CHINHOYI UNIVERSITY OF TECHNOLOGY

School of Entrepreneurship and Business Sciences Department of

Accounting and Finance
EFFECT OF CAPITAL STRUCTURE ON FINANCIAL
PERFORMANCE OF RETAIL FIRMS LISTED ON
ZIMBABWE STOCK EXCHANGE
BY
LEWIS MUTSWATIWA
C1213393G
A research project submitted to Chinhoyi University of
Technology, School of Entrepreneurship and Business Sciences,
Department of Accounting and Finance in partial fulfilment of the
requirements of the award of Bachelor of Science Honours degree
Accountancy
Chinhoyi, Zimbabwe
2015

RELEASE FORM
Name of student

LEWIS MUTSWATIWA

Title of the research project

Effect of capital structure on financial performance of

retail firms listed on the Zimbabwe Stock Exchange

Programme for which the

Project was presented

Bsc Hons in Accountancy (BSCAC)

Year granted

2016

Permission is hereby granted to the Chinhoyi University of Technology Library to produce

single copies of this project and to lend or sell such copies for private, scholarly, or scientific
research purposes only. The author reserves other publication rights and neither the project
nor extensive contracts from it may be printed or otherwise reproduced without the author`s
permission.
Permanent address

1072 Samoyo Cresent Cherutombo Marondera

Student`s signature

Date

DECLARATION
I Lewis Mutswatiwa do hereby declare that this research project is the result of my own work
except to the extent indicated in the acknowledgements, references and by comments
included in the body of the report, and that it has not been submitted in part or in full for any
other degree to any other university.

Lewis Mutswatiwa

Date

APPROVAL FORM
The undersigned certify that they have read and recommended to the Department of
Accounting Science and Finance, School of Business Sciences & Management, Chinhoyi
University of Technology, for acceptance; a project titled, Effect of capital structure on
financial performance of retail firms listed on Zimbabwe Stock Exchange, submitted by
Lewis Mutswatiwa in partial fulfilment of the requirements for the Bachelor of Science Hons
Degree In Accountancy.

Name of Supervisor

Signature

Date

DEDICATION
I dedicate this project to my mother and my father Mr and Mrs Mutswatiwa, my brother lee
mutswatiwa, my sisters lisa and Joyline Mutswatiwa, and my wife to be Carol Matanhire.

Acknowledgements

This research work would not have been successful without constructive and helpful advice
and the assistance provided by numerous people. My sincere gratitude goes to my supervisor
Mr J Mashonganyika for his immense contribution towards the success of this project by
patiently and carefully reading several drafts of this project and offering incisive comments,
corrections and suggestions. The same appreciation is forwarded to the staff in Accounting
and Science Department for their assistance as well.
I also want to express my gratitude to the following important people who have supported me
financially: Mr Misheck Matsvai, Mrs Pengeline Matsvai, Mr Misheck Govha, Mrs Margaret

Govha and Mr Joseph Tachiva. I am also grateful to my friends at Chinhoyi University of

Technology for their support and ideas during my research.
The most enjoyable acknowledgement goes to my family and my parents for their support. To
my pastor, Mr Ado Nyakudya, my wife to be Tatenda Marume and my beloved friends
Tafadzwa Leon Njiri, Japhet Manjova, Admire Bakasa, Tatenda Gotosa, Wadzanai Chirova,
Vongai Mukotami and Pettina Tadya I appreciate your contributions.
Finally to the Almighty God, I thank you for all your ideas and resources you made available
to me.

ABSTRACT
The main focus of this study was to research on the effect of capital structure on financial
performance of retail firms listed on the Zimbabwe Stock Exchange. The study was prompted
by the fact that several companies in the retail sector are struggling for survival with many
companies closing down and others being delisted from the ZSE because of poor
performance which is in most cases attributed to failure to employ the optimal capital
structure. The objectives of the research were to establish the relationship between capital
structure and financial performance, to establish the determinants of capital structure of listed
retail firms in Zimbabwe and to determine the optimal capital structure that maximises the
firms value in the current Zimbabwean environment. A longitudinal research design was
used for the study, making use of secondary data. Financial statements for a five year period
from 2010 to 2014 were used. Total population sampling was used for the retail sector which
consists four companies. This study used SPSS version 20 to examine the determinants of
capital structure and the relationship between capital structure and financial performance. The
gearing ratio was used as the capital structure measure while net profit margin (NPM) and
return on equity (ROE) were used as the financial performance measures. Pearsons
correlation analysis and linear regression analysis were performed. Size and profitability as
determinants of capital structure were found to negatively affect gearing whereas a weak
positive relationship was found between asset tangibility and gearing. A negative association
was established between gearing and financial performance measures NPM and ROE. The
findings of the study revealed an optimum capital structure for the retail sector to be a gearing
level of 38%. The study recommended the retail firms to use the optimal capital structure mix
that maximises performance so as to maximise shareholders wealth as well as to reduce the
prevailing risk of closure in this economic hardships era. Finally further researchers were
encouraged to carry out the same research using other sectors besides the retail sector.

TABLE OF CONTENTS

RELEASE FORM.......................................................................................................................i
DECLARATION........................................................................................................................ii
APPROVAL FORM..................................................................................................................iii
DEDICATION..........................................................................................................................iii
Acknowledgements...................................................................................................................iv
ABSTRACT..............................................................................................................................vi
LIST OF TABLES......................................................................................................................x
LIST OF FIGURES...................................................................................................................xi
LIST OF APPENCICES..........................................................................................................xii
LIST OF ACRONYMS...........................................................................................................xiii
CHAPTER ONE........................................................................................................................1
1.1 Introduction......................................................................................................................1
1.2 Background of the study...................................................................................................1
1.3 Statement of the problem..................................................................................................2
1.4 Research objectives..........................................................................................................3
1.5 Research Questions..........................................................................................................3
1.6 Significance of the study..................................................................................................3
1.7 Delimitations of the study................................................................................................4
1.8 Limitations........................................................................................................................4
1.9 Definition of terms...........................................................................................................4
1.10 Chapter summary............................................................................................................5
CHAPTER TWO........................................................................................................................6
2.1 Introduction......................................................................................................................6
2.2 Theoretical framework.....................................................................................................6
2.2.1 Modigliani-Miller Theory..........................................................................................6
2.2.2 Pecking Order Theory................................................................................................7
2.2.3 Trade-Off Theory.......................................................................................................8
2.2.4 Agency Theory...........................................................................................................9
2.3 Determinants of Capital Structure..................................................................................10
8

2.3.1 Collateral Value of Assets........................................................................................10

2.3.2 Non-Debt Tax Shields..............................................................................................10
2.3.3 Dividend policy........................................................................................................11
2.3.4 Size...........................................................................................................................11
2.3.6 Profitability..............................................................................................................12
2.3.7 Firm Age..................................................................................................................12
2.4 Components of Capital Structure...................................................................................13
2.4.1 Equity Financing......................................................................................................13
2.4.2 Debt Financing.........................................................................................................13
2.5 Financial Performance....................................................................................................14
2.5.1 Profitability..............................................................................................................14
2.5.2 Net Profit Margin.........................................................................................................14
2.5.3 Return on Investment and Return on Equity...........................................................14
2.6 The Optimal Capital Structure........................................................................................14
2.7 Empirical Studies............................................................................................................15
2.7.1 Positive association between capital structure and performance.............................16
2.7.2 Negative association between capital structure and performance...........................17
2.7.3 Insignificant or no association between capital structure and performance............19
2.8 Conclusion......................................................................................................................20
CHAPTER THREE..................................................................................................................21
3.1 Introduction....................................................................................................................21
3.2 Research Design.............................................................................................................21
3.3 Study Population............................................................................................................21
3.4 Sampling.........................................................................................................................22
3.5 Research Instruments......................................................................................................22
3.4 Data Source....................................................................................................................22
3.5 Use of measures..............................................................................................................22
3.5.1 Gearing.....................................................................................................................23
3.5.2 Return On Equity (ROE).........................................................................................23
3.5.3 Net Profit Margin.....................................................................................................24
3.7 Data Analysis..................................................................................................................24
3.8 Data validity and reliability............................................................................................25
3.8 Chapter summary............................................................................................................25
9

CHAPTER FOUR....................................................................................................................26
4.1 Introduction....................................................................................................................26
4.2 Data availability..............................................................................................................26
4.3 Descriptive statistics on determinants of capital structure.............................................27
4.3.1 Firm leverage...........................................................................................................27
4.3.2 Profitability..............................................................................................................27
4.3.3 Size...........................................................................................................................28
4.3.4 Tangibility................................................................................................................28
4.4 Correlation analysis of the determinants of capital structure.........................................28
4.4.1 Determinants of capital structure.............................................................................29
4.5 Regression analysis of the determinants of capital structure..........................................30
4.6 Relationship between capital structure and financial performance................................32
4.7 Pearson correlation analysis of gearing and performance proxies.................................34
4.8 Regression analysis model for gearing and performance proxies..................................35
4.9 The optimal capital structure..........................................................................................36
4.9.1 The relationship between capital structure and net profit margin............................37
4.9.2 The relationship between capital structure and return on equity.............................38
4.9.3 Net Profit Margin and Return on equity in relation to gearing................................39
4.10 Chapter summary..........................................................................................................40
CHAPTER FIVE......................................................................................................................41
SUMMARY CONCLUSIONS AND RECOMMENDATIONS..........................................41
5.1 Introduction....................................................................................................................41
5.2 Summary of findings......................................................................................................41
5.3 Conclusions....................................................................................................................42
5.4 Recommendations..........................................................................................................43
5.5 Suggestions for further research.....................................................................................43
LIST OF REFERENCES.........................................................................................................45

10

LIST OF TABLES
Table 4.1 Descriptive statistics
Table 4.2 Correlations
Table 4.3 Regression model
Table 4.4 Coefficients
Table 4.5 Capital structure and financial performance statistics
Table 4.6 Correlations
Table 4.7 Regression analysis
Table 4.8 Coefficients
Table 4.9 Regression model for gearing and Return on Equity
Table 4.10 Coefficients

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LIST OF FIGURES
Fig 2.1 Trade off theory.
Fig 2.2 Optimal capital structure
Fig 4.1 Data availability
Fig 4.2 Gearing trend
Fig 4.3 Net Profit Margin
Fig 4.4 The relationship between capital structure and net profit margin
Fig 4.5 The relationship between capital structure and return on equity
Fig 4.6 Net Profit Margin and Return on equity in relation to gearing

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LIST OF APPENCICES

Appendix I

ZSE retail sector

Appendix II

Consolidated financial statements extract

Appendix III Descriptive statistics

Appendix IV ZSE company financials

13

LIST OF ACRONYMS
NPM: Net Profit Margin
ROE: Return On Equity
SPSS: Statistical Package for Social Science
WACC: Weighted Average Cost of Capital
ZSE: Zimbabwe Stock Exchange

CHAPTER ONE

INTRODUCTION

1.1 Introduction

This chapter sets the foundation of the study and covers background of the study, statement of
the problem, research objectives and questions, significance and scope of the study,
limitations as well as assumptions associated with the study.
1.2 Background of the study

Myers, (2001) pointed out that capital structure studies aim to explain the mix of the sources
of finance used by companies to finance investments. Brigham, (2004) alluded capital
structure to be the way in which a company finances its operations, which can either be debt
or equity or a combination of both. Myers, (2001) acknowledged that there is no universal
14

theory on capital structure choice but noted the existence of some theories that attempt to
explain the capital structure mix. He also referred to the trade-off theory which expresses that
organizations look for gearing levels that balance the tax relief of using debt capital against
the potential financial distress that debt capital brings. The pecking order theory postulates
that firms first utilise internally generated funds and would rather borrow than issue new debt
capital, (Myers, 2001). In conclusion the theory states that the debt level of a firm shows its
cumulative need for external funding. Another theory, the free cash flow theory says high
gearing increases the firms value notwithstanding the threat of financial distress posed when
the operating cash flow of a company outweigh its profitable investments.
Erasmus, (2008) highlighted that financial performance measures like profitability and
liquidity provide a useful tool to stakeholders for evaluation of the firms past financial
performance and the current position of a firm. Brigham and Gapenski (1996) argued that the
validity of the Modigliani and Miller model was only in theory as bankruptcy costs did exist
in practice and the costs were directly proportional to the gearing levels in a firm. This
inferred a direct relationship between capital structure and financial performance of a firm.
Berger and di Patti, (2006) presumed that more profitable firms were more likely to yield a
higher return from a given capital structure, and that higher returns can go about as a shield
against portfolio risk so that more effective firms are in a superior position to substitute
equity for debt in their capital structure. This is an incidental of the trade-off theory where
differences in efficiency enable firms to adjust their ideal capital structure either upward or
downwards. Also, Singh and Hamid, (1992) in their research, utilized information on the
largest companies in developing nations and found that organizations in developing nations
employed more of debt finance in financing their investments than was the situation in
industrialized countries. Abor, (2005) likewise discovered a positive relationship between
total assets and return on equity and that profitable companies in Ghana depended more on
debt as a main financing alternative because of low financial risk. Empirical studies, like
those of Ruland and Zhou, (2007) and Robb and Robinson, (2009) concur with Modigliani
and Miller (1963) that the gain from gearing are significant, and that the utilization of debt
increases the market value of a firm. Another empirical study, however of non financial firms
listed on Karachi Stock Exchange (KSE) that has been completed in Pakistan for a six year
period from 2004 to 2009 presumed that aggregate debt has negative effect on profitability,
thus performance. As a synopsis, there is no universal theory of the debt-equity choice.
Diverse perspectives have been advanced in regards to the financing decision.
2

In Zimbabwe interest rates are high (above 14%) as shown by the Trading Economics (2014).
Eighty seven companies were closed in 2014, a situation that can be minimised if strategic
decisions such as the optimal capital structure were employed. This, in addition to the
absence of a universally accepted capital structure theory, leaves the optimal capital structure,
especially for the current Zimbabwes economic environment, an area of more questions than
answers. It is a critical area to facilitate survival of the local companies.
1.3 Statement of the problem

Several companies in the retail sector are struggling for survival with many companies
closing down and others have been delisted from the Zimbabwe Stock Exchange because of
poor performance. As a result investors have lost wealth and confidence on the stock market.
The poor performance is largely attributed to the capital structure mix as the cost of debt
capital is high therefore there is need to establish the optimal mix of debt and equity for the
retail companies operating in local current economic environment in Zimbabwe.
1.4 Research objectives
The main objective of this research is to determine the effect of capital structure on financial
performance of listed retail firms in Zimbabwe and the specific objectives of the research are:
1. To establish the relationship between capital structure and financial performance of listed
retail firms in Zimbabwe.
2. To establish the determinants of capital structure of retail companies listed on the
Zimbabwe Stock Exchange.
3. To determine the optimal capital structure that maximises the firms value in the current
Zimbabwean environment.
1.5 Research Questions
1. What is the relationship between capital structure and financial performance of listed retail
firms in Zimbabwe?
2. What are the determinants of capital structure of retail companies listed on the Zimbabwe
Stock Exchange?

3. What is the optimal capital structure that maximises the firms value in the current
Zimbabwean environment?
1.6 Significance of the study
1.6.1 To the researcher
The research gave the researcher a smooth platform to integrate the theoretical fundamentals
mastered during his studies at University with the practical aspects of the business
environment as far as capital structure is concerned. The research can be viewed as the
training ground to the researcher for future academic researches. The research gave the
researcher an in depth understanding and knowledge of the field under study as going through
the process added knowledge on the subject and it was also in partial fulfilment of an
Honours degree in Accountancy.
1.6.2 To the University
If incorporated, this research will add literature on the relevance of adequate knowledge of
the optimal capital structure thereby providing a line of thought to other succeeding students.
Other researchers and scholars may borrow ideas from this research project and use it as a
research tool on any related study.
1.6.3 To the corporate world
The Corporate World will be assisted by the findings of the study to achieve the best
sustainable capital structure that is to the best interest of the shareholders. It is hoped that this
project would assist companies to improve performance and escape closure as a result of
taking advantage of the most favourable capital structure. This research study will help
different stakeholders of various organizations to assess the well being of the organizations
using the capital structure as a measure.
1.7 Delimitations of the study
The research was limited to retail companies listed on the Zimbabwe Stock Exchange. The
researcher used data from financial statements of the companies for the five year period from
2010 to 2015. The listed retail companies are Edgars Stores Limited, OK Zimbabwe Limited,
Pelhams Limited and Truworths Limited.

1.8 Limitations
This research was carried out under a short period of time but the researcher could use all the
free time to concentrate on the research. The researcher also faced some financial constraints
during this research; he had to look for assistance from friends and relatives. Financial
statements for the year 2009 were not available in full due to the changeover from the highly
inflationary Zimbabwean dollar era to the multicurrency era. The year was therefore left out
of the scope of the study.

1.9 Definition of terms

Listed firm: A firm with its shares being traded on an official stock exchange
Capital structure: The mix between debt and equity of a company.
Financial performance: The monetary measurement of the companys policies and operations.
1.10 Chapter summary
The chapter gave a brief summary of the challenges being faced by the companies in
Zimbabwe, the statement of the problem, research objectives and questions, significance and
scope of the study, limitations as well as assumptions associated with the study. The purpose
of the chapter was to put the research study into an intelligent context as well as to give
theoretical statement. The following chapter will give a review of related literature on the
effects of capital structure on financial performance.

CHAPTER TWO

LITERATURE REVIEW

2.1 Introduction

This chapter reviews theoretical and empirical literature relevant to the study. The views of
different authors and researchers were scrutinized in order to shade more light into the subject
under study and the literature under review was obtained from text books, journal articles and
websites. The main aim of this section is to give an insight and critique of what has been
written on the role of capital structure in determining financial performance by different
accredited scholars and researchers. The chapter ends with a summary.
2.2 Theoretical framework
Capital structure theories try to explain capital structure and the factors that contribute to cost
of capital and whether there is an optimal capital structure mix that maximises firm
performance by minimising the cost of capital.
2.2.1 Modigliani-Miller Theory

Modigliani and Miller (1958) came up with a capital structure commonly known as the MM
theory, before which no generally accepted theory of capital structure existed. Their theory
comprise of two express propositions which assume a perfect capital market, no transaction
costs, bankruptcy costs, symmetry information and a world with no taxes.
Modigliani and Millers first proposition assert that the companys value is independent from
its capital structure, implying that whatever capital structure chosen for a company, its value
would be the same. In other words, they assert that the value of a levered firm is the same as
the value of an unlevered firm therefore managers need not to stress themselves on the choice
of the capital structure, they can employ any capital structure of their choice.
VL = VUL
Where: VL is the value of a levered firm
VUL is the value of unlevered firm
Modigliani and Millers second proposition assert that cost of equity increase with debt on
the grounds that risk to equity increase too, so weighted average cost of capital (WACC) stay
consistent as lower cost of debt compensate with higher cost of equity. This proposition
implies that the cost of equity is a linear function of the gearing ratio.
Modigliani and Miller (1963) developed their propositions under vicinity of corporate tax rate
while maintaining all other assumptions in place. They contend that leverage increases the
value of the firm as interest paid to debt holders is an allowable deduction for tax purposes. In
addition WACC will decrease because of the tax shield on the cost of debt.
VL = VUL + Dt
Where: VL is the value of a levered firm
VUL is the value of unlevered firm
D is the interest paid
t is the tax rate

Friend and Lang (1988) contradicts with MM as they state that there is a negative relationship
between leverage and profitability whereas MM proposition is that the more profitable firm
use more of debt capital to benefit more from the tax shield advantage of debt.
Brigham and Gapenski (1996), stated that the Miller-Modigliani (MM) model is valid
theoretically, however in the real world bankruptcy costs exist and they increase as leverage
increases.
2.2.2 Pecking Order Theory

According to Myers and Majluf (2000), the pecking order theory is based on the idea of
asymmetric information between the management and the finance providers, which gives
managers a guide on the preference of sources of funds. As the cost of debt increases with the
extent of asymmetric information, the pecking order theory states that managers prioritise
sources with the lowest levels of asymmetric information. The pecking order theory,
expresses that organizations like to fund new investments, first by making use of internally
generated funds, then with debt, and the issue of additional share capital is the last option.
Myers contends that an ideal capital structure is hard to ascertain as equity shows up at the
top (as retained earnings) and the bottom (as new shares) of the pecking order. An
organisation with access to market financing information would accordingly be in a superior
position to fund its investments conveniently and at a low cost thus gaining the desired
capital structure.
2.2.3 Trade-Off Theory

Fig 2.1 Trade off theory.

Source: Determinants of capital structure

In the trade off theory firms measure the benefits against the cost of debt financing. Fig 2.1
above shows how the value of a firm is affected by gearing. It shows that gearing increases
the value of a firm but only to a certain extent beyond which the cost of debt outweighs the
benefit of debt. The benefit of debt capital is the tax shield on interest paid, that is, it lowers
the cost of capital, and also the discipline laid upon the management because of the loan
covenants. Brigham & Ehrhardt (2005), lays it down that the value of a levered firm is
equivalent to the value of an unlevered firm plus the value of side effects (tax shield and
expected costs due to financial distress). At the point when an organisation has zero or low
levels of debt, the likelihood of liquidation is low and immaterial. Baxter (2007) contended
that high gearing of a company increases its probability of insolvency which in turn makes
creditors to charge higher rates of interest because of the increased risk. He recommended
that organizations ought not to use debt past the point where the cost of debt surpasses the tax

advantage. The higher the gearing, the higher the bankruptcy costs therefore the effect of the
tax advantage of debt will be reduced.
As per the trade off theory the ideal capital structure is the point where the marginal tax
shield is equivalent to the marginal bankruptcy related costs. In this way, organisations would
first give priority debt financing up to the point where the likelihood of financial distress and
bankruptcy costs begins to be vital. Bas et al. (2009) recommended that this theory could be
applicable for large firms with a high probability of generating huge profits. Pettit and Singer,
(2005) say small firms may not have the option to choose debt capital for the tax shield as
they are less likely to generate huge profits.

2.2.4 Agency Theory

Agency theory concentrates on the behavioural relationship between the proprietors
(principals) and those entrusted by the proprietors (agents) to perform the business tasks on
their behalf. The management may shun high level of leverage in the event that they feel that
it puts their jobs at risk. On the contrary, proprietors, because of their ability to diversify
away the unsystematic risks that are specific to the company, may prefer the organisation to
invest in risky projects. Neilson, (2004) recommends that managers may forgo projects that
have positive net present values when the gains would accumulate primarily for debt holders.
Despite the best interests of the shareholders (principals), the managers (agents) are tempted
to employ a capital structure which does not threaten their job security. To mitigate the
agency problems managers can increase their share of ownership so as to align their interests
with those of the shareholders (Jensen and Meckling, 2006)
2.3 Determinants of Capital Structure

The capital structure choice is influenced by factors such as corporate governance practices,
economic environment, level of investor protection, relationship between borrowers and
lenders and capital markets. Literature has also identified firm level determinants of capital
structure including asset tangibility, Non-Debt Tax Shields, Dividend policy, firm size,
business risk, profitability and firm age.

10

2.3.1 Collateral Value of Assets

Most of the capital structure theories acknowledge that the assets owned by a company
somehow influences its capital structure decision. Scot (1976) propounds that, by offering
secured debt, companies boost equity value by seizing wealth from their existing unsecured
lenders. Contentions set forth by Myers and Majluf (2000) additionally recommend that
organizations may find it profitable to offer secured debt. Their model shows that there may
be costs connected with issuing securities about which the company's directors have upper
hand information over outside shareholders. These costs can be evaded by issuing debt
secured by assets with known monetary values. Hence, companies that have properties that
can be utilised as collateral are expected to exploit that opportunity to issue more debt.
Availability of collateral security mitigates costs associated with moral hazard and adverse
selection. More funding can be availed where there is high collateral security therefore
tangibility of assets is positively associated with leverage, (Ramjee and Gwatidzo, 2012).
Asset tangibility is calculated by dividing fixed tangible assets by total assets.
2.3.2 Non-Debt Tax Shields

Tax shields have the effect of bringing down the effective marginal tax rate. Ali et al. (2013)
stated that the availability of non debt tax shields can reduce the attractiveness of debt
financing for tax bill minimisation. Such shields include capital allowances, research and
development costs and pension funds. Firms can take advantage of such tax shields, instead
of interest tax shield, to reduce their tax bills. Organisations with high non debt tax shield are
less likely to be motivated to use debt capital in their capital structure. Mazur (2007) found a
negative relationship between debt and non debt tax shields of Polish companies. Non debt
tax shield is usually calculated as the ratio of depreciation to total assets.
2.3.3 Dividend policy

The dividend payout ratio of a company is one of the major determinants of the capital
structure. In general, companies with low dividend payout rates have the capacity to hold
more profits for funding of their capital expenditure. Such firms would consequently depend
more on internally generated funds than debt. Arulvel (2013) noted that companies that

11

companies with high dividend payout rates are bound to rely more on debt to finance their
investments.
2.3.4 Size

The size of an organisation has been seen as a determinant of its capital structure. Bigger
companies are well diversified and henceforth have lower variance of income, making them
ready to endure high levels of leverage. Small organisations may find resolving information
asymmetries with lenders costly, accordingly may prefer lower debt ratio. Naz et al. (2011)
found out that loans to bigger companies have a greater probability to be repaid than loans to
smaller companies, thus bigger organisations will have bigger debts. A research by Jamal et
al. (2013) revealed that the relationship between size and capital structure is positive and
significant. Small companies consider short term debt and large companies consider long
term debt. The perception that bigger firms can afford higher gearing however may be wrong
in the sense that not every big firm can repay, the ability to repay may rather depend on
availability of liquid funds than size. Firm size is measured as logarithm of sales.
2.3.5 Organisations risk
If an organisations operating risk is high, it means it is difficult to predict its profits and there
are high chances of it defaulting. Organizations with more unpredictable profits may
encounter more circumstances in which their cash flows are insufficient for debt servicing.
Kim and Henson (2013) observed that organizations whose business risk is high have less
ability to withstand financial risks therefore they utilize less debt. According to Ramjee and
Gwatidzo (2012), the higher the level of volatility in the organisations profit the higher the
chances of defaulting because it is more likely that the organisation will fail to service its
debt.
2.3.6 Profitability

Myers (1984) stated that organizations financing preference order is from retained earnings
first, debt second and issuing new shares as the last preference. He proposes that this
preference order may be because of the costs involved in issuing new equity. These can be
transaction costs or the costs that arise because of asymmetric information. Whichever the
case, the organisations past profitability, which translates to the amount of retained earnings
12

available, should be an important factor that contributed to its current capital structure. Chen
et al. (1998) supported this when he revealed that Dutch firms prefer internal funds over
external funds, but debt is still more essential than equity finance. The higher the level of
profits, the more funds are available for financing the organisations activities and therefore
the less the organisations reliance on external sources, (Jamal et al, 2013). On the contrary,
other researches shows that, more profits push a firm to depend more on debt because of its
ability to service it. Profitability can be both negatively and positively related to leverage,
(Chechet et al, 2013). Profitability can be measured as follows; Operating Income divided by
Total Revenue.
2.3.7 Firm Age

The number of years that the company has been in existence is believed to play a part on its
capital structure. Newly emerged organisations tend to rely more on equity finance, whereas
larger and old companies firms are able to increase their leverage in order to finance new
investment opportunities, (Noulas and Genimakis 2011). More debt capital is expected in the
capital structure of companies that have managed to establish themselves over the years.
Gwatidzo (2012) shows that a company builds its reputation over the years and lenders tend
to consult the firms relations with others over its period of existence. Therefore, a positive
association has been found to exist between both long and short term debt and the age of a
firm. Firm age is measured by the number of years the organisation has been in operation.

2.4 Components of Capital Structure

Capital structure is made up of two components, equity and debt. Equity (also known as the
shareholders funds) comprises of share capital and reserves while debt (also known as
borrowed funds) consists of loans and debentures.
2.4.1 Equity Financing

13

In the event that a company does not utilize debt financing, it is alluded to as an unlevered
firm (Brigham 2004). This brings about business risk, which is described as riskiness inherent
to the organisations operations in the event that it doesn't utilize debt. If an organisation does
not utilize debt then the return on capital investment should be measured by dividing net
income to common stock holders by common equity.
ROE = Net income to common stock holders
Common equity
This just implies that the business risk of an unlevered organisation will be measured by the
standard deviation of its ROE (Brigham & Houston, 2007).
2.4.2 Debt Financing

At the point when a company chooses to utilize debt financing for its operations it is
confronted with a financial risk and it is alluded to as a levered firm. Financial risk is that
extra risk set on common stock holders as a consequence of the choice to utilise debt
(Brigham & Houston, 2007). Financing risk is the likelihood that the income of the company
will not be as anticipated in light of the strategy for financing. He additionally proceeds by
saying that financing risk emerges in light of the fact that debt has a fixed financing
commitment (interest) which must be met when it falls due before the shareholders can
partake in the retained profit.

2.5 Financial Performance

2.5.1 Profitability
The idea of profitability takes into account the comparison of the required cash outflows for
the implementation of a strategic alternative and the expected inflows to be generated by the
alternative. As determined by Pandey (2006), profitability measures included profitability in
relation to investment and profitability in relation to sales.

14

Profitability in relation to sales is measured by the Net Profit Margin (NPM):

2.5.2 Net Profit Margin
This is arrived at by expressing net profit (arrived at after operating expenses, financing costs,
and tax expense are subtracted from gross profit) as a percentage of sales. It establishes the
relationship between net profit and sales and also shows the efficiency of the management in
manufacturing, administration and selling the firms products. The general principle is to
convert every dollar invested into profits (Johanson and Runsten, 2005).
2.5.3 Return on Investment and Return on Equity

Both Return on Investment (ROI) and Return on Equity (ROE) relate profitability
investment. ROI is calculated by expressing after tax profit as a percentage of investment and
ROE is calculated by expressing after tax profit as a percentage of the net worth of the
company. The ratios demonstrate how well managers are using the resources of the
shareholders to increase their wealth (Johansson and Runsten, 2005).
2.6 The Optimal Capital Structure

According to Weston, Eugene and Brigham (2010), optimal capital structure is a mix of debt
and equity which results in minimum weighted average cost of capital (WACC). Optimal
capital structure is acquired by firms by trading off the costs of debt and equity by their
benefits (Myers, 2001). At a point where the weighted average cost of capital is minimized
the value of the firm is maximized. Although optimal capital structure is a topic that had
widely been done in many researches, researchers failed to find any formula or theory that
decisively provides an optimal capital structure for a firm. In reality, capital structure of a
firm is difficult to determine. Financial managers find it difficult to exactly determine the
optimal capital structure of the firm (Saad, 2010). A firm has to issue various securities in
countless combinations to come up with particular combinations that can maximise its overall
value, meaning it has an optimal capital structure.

15

Fig 2.2 Optimal capital structure

Source: CFA study notes
At a point where the WACC is minimised the value of the firm is maximised. Fig 2.2 above
demonstrates that there is a certain mix of debt and equity that can minimise WACC.

2.7 Empirical Studies

The studies on the effect of capital structure on firms performance have generated mixed
results ranging from those supporting a positive relationship to those opposing it. Some of the
researches came up with no effect on performance; they found that capital structures did not
have any relationship with the performance of the firm. The results of previous researches
about the effect of capital structure on performance can be summarised into three categories.
2.7.1 Positive association between capital structure and performance
Musiegaet.al (2013) in carrying out a study to examine the relationship between an
organisation's capital structure and performance considered a sample size of thirty non
financial companies listed on Nairobi Stock Exchange over a five year time from 2007 to
2011. A linear regression analysis was performed utilizing both inferential statistics and
16

descriptive statistics. Five performance measures were used for the purpose of the study
which are earnings per share (EPS), return on assets, (ROA), dividend payout (DPO), return
on equity (ROE) and market price to book values as the dependant variables. Three capital
structure measures: total debt to asset ratio (TDA), long term debt to asset ratio (LTDA) and
short term debt to asset ratio (STDA), were used as the independent variables. The outcomes
demonstrated a significant positive relationship between total assets of a company and capital
structure components, demonstrating that long term debts were used by big companies that
had substantial assets which could be utilized as security for debt. In this way according to
the study, companies on Nairobi Stock Exchange seemed to utilize less debt in their capital
structure making them pay less interest and accordingly minimising the risk the companies
may be exposed to, as debt has a tendency to decrease performance.
Saeed et al. (2013), analysed the effect of capital structure on the performance of Pakistan
banks utilising multiple regression models. The study used information of banks listed on
Karachi Stock Exchange (KSE) for a period of five years from 2007 to 2011. Return on assets
(ROA), return on equity (ROE) and earnings per share were used as the performance
measures while determinants of capital structure were the short term debt to capital ratio,
long term debt to capital ratio and total debt to capital ratio. The outcome of the study
demonstrated a positive relationship between capital structure and financial performance of
firms in the banking sector in Pakistan.
In the examination of the effect of capital structure on performance of retail companies in Sri
Lanka, Nirajini and Priya (2013) extracted secondary data from annual reports for a sample
of companies for a period which ranges from 2006 to 2010. The study employed correlation
and multiple regression analysis. The results of the study revealed that there is a positive
relationship between capital structure and financial performance. The study additionally
revealed that at significant level of 0.05 and 0.1 debt to equity ratio, debt to asset ratio and
long term debt positively correlate with net profit margin, gross profit margin, return on
capital employed, return on assets, and return on equity.
Fosu (2013), examined 257 listed companies in South Africa with the aim to explore the
relationship between capital structure and organisation performance, giving much
consideration to the level of industry rivalry. The study revealed that leverage affects
performance positively.

17

Muhammad et al (2014) in an empirical exploration of the effect of capital structure on

companys performance carried out a study using cement companies on the Karachi Stock
Exchange for a five-year period from 2009 to 2013. The study performed Pearsons
correlation and multiple regression analysis and the results showed a positive relationship
gearing and performance variables (gross profit margin and net profit margin), and a negative
relationship between debt to equity and return on assets and return on equity. The study
concluded that the capital structure has a significant impact on the organisations performance
and it concurred with the pecking order theory by recommending that organisations should
attempt to make use of internally generated funds and make debt the last option.
2.7.2 Negative association between capital structure and performance

Mwangi et al (2014), were motivated to carry out a study of the relationship between capital
structure and performance by the fact that corporate failures in Kenya were largely attributed
to companies financing behaviour. The study which was carried out using an explanatory
non experimental research had a census of forty-two non financial companies listed on the
Nairobi Stock Exchange. Secondary data from the companies annual reports and financial
statements was used. The results were that leverage has a negative relationship with
performance, return on assets (ROA) and return on equity (ROE) being the measures of
performance.
Mohammadzadeh (2011) examined companies listed on Tehran Stock Exchange and found
that organizations performance as measured by earnings per share and return on assets have
negative relationship with capital structure. These findings are in line with those of Zeitun
and Tian (2007) and Abor (2007) who show performance as having been negatively affected
by capital structure while it contradicts with the study of Berger and Patti (2006) who found a
positive relationship of capital structure and performance.
Thamila and Arulvel (2013) examined the relationship between capital structure and
performance basing on a sample of thirty companies listed on Colombo Stock Exchange
during the five year period from 2007 to 2011. Secondary data was used for the study
(financial statements of the companies). Performance measures used are return on capital
employed (ROCE), return on equity (ROE) and net profit ratio. The results revealed a
negative relationship between capital structure and companies performance.

18

Muritala (2012) carried out a study on the impact of capital structure on organisation
performance by using a sample of ten listed non financial organisations in Nigeria over a five
year period of time covering from 2006 to 2010. Return on assets and return on equity were
used as the performance measures while debt ratio, growth opportunities and investment in
tangibles assets were used as the explanatory variables. Organisation size and age were
presented as control variables in the study to examine their impact on performance. Panel
Least Square (PLS) was utilized for data. The study show negative correlation between debt
proportion and performance and further show a significant negative correlation between asset
tangibility and return on assets (ROA).
Sovbetov (2013) carried out an investigation of the relationship between capital structure and
profitability for banks in United Kingdom. He used gearing as the capital structure measure
and return on equity and return on assets as the measures of performance. The significant
result for this study provided confirmation of a negative relationship between capital structure
and firm performance.
In a study to investigate the effect of capital structure on the performance of pharmaceutical
businesses in Kenya, Adekunle (2009) utilized gearing as a measure of capital structure and
return on equity and return on assets as performance measures. The Ordinary Least Squares
estimation technique was used for the purposes of the study. A significant negative impact of
debt ratio on measures of financial performance was revealed by the study.
Pratheepkanth (2011) investigated the effect of capital structure on company performance for
the time from 2005 to 2009. For this reason, thirty companies listed on Colombo Stock
Exchange were chosen and regression analysis was employed for data analysis. Gross profit
(GP), net profit (NP), return on assets (ROA) and return on investment (ROI) have been
utilized as dependant variables whereas debt to equity ratio was utilized as explanatory
variable. The regression analysis showed that debt to equity used under the study has no
relevant relationship with performance. Correlation analysis demonstrated that only the gross
profit has a positive but weak relationship with debt to equity ratio while other performance
measures have negative relation with debt to equity ratio.
2.7.3 Insignificant or no association between capital structure and performance

19

Ibrahim (2009) analyzed the effect of capital structure mix on company performance in
Egypt, utilizing a multiple regression analysis to assess the relationship between gearing and
performance. The study covered the period from 1997 to 2005. Return on equity (ROE),
return on assets (ROA) and gross profit margin (GPM) were used as the performance
measures. The outcome uncovered that capital structure choice in general has minimal or no
effect on organisations performance.
Musilo (2005) did an exploration on capital structure decisions of industrial firms in Kenya.
His goal was to figure out the components that spur management of industrial firms in
picking their capital structure. The exploration figured out that industrial firms are more
prone to follow the financing pecking order than to keep up a target debt to equity proportion,
and that the models in light of corporate and individual taxes, bankruptcy and other debt
related expenses are not as helpful in deciding the financing mix just like the models that
propound that new financing shows the companys marginal performance. The study further
included that the significance managers give to particular capital structure theories is
independent from administrative view of market efficiency.
Ebaid (2009) carried out a study to examine the effect of capital structure decisions on the
performance of firms in Egypt. Return on equity, return on assets and gross profit were the
measures of performance. Capital structure measures used were long term debt to asset ratio,
short term debt to asset ratio and total debt to total assets. Multiple regression analysis was
utilised for estimation of the relationship between gearing and performance. The study
demonstrated that capital structure has practically no effect on a firms performance.
Matarirano and Fatoki, (2010) agreed with the Modigliani and Miller theory of the "capital
structure irrelevancy principle" without bankruptcy costs, asymmetric information and an
efficient market, the value of the firm is unaffected by how it is financed. However, the
Zimbabwean environment is somehow different in that the interest costs are higher than the
average global rates due to the current market liquidity crunch.
2.8 Conclusion

The chapter looked at the theoretical and empirical literature on the effect of capital structure
on financial performance. It made use of the findings that were made by past researchers on
the same issue and what they used to measure the relationship between the aforesaid
20

variables. The literature reveals no universally accepted relationship between capital structure
measures and the financial performance measures. Some researchers found that there is a
relationship between capital structure and financial performance, either positive or negative,
while others found no relationship at all. Chapter 3 is going to look at research techniques
and sampling methods that were used to collect secondary data. It shall also go further giving
a justification of the selected research methodology.

CHAPTER THREE
METHODOLOGY

3.1 Introduction

21

This chapter describes the methodology and the design of the study. It laid down the
population and sample of the study, the sampling technique used the source of the data, the
measurement of the variables used and a summary of how the data analysis was done.
3.2 Research Design
A longitudinal research design was used for the study, making use of secondary data. Data for
five years from 2010 to 2014 was used. A longitudinal research design was the most
appropriate research design for the purpose of the study as it can establish a correlation by
repeating an observation of the same variables over a period of time. It can establish the
relationship between capital structure and performance by observing the changes in
performance as the capital structure varies over years. This approach was employed by Leon
(2013) in conducting a similar research on listed manufacturing companies in Sri Lanka. He
used the data for thirty listed companies over a five year period from 2008 to 2012. Zeitum
and Tian (2007) also used longitudinal research design in investigating the effect of capital
structure on corporate performance using evidence from Jordan. Their research covered a
period of fourteen years from 1989 to 2003.
3.3 Study Population
The population for the study constitutes listed companies classified under the retail sector by
the Zimbabwe Stock Exchange. Currently, there are four companies listed on the Zimbabwe
Stock Exchange and classified under the retail sector. The companies are Edgars Stores
Limited, OK Zimbabwe Limited, Pelhams Limited and Truworths Limited.

3.4 Sampling
The study used a type of purposive sampling called total population sampling where all the
companies constituting the study population were used for the study. This sampling technique
was used as the population size is relatively small as there are only four companies. It is also
a perfect representation of the population as all the listed retail companies are included in the
study.
22

3.5 Research Instruments

Document analysis was used in this study. It is the most appropriate instrument on the subject
as all the necessary information can be obtained from the abridged financial statements and
annual reports. It clearly gives answers to the research questions and helps in meeting the
research objectives. The greatest advantage of document analysis is that it overcomes the
respondents tendency of distorting responses once they get conscious of being studied.
Web-Based Survey was also employed to gather data needed for document analysis. It offers
the researcher immediate results as time is one of the constraints faced. This is linked to an
online databases and the major one being the Zimbabwe Stock Exchange with all the required
information for all the listed retail companies.
3.4 Data Source

The study made use of secondary data. The data was collected from audited financial
statements of the companies for the financial years ranging from 2009 to 2014.The data was
extracted from the websites of the Zimbabwe Stock Exchange and those of the companies
used for the study. Various capital structure researches that deal with listed organisations
utilise data from the stock exchange. Leon (2013) gathered secondary data from Colombo
Stock Exchange in assessing the impact of capital structure on financial performance on
corporate performance.
3.5 Use of measures
When assessing an organization's execution, Johansson and Runsten (2005) contend that net
profit is useless as a measure. On its own, it does not give information as to whether an
organization is generating any return to the shareholders, which is essential with a specific
end goal to guarantee the organization's survival. Net profit is rather important first when it is
expressed in relation to the capital that was needed to generate the profit. Basing on this
regard, financial performance was measured by the financial ratio Return On Equity (ROE).
As indicated by Johansson and Runsten (2005), ROE is the most critical financial ratio from a
shareholders point of view as they can easily compare it with the market cost of capital. It is
computed as a percentage of the net profit after tax compared to shareholders equity.

23

Net Profit Margin was also used as a measure of performance. It measures the companys
effectiveness in converting revenue into profits for shareholders. It is arrived at by dividing
net profit after tax by revenue. It is expressed as a percentage.
On the capital structure side, figures of debt and equity on their own also do not provide
meaningful information. Ratios are used to derive sense out of the debt and equity figures.
For this study the gearing ratio was used as the measure of capital structure.
3.5.1 Gearing

Gearing measures the proportion at which the company is financed by debt. The gearing ratio
was arrived at by expressing fixed cost capital (long term loans) as a proportion of total
capital (total of long term loans and equity shareholders funds).

Long - term debt

Equity shareholde rs funds long term debt
Gearing =

100%

Equity shareholders funds constitute issued ordinary share capital and reserves.

3.5.2 Return On Equity (ROE)

The return on equity is arrived at by dividing profit attributable to equity holders by the book
value of the shareholders funds. The profit attributable to equity holders is arrived at after
deducting all expenses of the business, including tax and interest. The shareholders funds
comprise of the issued share capital, retained earnings and other reserves. ROE expresses the
return in dollars for each dollar of the shareholders funds.

ROE =

Profit after interest and tax

Book value of shareholde rs' funds

24

3.5.3 Net Profit Margin

It measures profit made per dollar of sales made by a company

Net profit

Net Profit Margin =

Sales revenue

X 100

3.7 Data Analysis

The data for all the four companies are summed up so the consolidated data will be analysed
and not individually. Descriptive statistics were utilized to portray the characteristics of the
population under study. SPSS version 20 was utilised to calculate the mean and variance.
Pearsons correlation analysis was used to explain the relationship between capital structure
and its determinants. The same analysis was employed by Siro (2011) in a similar study for
firms listed on the Nairobi Stock Exchange. The relationship between gearing and
performance was established utilizing the linear regression model:
ROE = c + m(g)

Where:
ROE is the return on equity
c is the intercept
m is the incline
g is the gearing
SPSS v20 was also utilised to get the correlation coefficients.
3.8 Data validity and reliability

25

All the companies listed on the Zimbabwe Stock Exchange are required to prepare their
financial statements in accordance to the International Financial Reporting Standards (IFRS).
All the data was collected from the Zimbabwe Stock Exchange and the companies official
websites. Validity and reliability of the data is enhanced by the fact that the financial
statements used were audited by independent external auditors.
3.8 Chapter summary

This chapter described the methodology and the design of the study. It stated the population
and sample of the study; the sampling technique used the source of the data, the measurement
of the variables used and a summary of how the data analysis was done. The following
chapter takes a look at data analysis and presentation.

CHAPTER FOUR
DATA PRESENTATION, ANALYSIS AND INTERPRETATION

26

4.1 Introduction

This chapter focused on the presentation, analysis and interpretation of the data collected
using different research instruments discussed in the previous chapter on methodology.
Regression model and correlation analyses were employed for the study. The chapter went on
to interpret the results, give a conclusion based on the findings done on the retail firms on
ZSE. The findings are based on the objectives and research questions on the determinants and
relationship between capital structure and financial performance. The researcher also
attempted to establish the optimal capital structure that maximises the shareholders wealth
based on the current Zimbabwean economic environment.
4.2 Data availability

Data availability
Unavailable; 17%

Available; 83%

Fig 4.1 Data availability

The researcher intended to make use of the financial statements of the retail companies for a
six year period ranching from 2009 to 2014 but some of the 2009 financial statements were
not available because of the change of the functional currency from the highly inflationary
Zimbabwean dollar to the US dollar therefore the year was left out of the scope of this study.
The financial statements from the year 2010 were all available representing a response rate of
83% as shown by fig 4.1 above.
4.3 Descriptive statistics on determinants of capital structure

27

Table 4.1 Descriptive statistics

N
LEV
SIZE
TANG
PROF
Valid N
(listwise)

5
5
5
5

Minimum Maximum
.28
.52
19.30
20.19
.28
.47
.04
.17

Mean
.3600
19.8774
.3435
.1073

Std. Deviation
.09695
.38964
.07356
.04763

Descriptive statistics were utilized to provide summaries of the measures. Table 4.1 above
provides information for the mean, the standard deviation, the maximum and the minimum
values of the variables for the period 2010 to 2014. LEV represents leverage, TANG
represents asst tangibility, PROF represents profitability.

4.3.1 Firm leverage

From the information on the table, the mean leverage for the firms over the period under
study is 0.36 implying that approximately 36% of the companies total assets are financed by
borrowings. This average is slightly higher than the 29% that Frank and Goyal (2009) got,
which demonstrates that the organizations in this study are marginally more geared than the
American organizations they studied. On the other hand, Kouki and Said (2012) on the study
of French firms got a higher average mean of 51%.
4.3.2 Profitability

Profitability was measured by expressing earnings before interest and tax (EBIT) as a
percentage of total assets. A mean of 10.73% was found and a respective standard deviation
of 0.48. The mean profitability is higher than the 8% the research of Song (2005). The proxy
reflects how efficient the firms use their assets to generate profits. On average the retail firms
are achieving a profit equivalent to slightly above 10% of the book value of their assets
annually. Though the standard deviation of 0.48 is higher than that of Song (2005) which was
0.28, the conclusion is that the variability of the annual profitability from the mean was
relatively low over the years under study.

28

4.3.3 Size

Size is represented by the logarithm of revenue. It had a mean of 19.88. The calculation of the
proxy makes it make little economic sense. However the standard deviation of 0.39 reveals
that there are minor variations from the mean size over the years. This is further shown by the
fact that both the minimum of 19.30 and the maximum of 20.19 are close to the mean of
19.88.
4.3.4 Tangibility

The proxy used for total assets is property, plant and equipment to total assets. It has a mean
of 0.34. This means that on average, of the assets of the firms, 34% is property plant and
equipment. Therefore considering the fact that tangible assets are highly considered by
lenders, it is difficult and expensive for the firms to borrow beyond 34% of the book value of
their assets. The mean tangibility of the retail firms under study is a bit less than the 0.35 that
Frank and Goyal (2009) found in their research. The research of Song (2005) got 0.288 as the
tangibility ratio mean, which is about 0.05% less than of this research.
4.4 Correlation analysis of the determinants of capital structure
Table 4.2 Correlations
Correlations
FLEV
SIZE
Pearson
Correlation
Pearson
SIZE
Correlation
TAN Pearson
G
Correlation
Pearson
PROF
Correlation
FLEV

TANG

PROF

-.810

-.345

-.667

-.810

.416

.802

-.345

.416

.499

-.667

.802

.499

A correlation analysis was performed so as to test the level of linearity of the variables. Table
4.2 above shows the correlation matrix and presents an overview of the variables correlation
coefficients.

29

4.4.1 Determinants of capital structure

At 5% level of significance, profitability had a significant negative coefficient of -0.667
which implies that as the profitability of the companies increase, they tend to utilise less of
debt. The result suggests that a 1 percentage point increase in profitability will lead to a 0.667
percentage point decrease in leverage. That is to say more profitable firms utilise less of
borrowed funds as they will use retained earnings to fund their projects instead of using
external debt. In contrast, the trade-off theory assumes that companies that are profitable
shield their earnings from tax, and therefore borrow more than the less profitable companies.
The negative relationship between leverage and profitability is consistent to the results from
Mojtahedzadeh and Nejati (2011) and Titman and Wessels (1988).
A negative relationship was revealed between size and leverage. An increase by 1 percentage
point in size will lead to a decrease in leverage of 0.81 percentage points. This outcome
contradicts the trade-off theory which predicts a positive relationship between the companies
profitability and their leverage basing on the assumption that as a company grows bigger it
diversifies therefore its default risk will be lower. The negative relationship is consistent to
the findings of Wahap and Ramli (2014) and Yolanda and Soekarno (2012).
At 5% level of significance, the study reveals a negative relationship between asset tangibility
and the gearing of the companies. An increase by 1 percentage point in asset tangibility will
lead to a decrease in leverage of 0.345 percentage points. These findings contradict the trade
off theory which anticipate a positive relationship between asset tangibility and leverage as
the assets can be used as collateral security for securing loans. Most studies reveal a positive
relationship between asset tangibility and leverage. However the results are supported by the
agency theory as it is easy for debt finance providers to monitor the use of tangible assets, the
managers may not willing to issue debt for such a reason.

4.5 Regression analysis of the determinants of capital structure

A multiple regression test was performed to predict leverage from size, profitability and
tangibility. For the interpretation of the coefficients, all the other variables are held constant.

30

Table 4.3 Regression model

Regression model for determinants of capital structure
Model
R
R Square
Adjusted R
Std. Error of the
Square
Estimate
1
.811a
.657
-.372
.11358
a. Predictors: (Constant), PROF, TANG, SIZE
The R square value is calculated to identify the effect of profitability, tangibility and size on
capital structure (gearing). The R square value is 0.657. This means profitability, tangibility
and size contributed 65.7% to determine the net profit margin. The remainder is contributed
by some other factors that are not considered for this research.

Table 4.4 Coefficients

Coefficientsa
Model
Unstandardized
Standardized
Coefficients
Coefficients
B
Std. Error
Beta
(Constant)
4.180
4.679
SIZE
-.192
.244
-.770
1
TANG
.001
.891
.001
PROF
-.102
2.095
-.050
a. Dependent Variable: FLEV

.893
-.785
.001
-.048

Sig.

.536
.576
.999
.969

The findings presented in table 4.4 above suggest firm size is the major determinant of capital
structure for the listed retail companies in Zimbabwe. A negative relationship exists between
size and leverage. As the size increase by 1 percentage point, leverage will decrease by -0.92
percentage points. This is consistent with the findings of Wahap and Ramli (2014) and
Yolanda and Soekarno (2012). The relationship contradicts the trade off theory which
assumes a positive relationship between size and indebtedness, the rationale being that larger
firms have less risk of defaulting. However the results are not a surprise given the current
economic situation in Zimbabwe where interest rates are very high, larger companies find it
cheaper to issue equity (as it is easier for them than the smaller ones) so as to avoid the high
interest rates.
A negative relationship is shown between profitability and leverage, that is the higher the
profitability the lesser the leverage. These results support the pecking order theory where
31

profitable firms tend to utilise much from their internally generated funds as the first priority
before they can opt for debt. These findings are similar to the findings of Tomak (2013) and
Wahap and Ramli (2014). There is an insignificant positive relationship between asset
tangibility and leverage. Although the coefficient is not significantly different from zero, the
results are similar to the predictions of the trade off theory. This is because the firms will have
an added advantage in securing loans as they will use the assets as collateral security for the
loans.
Fig 4.2 Gearing trend

Gearing trend
60.0%
50.0%
40.0%
gearing
30.0%
20.0%
10.0%
0.0%
2009

2010

2011

2012

2013

2014

2015

The bottom line of the findings on the determinants of capital structure for the listed retail
firms is that firms are trying as much as they can to run away from debt despite the borrowing
advantages such as profitability and size. The most probable reason is the high local current
interest rates in an economy experiencing a liquidity crunch. Trend analysis as shown by Fig
4.2 above reveals that generally the retail companies are reducing their gearing levels from as
high as 52% in 2010 to 28% in 2014. The trend can even predict a further reduction in the
gearing in the next few years.

32

Fig 4.3 Net Profit Margin

NPM
3.5%
3.0%
2.5%
NPM

2.0%
1.5%
1.0%
0.5%
0.0%
2010

2011

2012

2013

2014

The companies may be trying to lower gearing as much as they can due to their level of
performance which is also very low as shown by low net profit margin which for the period
under study ranged from a minimum of as low as 1.1% and a maximum of only 3.1%, the
mean being 2.4%. The net profit margins for the period under study are depicted by Fig 4.3
above.
4.6 Relationship between capital structure and financial performance

Capital structure was measured by the level of gearing while financial performance was
measured by the return on equity and the net profit margin. The table below provides
information for the mean, the standard deviation, the maximum and the minimum values of
the variables for the period 2010 to 2014.

33

Table 4.5 Capital structure and financial performance statistics

N

Minimum

Maximum

Mean

Statistic
5

Statistic
27.69

Net Profit
Margin

1.13

3.13

2.3656

.79616

Return On
Equity

10.77

23.90

16.9749

5.39660

Valid N
(listwise)

Gearing

Statistic
Statistic
51.55 35.8270

Std.
Deviation
Statistic
9.50302

Gearing was used as the capital structure proxy. The mean gearing of 35.83% shown on Table
4.5 above means that on average 35.83% of the companies operations for the period 2010 to
2015 were funded by borrowings. The gearing is higher than a 29% found by Frank and
Goyal (2009) on the American companies that they studied. For the period under study, the
minimum gearing of the retail sector was 27.69% while the maximum was 51.55%. There
were relatively high variations from the average gearing as shown by the standard deviation
of 9.5.
A mean net profit margin of 3.13% was revealed for the combined retail companies during
the period. It means on average approximately 3.13% of revenue was converted into profit.
The percentage is very low implying that the companies have high operating expenses. It had
little variations from the mean over the period as evidenced by the low standard deviation of
0.78. The mean is slightly higher than the 2% that was revealed in the case of Frank and
Goyal (2009). However, the difference in results could be the proxy used for profitability
because in their research they used profit before interest and tax divided by total sales while
in this research the proxy used was profit after tax divided by total assets.
Return on equity had a mean of 16.97%. It is slightly less than the 17.75% that was found by
Musiega et al (2013) in their research. The proxy mean implies that the average rate of return
for the common stock holders is 17c per every dollar of equity.

34

4.7 Pearson correlation analysis of gearing and performance proxies

A correlation analysis was performed using Karl Pearson correlation coefficient. A negative
coefficient shows that an inverse relationship exists between the variables correlated meaning
an increase in one variable result in a decrease in the other variable and vice versa. On the
other hand a positive coefficient shows a direct relationship of the variables meaning an
increase or decrease in one variable would result in an increase or decrease of the other
variable respectively.
Table 4.6 Correlations
Correlations
Gearing
Pearson Correlation
1
Gearing
Sig. (2-tailed)
N
5
Pearson Correlation
-.631
Net Profit Margin Sig. (2-tailed)
.254
N
5
Pearson Correlation
-.330
Return On Equity Sig. (2-tailed)
.588
N
5
*. Correlation is significant at the 0.05 level (2-tailed).

Net Profit
Margin
-.631
.254
5
1
5
.931*
.022
5

Return On
Equity
-.330
.588
5
.931*
.022
5
1
5

The results in table above on Pearson correlation coefficient, a significant negative

correlation exists between gearing and net profit margin (r = -0.631, p<0.05). This implies
that it is 63.1% of variance in net profit is affected by gearing. The negative relationship is
consistent with the pecking order theory which assumes an inverse relationship between
profitability and indebtedness. Therefore more profitable firms use less debt as they will use
retained earnings instead of borrowing from lenders. Wahap and Ramli (2014) established a
similar relationship in their research. A medium negative relationship between gearing and
return on equity is indicated by a Pearsons correlation coefficient of -0.33. This implies that
1% point increase in gearing would result in a 0.33% point decrease in the return on equity.

35

4.8 Regression analysis model for gearing and performance proxies

Table 4.7 Regression analysis
Regression model for capital structure and Net Profit Margin
Model
R
R Square Adjusted R Std. Error of
DurbinSquare
the Estimate
Watson
1
.631a
.398
.198
.71318
1.383
a. Predictors: (Constant), Gearing
b. Dependent Variable: Net Profit Margin
The R square value is calculated to identify the effect of gearing ratio on net profit margin.
The R square value is 0.398. This means gearing contributed 39.8% to determine the net
profit margin. The remaining 60.2% is contributed by some other factors that are not
considered for this research.

Table 4.8 Coefficients

Coefficientsa
Model
Unstandardized
Standardized
Coefficients
Coefficients
B
Std. Error
Beta
(Constant)
4.260
1.382
1
Gearing
-.053
.038
-.631
a. Dependent Variable: Net Profit Margin

3.083
-1.409

Sig.

.054
.254

From the table above, the regression equation could be derived as follows:
Y = 4.26 0.053X
The b value is -0.053. It shows that gearing ratio and net profit margin tend to move in
opposite directions. The relationship concurs with the findings of Yogendrarajah (2011) on
his study on the effect of profit margin on capital structure of manufacturing companies on
Colombo Stock Exchange.

36

Table 4.9 Regression model for gearing and Return on Equity

Regression model for gearing and Return on Equity
Model
R
R Square Adjusted R Std. Error of
DurbinSquare
the Estimate
Watson
1
.330a
.109
-.188
5.88252
1.476
a. Predictors: (Constant), Gearing
b. Dependent Variable: Return On Equity
The R square value is 0.109. This means gearing contributed 10.9% to determine the return
on equity. The remaining 39.8% is contributed by some other factors that are not considered
for this research.
Table 4.10 Coefficients
Coefficientsa
Model
Unstandardized
Standardized
Coefficients
Coefficients
B
Std. Error
Beta
(Constant)
23.688
11.397
1
Gearing
-.187
.310
-.330
a. Dependent Variable: Return On Equity

2.078
-.605

Sig.

.129
.588

From the table above, the regression equation could be derived as follows:
Y = 23.688 0.187X
The b value is -0.187. It shows that gearing ratio and return on equity tend to move in
opposite directions. The negative relationship is in consistent with the findings Leon (2013)
4.9 The optimal capital structure

This study seeks to establish the optimal capital structure which maximises the financial
performance, which is measured by the net profit margin and the return on equity in this
study. Over the period of years under study, the overall capital structure of the companies has
been shifting and so was the financial performance. Analysing the trends by the variables
helps to establish the optimal capital structure mix

37

4.9.1 The relationship between capital structure and net profit margin

Fig 4.4 The relationship between capital structure and net profit margin

The graph above shows that the net profit margin increases as the gearing ratio increases, but
up to a certain point beyond which the a further increase in gearing results in a decrease in net
profit margin. The companies strive to maximise the net profit margin hence the point where
the net profit margin is at the peak is considered to be the optimal point. The study as shown
on the Fig 4.4 above, reveals the peak net profit margin of 3.1% at a point where gearing is at
38%. These results support the trade off theory of capital structure which propounds that
there is a certain point where the benefits of debt (interest shield and discipline instilled on
management) are equivalent to the cost of debt (interest and bankruptcy costs). Such a point
of gearing is what the theory describes as the optimal capital structure. Using a gearing ratio

38

below such a point results in a higher WACC by foregoing the debt interest shield and using a
gearing ratio higher than that point results in increased expenses (due to bankruptcy costs).

4.9.2 The relationship between capital structure and return on equity

Fig 4.5 The relationship between capital structure and return on equity
Return on equity, as evidenced by the Fig 4.5 above, is following the same trend as the net
profit margin. It also has a point where it is at peak, before and after which it begins to fall.
The maximum return on equity is 23.9%. The point is the same as the one shown by the net
profit margin, which is a gearing of 38%. These results, as stated above, support the trade off
theory of capital structure. Boodhoo (2009) during his study using evidence from Mauritius
established an optimal capital structure of 50%. His optimal gearing is higher than for the
Zimbabwean retail firms most likely because the interest rates in Zimbabwe at the present
moment are not favourable for sustaining high levels of debt.
39

4.9.3 Net Profit Margin and Return on equity in relation to gearing

Fig 4.6 Net Profit Margin and Return on equity in relation to gearing

Fig 4.6 above presents how financial performance responds to various gearing levels and
depicts the existence of an optimal capital structure maximises performance. According to the
trade off theory, at such a point the benefits of debt are equivalent to the costs of debt. For the
retail companies to strike that balance they have to employ a gearing ratio of 38%.

40

4.10 Chapter summary

The chapter analysed in detail the findings on the objectives of the research which was based
the review of secondary data obtained mainly from the Zimbabwe Stock Exchange website
and also the companies official websites. The researcher used tables, graphs and pie charts to
interpret and analyse data by making use of SPSS v20. The research revealed that size is a
negative determinant of capital structure. It also established the relationship between capital
structure and financial performance of the retail companies. The next chapter brings the
whole research to an end by laying down the findings which the researcher gathered and
recommendations shall be given thereon.

41

CHAPTER FIVE

SUMMARY CONCLUSIONS AND RECOMMENDATIONS

5.1 Introduction
This chapter focused on the summary, conclusions and recommendations of findings
pertaining to the relationship between capital structure and financial performance for retail
companies listed on ZSE. It also focused on establishing the determinants of capital structure
for the listed retail firms. Conclusions and recommendations were drawn from the summed
up answers to the research questions basing on the findings presented in the previous chapter.
5.2 Summary of findings

The study was motivated by the fact that there are many companies that are collapsing and
the closures are largely attributed to failure to adopt optimal capital structure. The research
aimed to gather capital structure data of all the four listed retail companies in Zimbabwe.
Descriptive analysis, linear regression and Pearsons correlation coefficient was employed for
data analysis. SPSS v20 was used to analyse the data. Data for all the four companies that
form the population of the study was used. The data was available for the period from 2010 to
2014.
On attempting to establish the determinants of capital structure for the retail listed firms, a
negative relationship was found between gearing and size and profitability. Though in
literature it is believed that asset tangibility gives organisations an advantage to increase debt
using the assets as collateral security, the results of the study implies the companies are
reluctant in exploiting that advantage as an insignificant positive association between the
variables was revealed.
The mean gearing was found to be 35.83% which means on average the retail firms are
funded by equity more than debt. The aggregate debt is shown to be continuously
diminishing from 51.5% in 2010 to 27.7% in 2014. The retail firms are shunning debt in their
capital structure mix.

42

A negative association was established between gearing and net profit margin and return on
equity. A coefficient of -0.053 was found between gearing and the net profit margin which
means as gearing increases, net profit margin decreases. The results also reveal that capital
structure contributed 39.8% to the net profit margin. For return on equity, the association is
explained by a coefficient of -0.187. Capital structure contributed 10.9% to determine the
return on equity.
The findings of the study revealed an optimum capital structure for the retail sector to be a
gearing level of 38%. At such a point net profit reaches its peak of 3.1%. At the same gearing
level the return on equity also reaches its peak of 23.9%
5.3 Conclusions

The study concludes that for listed retail companies in Zimbabwe, as the size increases, the
level of gearing decreases. The negative relationship is attributable to the fact that size makes
it easier to raise more equity either by issuing more share capital or by retaining internally
generated funds in the presence of factors that make debt unattractive like the high interest
rates and liquidity problems in the current economic environment where cash generation is
difficult.
A negative relationship also exists between profitability and gearing. This can be attributable
to the fact that as the companies generate profits, they afford to do away with debt and fund
their operations using internally generated funds as explained by the pecking order theory.
The ability to generate profit reduces the need for leverage therefore profitability is a major
determinant of capital structure for the retail firms in Zimbabwe.
The results of the study reveal an insignificant positive association between asset tangibility
and gearing. Despite the fact that asset tangibility is a factor that gives firms a borrowing
advantage, the study shows that there are other factors that are making the use of debt capital
unattractive. Examples of such factors are high interest rates and liquidity problems as stated
earlier.
On the relationship between capital structure and financial performance, the study shows that
gearing indeed affect the financial performance of the firms. Gearing as the capital structure
measure was found to be negatively associated with the performance measures net profit
margin and the return on equity.
43

An optimal capital structure for the firms was sought and was established to be a gearing
level of 38%. This level was established by analysing the trends of financial performance in
response to the changes in gearing. The graphs reveal that a positive relationship exists
between gearing and financial performance for as long as the gearing is still less than 38%,
after which the relationship turns to be negative. The findings fully support the trade off
theory where the optimal capital structure has to be the point where the benefits of using debt
are equivalent to the costs of using debt. At that point the WACC will be minimal and
performance maximised.
5.4 Recommendations

Capital structure is an important area that can help ensure survival of an organisation in a
harsh economic environment if well informed decisions are taken. It affects financial
performance hence care need to be taken to employ the optimal capital structure. The
outcomes from this study demonstrate that debt does not at all time prompt enhanced
performance. At the point when an organization is operating below the optimal capital
structure, it may increase its gearing to improve performance. Nonetheless, this must be done
with caution on the grounds that at a certain level of gearing the leverage chance will turn
around into risk. Variability of economic conditions of the host country needs to be
considered like the countrys interest rates and the specific type of industry.
For the retail companies in Zimbabwe, instead of attempting to minimise gearing as the trend
portrays, an optimal capital structure of 38% gearing can be used to maximise financial
performance of the firms. The study made use of consolidated figures to determine the
optimal capital structure of the retail sector in general; firm specific optimal structure can also
be calculated by the companies.
5.5 Suggestions for further research

This research only focused on the relationship between capital structure and performance of
listed retail companies in Zimbabwe, another study could be carried out on other factors that
affect financial performance of the retail companies. An instance would be a study on the
impact of loss leader products as a marketing strategy on financial performance and
ascertain if the model can predict financial performance better.

44

Another study on the effect of indebtedness on return on assets would also be helpful to
ascertain how this area of financial performance is affected by gearing.
This study was limited to retail firms, a similar study should be carried out in for other sectors
for example manufacturing and mining in order to generalize findings. A comparison with
results from other sectors will help the researcher to justify his results based on observations
from the other sectors.

45

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APPENDIX I

APPENDIX II

APPENDIX III

Revenue

Shareholders
' funds

Debt

Range
$
343,2
49,243

Descriptive Statistics
Minimum
Maximum
$
$
240,9
584,2
86,982
36,225

Sum
$
2,268,3
84,125

Mean
$
453,6
76,825

70,5
97,044
16,1
67,356

25,3
23,974
24,7
71,649

95,9
21,018
40,9
39,005

323,0
03,527
164,6
96,170

64,6
00,705
32,9
39,234

Profit After
Tax

13,5
30,956

2,7
27,421

16,2
58,377

56,4
16,256

11,2
83,251

Valid N
(listwise)