Effect of Foreign Exchange Rate Risk on Financial Performance of Listed Firms at the Nairobi Securities Exchange, Kenya

Abstract

Fluctuations in exchange rates can affect various aspects of the company's financial performance, leading to implications for profitability, cash flows and overall financial stability. One key area where foreign exchange rate risk affects firms is through its impact on revenues and costs. If the foreign currency strengthens against the firm's home currency, the revenues earned from exports will be reduced when converted back to the home currency. This can lead to lower reported revenues and potentially impact the firm's profitability. This study investigated the effect of foreign exchange rate risk on the financial performance of cross-border listed firms at the Nairobi Securities Exchange (NSE), Kenya. The study draws on three key economic theories, namely Interest Rate Parity theory, Purchasing Power Parity theory, and the International Fisher Effect theory, to establish a theoretical framework. The research methodology involves a quantitative approach, utilizing secondary data collected from published financial statements of cross-border listed companies at the NSE. The data covered the period from 2018 to 2022, offering a comprehensive snapshot of the financial landscape of these firms. Descriptive statistics, correlation analysis, and regression analysis were employed to analyze the relationships among variables. The target population comprised the 14 cross-border listed companies at the NSE that trade their shares outside Kenya. From this population, a sample of 11 companies provided complete data, resulting in 55 observations for the analysis. The main variables included the dependent variable, Return on Assets (ROA), and independent variables, foreign exchange risk, financial leverage, firm liquidity, and firm size. The findings indicate that financial leverage and firm size significantly influence the financial performance of cross-border listed firms at the NSE. Financial leverage exhibits a negative correlation and regression coefficient, suggesting that higher debt levels are associated with lower ROA. Firm size, on the other hand, displays a positive and highly significant correlation and coefficient, indicating that larger firms tend to have higher financial performance. Foreign exchange risk and firm liquidity, while showing weaker correlations, do not exhibit statistically significant relationships with ROA. In conclusion, the study contributes to the understanding of the financial dynamics of cross-border listed firms in an emerging market context. It highlights the importance of managing financial leverage and achieving economies of scale for sustained financial performance. The study recommends the need for prudent financial management strategies, strategic growth initiatives to enhance firm size, and effective foreign exchange risk management. Future research should consider investigating the effectiveness of risk management strategies, considering macroeconomic factors, and conducting comparative studies across different emerging markets.