The Effect of Capital Structure on Financial Distress of Commercial and Services Companies Listed at the Nairobi Securities Exchange Kenya

Abstract

There is evidence of poor performance in the commercial and service establishments registered in the NSE leading to financial distress.. However, there are no deliberate moves by the stock markets to educate companies about the bearing that financial difficulty has on the results of firms in the stock market, causes or on ways of improving their profitability. Existing literature indicates that poor establishment of companies’ capital structure is a likely cause of the observed financial distress as well as the subsequent poor performance in the stock market. However, there are few studies done to verify the specific association between capital structure and financial distress and the few that attempt to asses this have used the Altman Z score which does not consider the endogeneity of the variables which leads to biased results. Similarly, these studies present inconsistent findings. This research locked this gap using a different approach from the others as it narrows down specifically to financial distress and also uses the shumway hazard model as modified. The aim of the investigation was to confirm the effects of capital structure on the financial distress of commercial and services companies listed on the NSE. It applied a descriptive research design and used the eleven (11) firms listed under commercial and service category as its target population. Because the population data was readily available the study applied census, a non-probability method for sampling. Information and data was sourced from secondary sources and mainly from the Nairobi Stock Exchange reports. The research evaluated the data by use of quantitative approach to generate descriptive statistics and thereafter carried out inferential statistics. The conclusions made were that the variables had the following effects on financial distress of NSE listed commercial and services firm; business size has negative immaterial influence on probability of financial distress; profitability has positive unsubstantial influence on the possibility of financial distress, liquidity of a business had a negative significant effect on financial distress and positive effect to firm performance and if not monitored can lead to financial distress, and capital structure has a positive insignificant impact on probability of financial difilculty among these particular group of firms . The study recommends that the managers of these firms should come up with policies that help to estimate the optimum levels of liquidity, debt, profitability and earnings growth to be sustained by the enterprise in order to ensure smooth running and long term sustainability of the company. The study also recommends for improvement of strategic decision making implemented by skilled and experienced professionals which will result to good returns due to sound and rational decision making for the firms; These firms should also match their debt amounts with their revenue volatility; and these firms should seek to employ more internal financing and less debt capital to fund their activities since employment of borrowed funds is a major recipe for corporate financial distress.