Effect Of Liquidity Risk On Stock Returns Of Manufacturing And Allied Firms Listed At The Nairobi Securities Exchange

Abstract

Tradeoffs exist between liquidity and returns and firms need to recognize and understand these tradeoffs and implement strategies that take them into account. Aggressive investment in current assets negatively impacts a firm’s returns and positive impact on the liquidity. On the other hand, conservatism investment in current assets results in low liquidity and higher returns although it could result in unmet customer demands. Liquidity risk management should therefore involve management of these tradeoffs to ensure optimization of firm returns and liquidity. The focus of this study was to ascertain the effect of liquidity risk on stock returns of manufacturing and allied firms at the NSE. The population for the study was all the 9 companies in that category quoted at the NSE. Predictor variables were liquidity risk, capital structure, firm size and profitability. Stock return was the dependent variable and was represented by change in share price plus any dividend issued during the period. Secondary data was collected over a five-year time frame (January 2014 to December 2018) annually. Research design for this study was descriptive cross-sectional design while multiple linear regression was applied in determining the how the variables relate. SPPS software was employed in the analysis of data. From the analysis an R-square value of 0.868 was produced which in other words mean that 86.8% of the changes in the stock returns of the listed firms at the NSE can be described by the predictor variables studied while the other 13.2% in the changes in stock returns is affiliated to other variables that outside the scope of this study. It was further found out that independent variables of this study strongly correlated with the stock returns (R=0.932). ANOVA outcomes revealed that the F statistic was significant at 5% level with a p=0.000. Therefore, the model was appropriate in explaining variables’ relationships. The findings also showed that capital structure and profitability showed positive and statistically substantial values for this study while liquidity risk produced negative and statistically substantial values for this study. Firm size was a statistically insignificant causal factor of stock returns. This study suggests that the firms should enhance their profitability and reduce liquidity risk as this will significantly improve their stock returns.