Commercial paper as a source of finance for Kenyan companies

Abstract

Financial structure decisions are a central part of corporate theory. Corporate managers need to make decisions pertaining to the sourcing of funds, and how much of the firm's earnings will be distributed to shareholders as dividends. The dividend decision is important because of its implications on the capital structure decisions that managers need to make all the time. The capital structure decision requires managers to choose between debt and equity as sources of financing investments of the business. The owners of the firm have certain expectations that they expect managers to fulfil. The main expectation is that managers will act in the interest of the shareholders at all times, with a core objective of maximizing the net worth of the shareholders and the market value of the firm as a consequence. Debt finance offers the advantage of a tax shield, which leads to the increase in the value of the leveraged firm. However, increased use of debt leads to financial distress, and this may offset the benefit accrued from the tax shield . The pecking order theory advanced by Myers (1990) shows that managers have an order of preference that moves from internal to external sources. When debt is used in the capital structure, the managers prefer safer to riskier debt. The use of short-term debt is an attempt to use safer debt, especially in times when interest rates are high and when there exists high uncertainty about the magnitude and timing of expected future cash flows. Commercial paper is one form of short term borrowing, and its use can be attributed to the following of the pecking order theory by corporate managers in practice. In light of the above background, this study explores the use of commercial paper as a source of finance for Kenyan companies, judging by its increased use by the corporate sector especially in 1999. The study attempts to find, inter alia, if there has emerged a pattern among the issuing companies that would show existence of any similarities as regards size, ownership and industrial class. It also seeks to find out the reasons that bring companies to source funds from the commercial paper market. The number of companies that have borrowed funds using commercial paper is at present still relatively small. This can be partly attributed to policy and infrastructural limitations within the capital markets framework. More commercial paper issues are expected in the future after the resolution of these limitations by the Capital Markets Authority, expected to be accomplished within this year. The study has determined that there has been a significant rise in the use of commercial paper as a source of finance in 1999. Use of funds sourced from commercial paper issuance has been mainly limited to the financing of working capital needs. This is within expectation considering that commercial. paper is a short-term source of funds. The study has determined that there is a demand for a secondary market for commercial paper so as to offer flexibility to both the lenders and borrowers.