The effect of industry leverage on firm performance: A case study of firms quoted at NSE

Abstract

Efficient financial management requires the existence of some objective or goal because judgment as to whether or not a financial decision is efficient must be made in light of some standard. Various objectives are possible of which the primary goal of the firm is to maximize the wealth of the firm’s present owners. This study sought to find out the effect of industry leverage on firm’s performance. The objective of this study is to evaluate the relationship between Industry Capital Structure norms and the performance of companies in the Industry. Secondary data was collected from the NSE. All sectors of the NSE are involved in the study with exception of the financial and investment sector whose leverage is subject to regulation. The sample period was five years between 2002 and 2006. The findings of the study were commercial and services sector had the highest figures for leverage ratio, market value to book value and price earning ratio. Among the companies involved in the study, Total Kenya and City Trust did not finance its operations with debt. Those with highest leverage ratios comprised of; Express Kenya Limited, Kakuzi limited, Kenya Power and Lighting Company Limited, Kenya Airways limited and East African Portland Cement. Firms adopting Industry leverage had low leverage ratio, similar to that of the industry, higher MV/BV and a higher PER as compared to the rest of the firms. This leads to the rejection of the null hypothesis that conformist firms do not record higher performance than non-conformist firms and acceptance of the alternative hypothesis. Further, in carrying out regressions tests and Analysis of Variance tests (ANOVA) it was found out that there was a significant difference in leverage for different Industries. Commercial and services sector had the highest financial leverage followed by Industrial and Allied sector and finally Agricultural sector. This is a manifestation of capital structure theories that different firms have different optimal capital structures depending upon firm characteristics.