Effect of Debt Financing on Financial Performance of Commercial and Services Firms Listed in Nairobi Securities Exchange

Abstract

Debt financing decision is among the key financial decisions that are taken by firms because debt financing has an effect on the financial performance. Theoretical foundations on debt financing have found different conclusion where Modigliani and Miller argued on the irrelevance of debt on capital structure and agency theory to stress on the importance of debt in capital structure to control the actions of management. No agreement exists on the nature of the impact of debt financing on financial performance from both the theoretical and different empirical studies. The aim of this study was to ascertain the effect of debt financing on financial performance of commercial and service firms quoted at the NSE. The population for the study was all the 12commercial and service companies quoted at the NSE. The independent variables for the study were debt financing as measured by the ratio of debt to assets, corporate governance as measured by the ratio of independent directors to total number of directors, liquidity measured by current ratio and asset tangibility as measured by the ratio of fixed assets to total assets. Financial performance was the dependent variable and was measured by return on assets. Secondary data was collected over a five 5 year time frame (January 2013 to December 2017) annually. The descriptive cross-sectional research design was employed for the study and the relationship between variables established using multiple linear regression analysis. Data analysis was undertaken using the SPSS software. The results of the study produced R-square value of 0.279 which means that about 27.9 percent of the variation in financial performance of commercial and service firms quoted at the NSE can be explained by the four selected independent variables while 72.1 percent in the variation of financial performance of commercial and service firms listed at the NSE was associated with other factors not covered in this research. The study also found that the independent variables had a strong correlation with financial performance of commercial and service firms listed at the NSE (R=0.528). ANOVA results show that the F statistic was significant at 5% level with a p=0.002. Therefore the model was fit to explain the association between the selected variables. The findings also showed that firm liquidity produced positive and statistically significant values for this study. Debt financing and corporate governance produced negative but statistically insignificant values while asset tangibility was also found to be a statistically insignificant determinant of financial performance of commercial and service firms’ quoted at the NSE. This study recommends that when firms are setting their capital structure they should strike a balance between the tax savings benefit of bankruptcy and debt costs associated with borrowing. The study also recommends that commercial and service firms quoted at the NSE should maintain adequate levels of liquidity as the findings of this study depict a positive significant effect of firm liquidity on financial performance.