The impact of financial leverage on firm performance: the case of non financial firms in Kenya.

Abstract

Optima capital structure is a puzzle to every manager and board of directors. Failure to put considerations on capital structure might lead to low profitability, bankruptcy, failure to invest in high returns project and ultimately decrease in the value of the firm. This study set out to investigate the impact of financial leverage on firm performance of the non-financial blue chip companies listed under the NSE 20 share index. It took performance measures in a wider perspective using ROA, ROE and Tobin’s Q. In addition to financial leverage the study expanded its explanatory variables by controlling for liquidity, firm size and firm age. The study analyzed the data from the three models using random effect model after the Hausman test results preferred the random effect model while Levin Lin Chu test results for unit roots indicated that the data was stationary. The results revealed that there is a significant negative relationship between leverage and return on assets. The result is also buttressing that profitable firms uses pecking order theory in its financing, the more profitable a firm is, the more likely they are going to reduce its debts hence internal financing is preferred. Findings from the Tobin’s Q model indicated that large firms have a positive insignificant relationship between financial leverage and firm performance while the older firms showed an increase in its market value; this is an indication of investors’ confidence on the older firms who have built their reputation over a long period.