Capital Structure and Financial Performance of Commercial and Services Firms Listed at Nairobi Securities Exchange, Kenya

Abstract

Numerous firms in our country and beyond deal with declining financial performance that can be attributed to financing decisions such as capital structure decisions among other factors. Decline in financial performance negatively affects the firm’s value as well as price of shares held by investors. However corporate managers are still not well equipped with sufficient knowledge on how capital structure choice affects financial performance and best way to set up the most appropriate capital structure that can improve financial performance. The objective of this study was to examine the effect of capital structure on financial performance of listed commercial and services firms at Nairobi securities exchange, Kenya. The specific objectives was to determine the effect of equity/ total assets ratio, long term debt/ total assets and debt to equity ratio on the financial performance of commercial and services listed firms in the NSE. Capital structure theories that guided this study are Modigliani and Miller theories, trade off theory, pecking order theory and the agency cost theory. Return on equity (ROE) was the financial performance measure used. Equity/ total assets ratio, debt-equity ratio and long term debt/ total assets ratio were the capital structure measures. The study population comprised all the 11active firms listed in the commercial and services sector at the NSE, Kenya. The study sample was thus a census of all the eleven listed firms. The study employed secondary data from published financial reports of listed firms accessible at CMA and NSE. Descriptive research design was used in the study. The study adopted the use of multiple regression models. Data analysis used Stata program to get descriptive and inferential statistics e.g. mean, standard deviation and others. Data presentation was done by use of tables. The finding of the projects indicated that equity to total asset ratio was positive and statistically significant for financial performance measure of ROE. Debt-equity ratio relationship with ROE was negative. Long term debt to total assets showed a positive and statically significant relationship. The result indicates that firms should inject more equity capital to fund their operations as it positively affects financial performance. Debt should be reduced as it has an inverse relationship with performance but if it is to be considered then long term debt is preferred as its effect on performance is positive. The finding of the project is inconsistent with the agency cost theory because debt-equity ratio and financial performance had a negative relationship whereas agency theory advocates for a positive relationship.