The Relationship Between Capital Structure and Stock Returns of Firms Quoted in the Nairobi Securities Exchange
Abstract
The study’s objective was to determine the relationship between capital structure and
stock returns of firms quoted in the Nairobi Securities Exchange. The researcher adopted
an empirical research design. In this case, data was gathered relating to capital structure
and stock returns of firms quoted in the Nairobi Securities Exchange over a three year
period between 2011 and 2013. The target population for this study therefore comprised
of all 50 presently listed companies in the Nairobi securities Exchange’s main segment.
However, banking and insurances companies were excluded from the study because their
capital is regulated by Central Bank of Kenya and Insurance Regulatory Authority
respectively. This study collected secondary data relating to stock returns and firm’s
capital structure of the listed companies at the Nairobi Stock Exchange for the period
between 2011 and 2013. Secondary data was collected from the annual reports of the
publicly listed companies. Data analysis method was based on Pearson correlation
analysis and a multiple regression model conducted on Statistical Package for Social
Sciences (SPSS) on the accounting based measures of firm’s capital structure used in this
study. Analysis of firm’s stock return was performed using one year stock returns (Y)
based on the market share prices, while capital structure was measured using the
following variables: Leverage ratio (X1 = Total market Debt/market Equity); Firm size
(X2 = natural log of sales); Cash generation capacity (X3 = Earnings before interest tax
depreciation and amortization); Operating leverage (X4= change in EBITDA divided by
change in sales); Industry dummy variable (X5). Adjusted R Square value and Analysis
of Variance (ANOVA) was used to test the significance of the model. The Pearson
product-moment correlation coefficient (PPMCC or PCC) was used as a measure of the
correlation (linear dependence) between stock price return as the dependent variable and
other variables as the independent variables, giving a value between +1 and −1 inclusive
for each tested variable. The researcher then presented the findings using appropriate piecharts,
graphs and tables. Research findings indicated that stock returns increase with
increase in the company’s leverage ratio of firms listed in the NSE and is consistence
with the theoretical review. It can therefore be concluded that management of such firms
should aim at maintaining high leverage ratio which will in turn drive an increase in stock
returns which will be favorable for the firm’s shareholders. Findings indicated that
although the increase in firm size results in a decrease in stock returns, this relationship is
not significant for publicly listed companies in the NSE. It can therefore be concluded
that management of firms listed in the NSE should not be too concerned with the firm
size as it is not significant in determining stock returns. Findings also indicated that firm
profitability has no significant impact on stock returns for firms listed in the NSE.
Findings further indicated that that an increase in operating leverage increases the firm’s
stock returns. It can therefore be concluded that management of firms listed in the NSE
should target higher operating leverage in order to increase stock returns. The study
recommended that on the effect of policy and decision making of the board with regard to
stock returns, it is recommended that the board of directors of companies quoted in the
NSE should set up policies that link firm performance to stock returns both in the short
term and long term to further reinforce the executive alignment to stockholders’ wealth
maximization.
Publisher
University of Nairobi