The Effect of Ownership Structure and Corporate Governance on Capital Structure Decisions of Firms Listed on the Nairobi Securities Exchange

Abstract

The research was undertaken in order to understand the effect of ownership structure and corporate governance on the capital structures of firms listed on the Nairobi Securities Exchange. The study was guided by the following research objectives, to examine the effect of ownership structure on capital structure of firms listed on the Nairobi Securities Exchange and, to examine the effect of corporate governance on capital structure of firms listed on the Nairobi Securities Exchange. A census study of the firms that have been consistently listed at the Nairobi Securities Exchange over the financial period 2008-2012 was done. Secondary data was collected from the Annual reports of the targeted companies. Analysis was done using multivariate regression in a panel data framework. The result shows that board size is negatively related with debt to equity ratio, the percentage of independent directors is negatively related to capital structure. Government ownership is positively related to capital structure. However, managerial ownership is negatively related to capital structure indicates that increased managerial ownership align the interest of manager with the interest of outside shareholders and reduces the role of debt as a tool to mitigate the agency problems. The percentage of Institutional shareholding is however positively correlated with debt to equity ratio suggesting firms with higher institutional shareholding are more likely to employ more debt than equity. The positive relationship between institutional shareholding and debt to equity ratio indicate that firms with larger percentage of institutional shareholding use debt as a tool to reduce agency problem and, are also able to negotiate more debt at a lower cost. It can also be argued that institutional investors enforce good corporate governance structure hence they get better recognition from the debt market. Debt providers also consider institutional investors to be more knowledgeable and, less likely to make uneducated investments. Firms with large percentage of government shareholding are viewed as less risky by the debt providers and in the event of financial distress they normally have state bail out and therefore they will continue to get more external recognition from debt providers. Therefore listed companies expecting to employ more debt to maximize the value of the firm and reduce agency problem can use institutional and government shareholding as a tool to achieve the objective. Firms with larger board size, more independent directors and managerial shareholding have a negative relationship between debts to equity ratio, this is because as the board size, percentage of independent director and managerial shareholding increases they tend to bring down a firms debt to reduce risk and bankruptcy cost. Therefore it can be expected that listed companies striving to lower their debt to equity ratio can use board size, percentage of independent directors and managerial shareholding as a tool to achieve the objective. The study recommends that future research could also be undertaken on large un-listed companies in Kenya and also the effect of an additional variable foreign shareholding on the model can also be investigated.