Effect of Debt Financing on Profitability of Listed Firms in Kenya

Abstract

Financial analysts argue in favour of debt utilization, believing that debt finance can help improve a company's performance. The listed firms in Kenya have been experiencing poor profitability in the recent years. Could this be attributed to the debt financing among the firms. This study sought to determine the effect of debt financing on profitability of listed firms in Kenya. The study adopted net income, agency and pecking order theories. The study adopted net profit margin as the measure for profitability which was the dependent variable. Debt financing was adopted as the independent variable and measured in terms of debt ratio. The study adopted firm size, liquidity and equity financing as the control variables. The study adopted descriptive research design on forty-two (42) listed firms in Kenya. This research was grounded on secondary data from individual firm reports of listed firms in Kenya between 2017 and 2021. The reports were mined from the NSE website. The data collection schedule was used for data collection. Stata 14 was utilized for generation of descriptive and regression statistics. Diagnostic tests of normality, multicollinearity, stationarity, autocorrelation and heteroscedasticity were done. The researcher used F-statistics generated through ANOVA to test for the significance of the regression model. The study found that, between 2017 and 2021, the listed firms showed an average profitability as measured by net profit margin of 8%; debt financing showed of 29.04% as reflected in debt ratio; liquidity at 10.59%; Firm size, average log of 9.70; and equity financing at 54.57% as measured by equity ratio. The regression model summary showed a strong relationship between the predictor variables and profitability. The predictors contributed a proportion of 51.1% of the profitability of listed firms. From the ANOVA, debt financing and the control variables had a significant effect on profitability of listed firms. From the regression coefficients, debt financing, liquidity and firm size had significant positive regression coefficients while equity financing had a negative insignificant regression coefficient. The study concludes that debt financing, liquidity and firm size have a positive effect while equity financing has an insignificant effect on profitability of listed firms in Kenya. The study recommends that listed firms in Kenya increase their debt financing; to increase their liquidity ratios optimally by increasing the level of liquid assets or by reducing the level of liquid assets; to increase their assets by purchasing more; and adopt less equity in financing their opertaions to increase the profitability of the firms. The study was limited by the variables of the study; scope; nature of data; and research methods adopted in the study. The study recommends a study based on other factors influencing profitability of listed firms; other firms other than listed firms; primary or quarterly or semi-annual data; as well as other analytical techniques like One Sample T-test or correlation.