The Effect of Financial Distress on Stock Returns of Firms Quoted at the Nairobi Securities Exchange
Abstract
The literature shows that publicly traded firms do encounter financial distressed from
time to time but does not conclusively determine whether or not such situations affects
the returns of equity stocks issued by the firms. The overall objective of the study was to
estimate financial distress in the firms quoted in the Nairobi Securities exchange. The
study proceeded to test the effect of financial distress on stock returns. Applying
descriptive correlation design, the study involved a total of 26 firms selected from the
population of 61 quoted firms. It excluded the firms in the banking, insurance and
manufacturing sectors to which the chosen model was not applicable. The study applied
secondary data from audited financial reports for nine years to estimate financial distress
using the Altman's Z" -score model. The score representing the probability of a company
falling into financial distress was computed out of four financial ratios namely: Working
capital/Total assets; Retained earnings/Total assets; Earnings before interest and tax/Total
assets and Book value of equity/total liabilities. The scores were then weighed against
Altman's zones of classification namely: 'safe zone, 'grey zone' and 'distress zone. The
study found that financial distress was prevalent among the sampled firms but the
estimates obtained from the sample were not significant enough to be generalized on the
population. Stock returns were then calculated for quarterly periods out of daily price
data published by Nairobi Securities Exchange and dividend payouts. Computed stock
return values were correlated with the financial distress scores. The resulting correlation
coefficient indicated a weak positive correlation between financial distress and stock
returns. Coefficient of determination indicated that financial distress did not explain any
variation in the firm's stock returns. The results suggest that the firms quoted in Nairobi
Securities Exchange did experience financial distress from time to time to which there
was minimal reaction from market observable in terms of movement of stock returns.
Recommended policy interventions include public education on equity stock trading and
review of financial reporting standards for publicly quoted firms. Further research
applying alternative test parameters and models for financial distress and incorporating
other firms quoted in the Nairobi Securities exchange that were not sampled for this study
is recommended.
Citation
George Munene Muthamia (2013). The Effect Of Financial Distress On Stock Returns Of Firms Quoted At The Nairobi Securities Exchange. Master Of Business AdministrationPublisher
University of Nairobi