| dc.description.abstract | Financing a firm is basically a mix of debt and equity which a firm deems appropriate to
enhance its operations. Firm financing constitutes its capital structure, which decision is crucial
for any business organization because of the need to maximize returns to various organizational
constituents and also because of the impact such a decision has on a firm's ability to deal with
its competitive environment. However, the tax paid by the firm affects the two, both debt and
equity ratios. Thus, tax constitutes a potentially important consideration in financing
decisions. The question is, how does effective corporate tax rate affect the financial leverage of
corporations? Therefore, this study assessed how the corporate tax rate affects financing for
firms listed at Nairobi Stock Exchange. Specifically the study aimed to establish the relationship
between effective corporate tax rate and debt ratio for firms listed at Nairobi Stock Exchange
between 2003 and 2007.
To achieve this objective of the study both correlation matrix and regression analysis were used.
A regression equation: X= a + rY + e, was specified and estimated; where X represents the debt
ratio, Y represents the effective corporate tax rate, a is the intercept, and r is the correlation coefficient
which measures of the strength of linear association between the two variables, i.e., X
and Y.
The result revealed that there was a negative correlation between effective corporate tax rate and
the debt ratio. First, the correlation matrix coefficient was -0.217. This linear correlation was
negative at 5% level of significance, indicating that there was negative relationship between
effective corporate tax and debt ratio. Secondly, the regression result revealed that the
coefficient between the effective corporate tax and debt ratio was -0.43. This indicated there was a
negative relationship between effective corporate tax rate and debt ratio. The negative
relationship supports the Pecking Order theory where firms prefer to use internal financing
before resorting to external funds, mainly debt. The theory supports the negative relationship
between tax ratio and the debt ratio as opposed to the Trade-off theory which supports a positive
relationship between debt and tax ratio where the higher the tax ratio, the higher the debt ratio.
Pecking order theory also explains negative intra-industry correlation between profitability and
debt ratio, where the higher the profitability, the lower the debt ratio. | en |
