Cashflow Volatility, Leverage Deviation, Corporate Investments and Value of Nonfinancial Firms Listed at the Nairobi Securities Exchange

Abstract

Volatility of corporate cashflows exacerbates reduction in investments, increases external cost of finance and causes a deviation of leverage from the target leading to adverse effects on firm value. There is a dearth of studies on cashflow volatility and its impact on leverage, corporate investment, and firm value. Furthermore, extant literature on the relations presents mixed findings and majority of the studies are from developed economies which are culturally and economically different from developing economies. This study sought to examine the interrelationships among cashflow volatility, corporate investments, leverage deviation and value of nonfinancial companies listed at the Nairobi Securities Exchange. It seeks to evaluate whether investors price smooth cashflows. Specifically, the study analysed the impact of cashflow volatility on corporate value, the mediating effect of leverage deviation and corporate investments on the cashflow volatility and firm value link and the joint effect of cashflow volatility, leverage deviation, corporate investments on firm value. The study was anchored on the theory of information asymmetry which explains the interrelations among the four study variables by linking signalling effect of corporate financial information on firm value. Dynamic trade off theory, free cashflow theory and underinvestment theory were also applied in the study and a positivist philosophy used to evaluate research hypotheses. A census was conducted on a population of 42 nonfinancial companies listed at the NSE for the period 2002 to 2019 and data collected from 36 companies which had consistent listing for at least three consecutive years. Descriptive longitudinal research design was applied to analyse the secondary data and descriptive analysis including mean, standard deviation, minimum and maximum were carried out to visualize the distribution of data, detect outliers and identify associations among variables. Correlation test was conducted to examine the intensity and direction of relationships among the study variables. Diagnostic tests of normality, multicollinearity, heteroskedasticity, stationarity, and autocorrelation were conducted prior to carrying out inferential analysis. Furthermore, panel specification tests indicated that random effects model was the most suitable for the study. To cater for non-normality log transformation of variables was done and robust standard errors applied as a remedial measure for heteroskedasticity and autocorrelation. Results from hypothesis testing showed an inverse and statistically significant correlation between cashflow volatility and corporate value. Secondly, results from a four-step mediation analysis provided evidence that leverage deviation does not mediate the cashflow volatility and firm value relationship however, it was observed that corporate investment has a mediating effect. Finally, the study findings provided evidence of a joint effect of cashflow volatility, leverage deviation, corporate investments on value of nonfinancial companies listed at the NSE. Thus, findings contribute to literature by reducing controversy on cashflow volatility and firm value link by introducing leverage deviation as an alternative measure of financial risk and providing evidence against optimal capital structure theory. The study cautions management to monitor closely their operational costs and enhance risk management measures to minimize cashflow volatility which impacts negatively on investments and firm value. The study recommends future research on antecedents of cashflow volatility and leverage deviation to obtain a holistic view of the effects of cashflow uncertainty on corporate value.