The Effect of Capital Structure on the Financial Performance of Companies Listed at the Nairobi Securities Exchange

Abstract

It is argued that capital structure influences the financial performance of a firm. What constitutes, an optimal structure of capital is an issue that has not yet been answered and so remains controversial in finance. This study aimed at ascertaining the influence of the structure of capital on financial performance of entities listed at the NSE. The population of the study was all firms trading at the NSE for the five-year period starting January 1, 2013 ending December 31, 2017 excluding banks and insurance companies. The independent variable of the study was capital structure described through the use of total debt to total assets ratio and long-term debt to total assets ratio. Size of the entity measured using natural logarithm of total assets was used as a control factor. Financial performance was the dependent variable measured through return on assets. Secondary data was collected annually for a 5-year period (January 2013 - December 2017). A descriptive cross-sectional research design was used. Multiple linear regression analysis was employed to determine the variables relationships. A Statistical software (SPSS) was used to analyze the data. The study findings produced R-square value of 0.336 meaning that about 33.6 percent of the variation in the performance of firms trading at the Nairobi Securities Exchange can be explained by the three selected predictor variables while 66.4 percent in the variation of financial performance of firms trading at the Nairobi stock exchange market 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 the firms. ANOVA results showed that the F statistic was significant at 5% level with a p=0.000. Therefore, the model was fit to explain the relationship between the selected variables. The study findings further revealed that firm size statistically significantly positively influenced financial performance while total debt to asset ratio statistically significantly negatively influenced financial performance. Long term debt ratio to total assets was shown to be statistically insignificant in determining financial performance of firms in the study. This study therefore recommends when firms are setting their capital structure they should strike a balance between debt and equity. High levels of debt was found to reduce financial performance of listed firms and so firm managers should maintain debt at levels that do not impact negatively on financial performance to ensure the goal of maximizing shareholders’ wealth is attained