Effects of Capital Structure on the Financial Performance of Firms Listed at the Nairobi Securities Exchange

Abstract

The choice whether equity or debt financing has led to never-ending search for the best capital structure. Numerous research studies indicates that a firm with high degree of financial leverage seem to have an optimal capital structure and thus it leads to better financial performance while others such as seminar paper of the Modigliani-Miller argues that it has no influence on the firms value. The significance of these financial issues has motivated numerous researchers to establish the effect of the capital structure composition on the firm financial performance of companies quoted at NSE with no conclusion. The purpose of this research study was to ascertain the effects of capital structure on the performance of quoted at NSE. The firm financial performance was measured in terms of asset returns while capital structure was measured using debt ratio. The research period was between 2011 to 2015. During this research period, numerous companies listed at NSE had embarked on massive debt acquisition to finance their development projects. However, some companies such as Uchumi and Kenya airways reported huge loss which triggered the need to examine the effect of such changes in the capital structure composition have on the financial performance. This presented a fascinating period of study considering the ups and downs of the business cycle. The study population constituted of all the 47 non-financial firms listed at NSE. Secondary data utilized was obtained from the audited financial statements obtained from the company website and NSE Handbook covering the period from 2011 to 2015. Correlation and regression analysis facilitated the statistical analysis with aid of Statistical Package for Social sciences (SPSS). The research findings obtained showed that capital structure has an inverse influence on the financial performance of firms listed at NSE. The findings pointed out that, financial performance decreases with the increase in the debt ratio in the capital structure, which supports the need for capital injection instead of borrowing because debt financing results in costs such as interest rates which exceed the benefits of debt financing. The research study recommended that firms should decrease the amount of the financial leverage in their capital structure in order to enhance the financial performance and create huge value to its shareholders