Effect of Capital Structure on Financial Performance of Firms Listed at the Nairobi Securities Exchange

Abstract

The choice between debt and equity financing has been directed to seek the optimal capital structure. Several studies show that a firm with high leverage tends to have an optimal capital structure and therefore it leads it to produce good performance, while the Modigliani-Miller theorem proves that it has no effect on the value of firm. The importance of these issues has only motivated researchers to examine the relationship between capital structure and firms financial performance. The objective of this study was to establish the effects of capital structure on financial performance of listed firms on securities exchange in Kenya. The financial performance was measured in terms of return on equity while capital structure was measured in terms of debt ratio. The period of study was 2012. It is important to note that during this period of study, Kenya experienced political anxiety, leading to uncertainty in the securities market. This presents an interesting period of study considering the ups and downs of the trade cycle. The population of study consisted of all the 61 listed firms duly registered with capital market authority of Kenya in 2012. Secondary data used was obtained from the Nairobi securities exchange handbook and also in firm’s publications. Data analysis was done by use of regression analysis model with the help of Statistical Package for Social sciences Software. The results obtained reveal that there was an inverse relationship between capital structure and financial performance of listed firms in securities exchange in Kenya. The findings indicate that the higher the debt ratio, the less the return on equity which therefore supports the need to increase more capital injection rather than borrowing, as the benefits of debt financing are less than its cost of funding.