Effect of Financial Leverage on Share Return of Non-financial Firms Listed in Nairobi Securities Exchange

Abstract

Capital structure decision is among the key financial decisions that are taken by firms because financial leverage has an effect on the share return. Theoretical foundations on capital structure 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 effect of financial leverage on share return from both the theoretical and different empirical studies. The aim of this study was to ascertain the effect of financial leverage on share return of non-financial firms quoted at the NSE. The population for the study was all the 40 non-financial firms listed at the NSE. However, out of the 40 nonfinancial firms, the researcher managed to get data for 39 companies amounting to 97.5% response rate. The independent variables for the study were financial leverage measured by the ratio of total debt to total assets; financial performance was measured by return on assets, liquidity measured by current ratio and firm size measured by a log of total assets. Share return was the dependent variable and was measured by change in total return. 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. Data analysis was undertaken using the SPSS software. The relationship between variables established using multiple linear regression analysis and correlation analysis. The study found that the independent variables had a correlation with share return of nonfinancial firms listed at the NSE (R=0.450). ANOVA results show that the F statistic was significant at 5% level with a p=0.000. Therefore the model was fit to explain the association between the selected variables. From the research findings, it is evident that firm size produced positive and statistically significant values for this study (high t-value (6.387), p < 0.00). Financial performance and firm liquidity produced positive but statistically insignificant values for this study as shown by p values that are more than 5%. Financial leverage produced negative and significant values for this study as shown by a p value 0.021<0.05. This study recommends 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 non-financial 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 share return.