Effect of Debt Financing on Financial Performance of Firms Listed at the Nairobi Securities Exchange

Abstract

Many firms rely on debt to finance investment projects because the retained earnings cannot solely support the firms operations. If firms settle on poor debt financing decisions, the outcome to the firm will lead to higher costs in capital, which in turn lead to reduction in overall financial performance. On the other hand, effective debt financing decisions results in higher present value, thereby boosting the worth of a company. However, finding the optimal structure is important because this decision gives a firm an edge over its competitors as it is very critical. The objective “of this research was to determine the effect of debt financing on financial performance of listed firms at the Nairobi Securities Exchange. It also aimed at reviewing the increasing body of theoretical and empirical studies that have endeavoured to examine the range of magnitude and effects of the debt financing on the financial performance. The target population was all the listed firms at the Nairobi Securities Exchange. Secondary sources of data were employed. Panel data was utilized, data was collected for several units of analysis over a varying time periods. The research employed inferential statistics, which included correlation analysis and panel multiple linear regression equation with the technique of estimation being Ordinary Least Squares (OLS) and so as to” establish the relationship of debt finacing and financial performance while incorporating the control effect of firm size, liquidity, and asset tangibility. The study findings were that firm size and liquidity are significantly positively associated to financial performance. Additional findings were that that the model consisting of debt financing and the control variables that entail; firm size, liquidity, and asset tangibility in unison influence financial performance and they can be utilized to significantly predict financial performance. The final findings were that debt financing and firm size have a significant positive relationship with financial performance. Policy recommendations are made to the CMA and NSE, and by extension, the National Treasury, to formulate and enforce rules and regulations on debt financing. The policy makers should strive to bolster the corporate bond sector of the capital market. Further conclusions were made to firm management and consultants to implement good working capital management practices, employ debt financing, and increase firm size in order to boost firm value. Recommendations were made to other stakeholders like investment banks, equity analysts, and individual investors to search for firms that employ debt financing, implement good working capital management practices and are large in size, to invest or recommend to invest.