Examining the effect of capital structure on financial performance: a study of firms listed under manufacturing, construction and allied sector at the Nairobi Securities Exchange

Abstract

This study sought to examine the effect of capital structure on financial performance of firms listed under manufacturing, construction and allied sector at the Nairobi Securities Exchange. Return on Asset and Return on equity were used as the measures of firm performance while Short term Debt, Long-term Debt and Total Debt represented capital structure indicators. The study covered the firms listed under manufacturing, construction and allied sector at the Nairobi Securities Exchange from 2010 to 2013. The research design used was a descriptive research. Data was collected from the firms consolidated financial statement. The target population for the study consisted of manufacturing, construction and allied firms Listed at The Nairobi Securities exchange from 2010 to 2013. The data was then analyzed using linear regression models using SPSS to establish if there is any significant relationship of capital structure and the financial performance . Two regression models were utilized, with return on asset and return on equity as the dependent variables so as to assess the effects of debt on firm performance. A series of regression analysis were executed for each model, where both one of the capital structure proxies was included in each analysis and lag values were used so as to achieve the best fitted relationship between capital structure and firm performance. The correlation between return on equity and current debt was significant compared to the correlation between return on equity and long-term debt with a correlation of 0.778 and -0.518 respectively. The study also found that only long term debt has significant relationship with return on assets but not with return on equity. It was concluded that capital structure changes does affect firm’s performance. The study recommended that firms should use high levels of long term debt for financing its operations as long as the cost of debt does not exceed the required rate of return of the firm.