| dc.description.abstract | Modigiliani and Miller, 1958, and 1963, proved that interest tax shield was important in
determining the value of a firm. They urged that, where interest expense arising from
corporate debt is deductible before arriving at taxable income, the value of the firm
increased by the amount of present value of interest tax shield less the present value of
financial distress. Modigiliani and Miller argued that the advantage of using debt at a
corporate level is in the deductibility of interest expense before arriving at the taxable
income and at a personal level, the equity income is generally taxed at a lower rate than the
debt income.
Miller, 1977, developed a model that incorporated the corporate and personal tax rates on
equity and personal income in determining the gain from corporate leverage rate (hereafter
referred to as GFL). Using Miller's model, the study empirically investigated the
characteristics of the GFL for firms listed in the Nairobi Stock Exchange (NSE). Further, the
research investigated whether the listed firms consider the gain from leverage in sourcing for
corporate finance.
The study considered all the listed firms in the NSE with the exception of financial and
banking institutions. Secondary data was obtained from the audited financial statements for
the period 1990 to 2001, a period of 12 years. The data on corporate tax rate, personal tax
rate for equity and debt incomes, interest expense charged, corporate tax charged, total
debt, shareholder funds (equity) and tax paid was obtained. Data analysis was done using
MS SPSS version 10 and MS Excel 2000.
The results revealed that, a total of thirty-three (33) firms had employed the maximum GFL
(at 37 percent), while three- (3) firms had attained a GFL of 33.5 percent and six firms had
the rate at 25.9 percent. Given the tax rates in Kenya, the gain from leverage range
between 22 percent and 37 percent. This implies that Kenyan finance managers recognised
the importance of GFL. In addition, the results show that, the coefficient of correlation
between the GFL and the corporate tax rate (Tc) was positive and strong at 0.931. Similar
results were obtained for the relationship between combined effect of corporate, and
personal taxes and the gain from leverage with coefficient of correlation of 0.966. Also,
relationship between personal tax loss (or personal tax - Td) on interest income and gain
from leverage (r = -0.908). The multivariate regression analysis also suggests that all
factors combined have a significant contribution to capital structure decisions, with
coefficient of correlation of 0.694.
However, it was noted that, the correlation coefficient between the combined effect of
corporate tax rate and personal tax rate and the debt equity ratio is weak, at (0.482) and
negative. Similar results were obtained for the relationship between (i) nominal interest rate
and debt equity ratio (r = -0.595), (ii) nominal interest rate to corporate tax rate GFL (r =
0.223) and (iii) corporate tax rate and debt equity ratio (r = -0.279). Further, the results
show that there is a delayed effect on debt equity ratio resulting from changes in corporate
and personal tax rates, which shows that, the coefficient of correlation was (0.482) and
(0.809) one-year afterwards. On the other hand the nominal interest rate has no delayed
effect to debt equity ratio. These results are expected in that tax changes affect the financial
results one year down the line while the interest rate on debt income take effect
immediately.
Further, the results reveal that the debt equity ratio have remained more or less unchanged,
raising doubts as to whether interest tax shield was considered as a single most important
factor in view of the declining corporate tax rate (which dropped from 42.5 percent in 1990 to
30 percent in 2001). The results also suggest that firms listed in the NSE do not cluster
around a given ratio of interest tax shield.
The study proved that the GFL rate is important in determining and sourcing for corporate
debt and equity finance. This implies that finance managers in Kenya consider the GFL in
sourcing for finance. In order to obtain the maximum gain from leverage the results imply
that Kenyan firms have established a clientele for debt and equity finance. In regard to
corporate, nominal interest, personal tax rates and debt equity ratio, the results suggest that
finance managers do not consider these factors in isolation as important. This implies that
there are other important factors that are considered more important in sourcing for finance.
It is recommended that corporate finance managers should obtain debt and equity finance
that yields the maximum gain from leverage rate while the fiscal monetary policy makers
should consider using the gain from leverage rate as a tools to vary the debt usage in the
economy. | en |
