The relationship between capital structure and financial performance of firms listed at Nairobi securities exchange

Abstract

The financing or capital structure decision is significant managerial decision. Locating the optimal capital structure has for a long time been a focus of attention in many academic and financial institutions that probes into this area. This is comprehensible as there is a lot of money to be made by advising firms on how to improve their capital structure. Defining the optimal capital structure is a critical decision. This decision is important not only because of the impact such a decision has an organization’s ability to deal with its competitive environment. The objective of this study was to determine the relationship between capital structure and financial performance of listed firms at Nairobi securities exchange for six year period i.e 2008-2013. The population of the study was all the 61 firms listed at the NSE but the study narrowed to a sample of 26 firms using the random selection sampling technique. The study used secondary data and descriptive research design was employed to achieve the objectives of the study. From the regression results obtained adjusted R square was 0.542 an indication that there was variation of 54.2% on financial performance of firms listed in the NSE due to changes in the independent variables which are capital structure, dividend payout ratio and growth opportunity at 95% confidence interval. It was also established that all the variables were significant as their significance value was less than 0.05. The three independent variables were correlated with profitability of firms listed at the Nairobi Securities Exchange. With growth opportunity and dividend payout ratio having a positive correlation but leverage has a negative correlation. The study concluded that increased financial leverage has a negative effect on firm performance as measured by ROE of companies listed in the NSE, Kenya. 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 study therefore recommends that corporate managers should reduce financial leverage in order to enhance firm performance. In addition the government should regulate the financial sector through various monetary and fiscal policies in order to reduce the cost of borrowing given that many companies rely on external borrowing to finance their cash requirements. Lowly geared firms perform better than their counterparts that are highly geared. It is also important for finance officers of the firms when seeking to fund the firm’s assets to understand the impact of capital structure on their organization’s financial performance as well the cost of funds.