, regulatory changes, and market dynamics on capital structure decisions and performance outcomes.

Banks should invest in training programs for financial managers and decision-makers to enhance their understanding of capital structure management, risk assessment, and financial analysis. This will enable them to make informed decisions that can positively impact financial performance.

Nigerian banks should leverage financial technology to improve their operational efficiency and reduce the costs associated with debt and equity financing. Technology can facilitate better risk assessment, financial forecasting, and capital allocation, leading to improved financial performance.

Regular monitoring and evaluation of capital structure decisions and their impact on financial performance should be instituted. This will help banks to identify trends, make timely adjustments, and align their capital structure with strategic goals.

Limitations of the Study:

This study acknowledges several limitations:

The study relies on secondary data from publicly available sources, which may have limitations in terms of completeness and accuracy. There may also be variations in how different banks report their financial data.

While the study focuses on quoted deposit money banks in Nigeria, the findings may not be applicable to other sectors or unlisted banks in Nigeria or other emerging markets.

The analysis is limited to the period from 2012 to 2021. Changes in economic conditions or banking regulations after 2021 may affect the applicability of the findings to current circumstances.

Capital structure decisions are influenced by numerous factors beyond debt and equity, including market conditions, economic cycles, and regulatory changes. This study does not comprehensively cover all such factors.

Acknowledgments:                                                                                                                 

Services involved: The authors gratefully acknowledge the support of the Directorate of Academic Planning, Department of Economics, Bursary Department, Division of Statistics and Records, Department of Audit, and Department of Social Studies of Adeyemi Federal University of Education, Ondo, Nigeria for the support and authorization obtained to conduct this study, as well as for the helpful guidance provided during the investigation. We are grateful to the Management of Adeyemi Federal University of Education in Ondo, Nigeria, for their hard work in supporting our research and providing insightful guidance. We sincerely thank the respondents' participation and understanding, as well as that of the facilitators and the leadership of the entrepreneurial skills acquisition centers.

Funding: The Tertiary Education Trust Fund (TetFund), which provided financing for the research through Institution-Based Research (IBR), is acknowledged by the authors.