The Relationship Between Capital Structure and Financial Performance of Firms Listed in the Nairobi Securities Exchange

Abstract

The company’s financial health is measured by its cash flows, if the cash inflows are more than the cash outflows at any given time; it is considered a good sign for the organization. In Kenya, interest on debt is tax deductible, thus debt use to finance firm operations is advantageous because debt interest will be tax deductible. Every organization expects a capital structure best fitted to its situation and one that simultaneously leads to cost of capital minimization and firm value maximization. This study sought to investigate the effect of capital structure on financial performance of listed firms. Descriptive research design was adopted. The study involved a population of 47 non-financial firms listed at NSE. Data collection and analysis was by SPSS software. The study found out that 4.4% change in capital structure among non-financial firms listed at the NSE is explained by the four independent variables of the study (Leverage, Profitability, Size, and operating efficiency), moderate positive correlation exists between leverage of firms listed at NSE and firm financial performance, profitability and financial performance have a positive relationship and a positive correlation exists between the firm size of the non-financial listed firms and financial performance. Furthermore, a positive relationship exists between operating efficiency and financial performance .The study concludes that capital structure affects firm performance of the firms listed at NSE. The study further concludes that statistically significant association exists between the independent variables (Leverage, Profitability and Size,) and the dependent variable. However the relationship between operating efficiency and financial performance is not significant. The study recommendation is that firm managers of listed firms in the NSE need to judiciously strike a balance between the debts and equity in their capital structure. Firms listed at the NSE should have considerable levels of debts in their capital structure so as to enjoy the interest tax shield that accrue from the use of debts in the capital structure, listed firms at NSE should also enhance their solvency positions by proper working capital management practices. There is also need for listed firms to employ growth strategies that will see their increment in sizes and reap the full benefits. A measured increase in firm size will enable listed firms to avoid the disadvantages of economies of scale that result out of large scale of operations.