The effect of Capital structure on agency costs of the firms listed at the Nairobi securities exchange

Abstract

The manager – shareholder agency conflicts and the resulting agency costs have received much attention in corporate finance by both industry and academic researchers. Corporate financial researchers posit that managers of firms have strong incentives to pursue sub-optimal risk strategies, either in pursuit of equity value maximization or in pursuit of narrow self interest. Furthermore , the agency theory postulates that firms will incur agency costs as a means of reducing agency conflicts between shareholders ( principal) and managers (agents).Hence, to deal with this situation, various proposals have been advanced to address the agency problems. One such theory is the use of the firm’s capital structure. The capital structure reveals information about the firm’s way of financing its operations and growth. It is basically a mix of debt and equity which a firm deems appropriate to enhance its operations. Therefore, the capital structure is an important strategic financing decision that firms have to make, especially in public limited companies. Despite this importance, empirical studies on the effect of capital structure on agency costs remains inconclusive and contradictory. Some of the studies reveal that the capital structure has a negative relationship with agency costs, while others observed a positive or no relationship at all. Furthermore, several NSE listed companies have previously been delisted, liquidated or placed under receivership on account of agency problems. The purpose of this study was to establish the effect of capital structure on agency costs of the firms listed at the Nairobi Securities Exchange (NSE) in Kenya. Descriptive survey design was used for this study whereby the researcher used quantitative data to answer the research question. The population of interest comprised of all the 61 firms listed on the NSE in Kenya for the period 2009-2014, a period of six years. However, firms in the banking, Investment and Insurance companies were excluded. This study used secondary data from the published audited financial statements of the firms under study. The data was collected from the Nairobi Securities Exchange (NSE) handbook, Capital Markets Authority website, concerned listed companies website and other published information. The data collected was the total assets, total debt, total equity, annual sales, Net Income (Earnings after interest and tax), annual audit costs and board remuneration. The data obtained was analyzed using descriptive statistics. Statistical package for Social Sciences (SPSS) aided in data processing and analysis. Multivariate regression analysis was used to find out whether the capital structure had an effect on the agency costs of the firms. The study findings established that 61.4% of the variations in agency costs were accounted for by capital structure, profitability, size and growth of the firms. Further, it emerged that the model predicting this relationship was statistically significant at 5% level of significance. Additionally, the findings established that capital structure, profitability, growth and size of the firms have a positive relationship with agency costs. Hence, the study concludes that capital structure has a positive and significant effect on the agency costs for firms listed at the NSE. The researcher recommends that the firms’ managers come up with, and implement financing strategies that ensures optimal proportion of debt and equity for their firm. Further, the researcher recommends that management of the firms make prudent decisions regarding their financial strategy and policy in a bid to maximize their firm’s value. In addition, further research should be done to establish the effects of other factors that were not explained by the model on agency costs.