The relationship between capital structure and size of the Firm: the case of companies listed at the Nairobi Stock

Abstract

This paper presents an empirical examination of firm characteristic determinants of the capital structure of 31 companies listed on the Nairobi Stock Exchange for a period of 6 years from 2000 to 2007. The capital structure of a company consists of a particular combination of debt and equity issues to relieve potential pressures on its long-term financing. To examine such issues, many theories have been developed in the literature and they generally focus upon what determinants are likely to influence the so-called leverage decisions of the firms. Among these, the MM theory, trade-off theory and agency theory have been said . to mainly playa crucial role in identifying and testing the various properties of the leverage decisions. This paper briefly tries to define the fundamentals underlying these theories and evaluates whether some a priori assumed macroeconomic determinants can be related to the leverage parameters of interest examined in the paper. The paper then zeroes in on size a determinant of capital structure. Studies that have been done so far relate to big firms in developed markets developed markets, Rajan and Zingales (1995).However, similar studies can now be done in small and medium sized firms in developing markets, Booth et al. (2001),like the NSE in Kenya. Following the developments in the contemporaneous estimation tech•.niques that allow us to use time series and cross section data concurrently, the panel data methodology has been applied to the actual data to compute the leverage ratios for each firm within the time period 2000-2007.0ur main result reveals that firm size has a positive and statistically significant impact on the firm's leverage ratio as evidenced in the empirical works of Huang and Song (2002), Rajan and Zingales (1995) and Friend and Lang (1988)