The relationship between capital structure and agency costs of firms listed at the Nairobi Securities Exchange

Abstract

Under agency theory, organizations incur agency costs as a means to reduce agency conflicts between shareholders (principal) and the managers (agents). The divergent views by different researchers especially from outside Africa in respect to agency costs, create a knowledge gap to determine to what extent capital structure affects the agency costs of companies listed at NSE given Kenya’s uniqueness in terms of culture, laws and regulations. Some of the studies carried so far in this field gives conflicting outcomes as to the effect of capital structure on agency costs. The objective of the study was to investigate the relationship between capital structure and agency cost of listed companies at the Nairobi Securities Exchange. The following research question guided the study: how does capital structure relate to agency costs of listed firms? In answering this question, the study used efficiency cost ratio as a proxy for agency costs, Long term debt to equity as a proxy for capital structure and two other variables that affects agency costs; this are information asymmetry as measured by market value/Book value per share and ownership concentration measured by corporate ownership/Equity. The historical data for these were obtained from the Nairobi Securities Exchange and the Capital Markets Authority data banks. The correlation research design was used in the study. The study covered a target population of all companies quoted at Nairobi Securities Exchange between 1st January 2009 and 30th December 2013. The study used secondary data from Nairobi Security Exchange. Statistical Package for Social Scientist (SPSS) was used to aid in analyzing data. Regression analysis was applied to determine the effect of capital structure on agency costs. A simple regression was used to test the main model and t-test was used as a test of significance. The key findings revealed that there was a positive correlation between capital structure and agency costs. The main conclusion from our analysis is that indeed capital structure determines agency costs. Given the evidence from this research, it’s evident that capital structure positively affects agency costs of listed firms at the Nairobi Securities Exchange. Some of the policy recommendations of the study are; Firms should formulate incentive schemes for managers who are able to reduce agency costs with an increase or decrease in the use of debt in the firm’s capital structure. Also looking forward, identifying and the use of appropriate and more unified estimation techniques will be most welcome, the reason why there is no consensus in the literature about the shape of the capital structure-agency costs relationship, is because there is no universal estimation technique, this study serves as a first attempt towards establishing a more pragmatic empirical model for agency cost modeling and its determinants.