The relationship between business risk and leverage empirical evidence from companies listed at Nairobi stock exchange

Abstract

This paper studies the relationship between business risk and leverage of companies listed at Nairobi stock exchange (NSE). The main objective is to test whether there exist a relationship between business risk and leverage for companies trading at NSE. Even though the study aims at determining the relationship between business risk and leverage, in the empirical tests, we include additional variables to minimize possible misspecification errors owing to omitted variables. The variables are; Non-debt tax shields, Firm size, Research and development and Advertising expenditures, Profitability and Industrial classifications. Using multiple regressions model and SPSS program as a tool of analysis, we analyze the relationship between business risk and leverage in sub-period 1998 to 2002 and 2003 to 2008. Our model finds no evidence to support theoretical work that predicts that leverage ratios are related to firm’s business risk and firm size in both sub-periods. The result of ‘nondebt tax shield’ and ‘profitability are mixed. In the period 1998 to 2002, the result confirms the prediction of regression model that non-debt tax shield and profitability are negatively related to leverage ratio and the relation is significant for non-debt tax shield attribute and insignificant for profitability attribute. In the period 2003 to 2008, we found profitability and non-debt tax shield attributes to be positively related to leverage but only profitability was significantly related to leverage ratio.