Relationship Between Capital Structure and Financial Performance of Firms Listed at the Nairobi Stock Exchange

Abstract

The capital structure of a firm is basically the mix of debt and equity which a firm deems as appropriate to enhance its operations in the midst of several constraints it poses. Berger and Bonaccorsi di Patti (2006) have noted that high leverage or low equity/assets ratio reduces agency cost of outside equity and thus increases firm value by compelling managers to act more in the interest of shareholders. Important theories have been advanced to explain capital structure decisions. The trade-off theories of corporate financing are built around the concept of target capital structure that balances various costs and benefits of debt and equity. An economic intuition indicates that, economy's business cycle phase should be an important determinant of capital structure decisions. Studies conducted by Bebczuk (2000) have indicated that credit markets are markedly segmented in Argentina and that the volatility of the environment and external shocks affects firm’s capital structure decisions. It could also be argued that if a firm's cash flow and value is sensitive to exchange rate fluctuations, then the firm may have to issue some of its debt in foreign currencies and also ascertain in which currency its cash flow will be denominated. Financial Performance is a subjective measure of how well a firm can use assets from its primary mode of business and generate revenues. This term is also used as a general measure of a firm's overall financial health over a given period of time, and can be used to compare similar firms across the same industry or to compare industries or sectors in aggregation. Measuring the results of a firm policies and operations in monetary terms. These results are reflected in the firm's return on investment, return on assets, value added return, etc.