Testing for variations in the capital structure of companies quoted at the Nairobi Stock Exchange:An empirical study

Abstract

In 1958, when Modigliani and Miller came up with the irrelevancy theory of capital structure a number of controversies sprang up, most of which sought to establish the relationship between capital structure and the value of the firm or its cost of capital. The answers given by the theorists aim at assisting investors to make proper investment decisions. This study aims at establishing the nature of capital structures employed by companies quoted on the Nairobi Stock Exchange, specifically whether the capital structures differ per industry category and whether the companies in the same sector have similar capital structures, hence lending support to the existence of an optimal capital structure. Discriminant analysis, regression analysis and variance analysis were the tests applied with the use of the computer SPSS program. Secondary data obtained from the Nairobi Stock Exchange was predominantly used for the 51 companies for the period between 1991-1998. The relationship between returns and capital structure of the companies forming the 20-share index was also investigated. The results indicate that there are indeed differences in the capital structures among industry groupings and that firms within a given sector tend to cluster towards some target equity / total assets ratio lending support to the existence of optimal capital structures as promulgated by the traditionalists. The results of the relationship between capital structure and returns indicate that returns increase with increased leverage also supporting the traditional view on capital structure. Still a lot needs to be done in the area of capital structures of companies in Kenya, specifically to establish the nature of capital structures of companies not quoted on the Nairobi Stock Exchange and to use other ratios such as debt / equity in carrying out a similar study.