Effect of Capital Structure on Value of Non-financial Firms Listed at the Nairobi Securities Exchange

Abstract

The association between a firm's financial structure and its market value has been a focal point of financial research over the years. Understanding this relationship is crucial for policymakers, investors, and firm managers, especially in emerging markets where the dynamics can be unique and distinct from developed economies. The Nairobi Securities Exchange (NSE), being a pivotal financial hub in East Africa, provides an ideal backdrop for examining these dynamics in the context of an emerging economy. This study sought to investigate the impact of capital structure on the value of non-financial firms listed on the NSE. In addition, the research aimed to understand how other financial variables like liquidity and firm size influence the market value of these firms. The dependent variable in the study, firm value, was gauged using Tobin's Q – a ratio comparing the market value of a firm to its replacement cost. The primary independent variable, capital structure, was measured as the ratio of total debt to total assets. Control variables included liquidity, assessed using the current ratio, and firm size, which was measured via the natural logarithm of total assets. The study was supported by trade-off theory, pecking order theory, as well as agency theory. Adopting a descriptive research design, the research utilized secondary data collected over a five-year span (2018-2022), resulting in a total of 200 observations. Statistical analyses, including correlation and regression, were employed to decipher the association between the variables. Regression results discovered a significant negative relationship between capital structure and firm value, with a coefficient of -0.1073 at a p-value of 0.003. Liquidity exhibited a positive correlation to firm value, with a coefficient of 0.1012 and a p-value of 0.000. Firm size showed a positive, albeit not statistically significant at conventional levels, relationship with firm value, evidenced by a coefficient of 0.0201 and a 0.078 p-value. The study concluded that a higher proportion of debt relative to assets is associated with a decline in the market value of non-financial firms listed on the NSE. Additionally, firms with better liquidity positions are generally perceived more favorably in the market, suggesting the value investors place on financial resilience and flexibility. Based on the findings, policymakers are advised to consider establishing guidelines for optimal debt ratios to ensure the financial stability of listed firms. Furthermore, the positive influence of liquidity on firm value underscores the importance of firms maintaining a healthy liquidity position, emphasizing the need for robust liquidity management practices. Future studies could benefit from an expanded timeframe, inclusion of other potential variables influencing firm value, and the adoption of a mixed-methods approach for richer insights.