Impact of Tax on Capital Structure of Listed Companies in Kenya

Abstract

Financing is among the important decisions that firms have to make, not limited to the source but also the cost of financing.The study looks at the determinants of capital structure of firms listed on the Nairobi Securities Exchange (NSE) from 2003to 2012. The main motivation is to establishhow firms respond to the effect of tax in their capital structure decisions. Conditional quantile regression is used in analysing the distributional differences of debt ratios across firms in different quantiles. Firm response to tax rate is proxied using average effective tax rate while controlling for the standard variables that have been established in the literature to determine capital structure together with non-debt tax shield.The results show that some of the main variables for capital structure decision are important for capital structure decision. Also, the term structure of debt is important in leverage decisions and depends on the size of the firm, profitability and whether a firm has non-debt tax shield. Increase insize of the firm leads to firms shifting from long term to short term debt,while asset tangibility leads to a shift from short term to long term debt by the firm. Profitable firms at higher debt levels will reduce the use of debt in their capital structure.The effect of tax on capital structure is only significant at lower quantiles and only for total debt ratios.Firms at higher debt quantiles use non-debt tax shields other than tax rate to determine their capital structure.Also,non-debt tax measure leads to different outcomes on short term and long term debt. Non- debt tax shield will lead to reduction in use of long term debt but increase in total debt.