Effect of Capital Structure on Financial Performance of Commercial and Services Firms Listed at the Nairobi Securities Exchange

Abstract

Capital structure plays a critical role in firms financial performance provided it is utilized efficiently and in an effective manner at its optimal level. However, the question of what constitute an optimal capital structure is still unanswered and with the finance circles remaining controversial. There is no agreement on the nature of effects of capital structure on the profitability from both the existing theoretical and empirical studies. The aim of this study was to ascertain the effect of capital structure 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 capital structure as measured by debt ratio, liquidity measured by current ratio and firm size as measured by the natural logarithm of 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 0.285 which means that about 28.5 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 71.5 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=0.534). ANOVA results show that the F statistic was significant at 5% level with a p=0.001. 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. Capital structure and firm size produced positive but statistically insignificant values for this study. The study 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.