The Relationship Between Capital Structure and Financial Performance of Investment Firms Listed at the Nairobi Securities Exchange

Abstract

A firm has to issue various securities in a countless mixture to come across particular combinations that can maximise its overall value which means optimal capital structure. If a wrong mix of finance is employed; the performance and survival of the business enterprise may be seriously affected. The study’s general objective was to evaluate the relationship between capital structure and financial performance of investment firms listed at the Nairobi Securities Exchange. A descriptive survey research design was employed in this study. The target population of the study comprised of the three investment companies which were listed under the investment sector of the market segment of the Nairobi Securities Exchange (NSE) as at June 2014. A census approach method was used in the study where the three companies were selected without sampling. The study utilised panel data which consist of time series and cross-sections. The data for all the variables in the study were extracted from published reports and financial statements of the listed investment companies in the NSE covering the years 2010 to 2013 where quarterly reports were used. Quantitative method of data analysis and inferential analysis were used as analysis techniques. A general model for panel data that allowed the study to be estimated using panel data with great flexibility and formulate the difference in the behaviour of the cross-section elements was adopted. From the findings on the Adjusted R squared, the study revealed that there was variation of financial performance of investment firms listed in the NSE due to variations in long-term debt, total debt and size. The study revealed that long term and total debt were the major factors influencing the financial performance of investment firms listed in the NSE. From the findings on the correlation analysis the study revealed that there was a strong relationship between capital structure and financial performance. The study concludes that total debt has a negative impact on financial performance of the firms listed in the NSE. The higher the total debt, the less the return on equity as well as reduced shareholders wealth which indicates a need to increase more capital injection rather than borrowing. The total loans in these firms could lead to high interest expense hence lowering the profitability of the firm. The firms should therefore fund investments from internal sources in order to enhance their financial performance. The study also recommends that there is need for the firms to adopt strategies that would increase their size base and utilize the profits generated from the operations to acquire more assets and improve their financial performance. There is need for the firms to have a strong capital structure which provides them strength to withstand financial crises and offers shareholders a better safety net in times of depressions.