Relationship Between Interest Rates and Gearing Ratios of Firms Listed in the Nairobi Securities Exchange

Abstract

Business enterprises use debt in their businesses, because it offers them potential to increase the volume of their operations and increase the average return on their equity funds. The use of debt will have this effect only if the rate of return on the investment is greater than the rate of return on the debt. The borrowing firm takes a chance to use debt in the hope that it will elevate the firm to a more valuable level, by increasing the turnover and therefore increase the profits. The financial leverage chance will arise if the interest charged to the firm is lower than the returns by the company, in which case the firm will be making enough to pay the interest charged and the principal repayment and retain the surplus for the shareholders. The objective of this study was to establish the relationship between interest rates and gearing ratios of firms listed in the Nairobi Securities Exchange. The study was carried out using a longitudinal design, employing secondary quantitative data. The population for this study constituted of all listed companies in the Nairobi Securities Exchange. As at December 2013, there are 62 companies listed on the Nairobi Securities Exchange. This study did not sample and hence a census survey was carried out for the study. The study used secondary data. All the data was collected by review of documents, annual reports of the companies, the Nairobi Securities Exchange Handbooks and published books of accounts. The selected period was year 2009 to year 2013 (5 years). The researcher used frequencies, averages and percentages in this study. The researcher used Statistical Package for Social Sciences (SPSS) to generate the descriptive statistics and also to generate inferential results. Regression analysis was used to demonstrate effect of interest rate on the gearing ratio of listed firms. The results were presented using tables to give a clear picture of the research findings at a glance. The study concluded that; increase in the interest rate results to a decrease of the gearing ratio, increase in the profitability of firm results to a decrease of the gearing ratio (debt-to-equity ratio), increase in the size of a firm results to increase of the gearing ratio (debt-to-equity ratio). From the findings the study realized that the firm size was significant in determining the firms used of debt financing, it thus recommended that in the event firms wanted to maximize on the use of debt they should adopt strategies that increase their firm size resulting to a scenario whereby they increase their collateral and thus granting them the ability to access more debt easily.