The Effect of Corporate Diversification on Capital Structure of Firms Listed in the Nairobi Securities Exchange

Abstract

Firms have to constantly review their strategies for them to remain competitive in the changing environment. Diversification is thus almost inevitable for firms with new entrants into the market threatening existing firms. This study thus sought to find out the effect of corporate diversification on a firm`s financial decisions. There have been mixed propositions as to whether diversification leads to value addition of a firm or it destroys a firm`s worth. The researcher targeted 44 non-financial firms, but the actual study focused on 35 firms which represented 80 percent of the target population for the period 2010 to 2014. The data was mainly from annual financial reports of respective companies. The annual reports were obtained from the firms’ websites, Capital Markets Authority and other relevant publications. Multiple regression and bivariate correlation were used to analyze the data. Diversification was measured using specialization ratio, calculated as a ratio of annual revenue from the core segment of a firm to its total annual revenue. The adjusted R2 value was 0.07, which meant that only 7 percent of variations in leverage for listed firms were explained by the variations in the model’s independent variable and control variables. The study found that diversification and tangibility of assets had a weak positive relationship with leverage. The relationship between leverage and diversification, and leverage and tangibility was not statistically significant. Firm size and profitability had statistically significant relationship with leverage. Firm size had a weak positive association with leverage, whereas profitability had a weak negative association with leverage. In summary, corporate diversification had a weak positive relationship with leverage. Further research should be carried out on the effect of related and unrelated diversification on a firm`s capital structure. A study on other factors affecting capital structure of a firm should also be carried out.