A Test of Relationship Between Capital Structure and Agency Costs: Evidence From the Nairobi Stock Exchange

Abstract

The financing decision is one of the most important roles played by a modern finance manager as it determines the value of a firm. Managers strive to maintain a capital structure that maximizes the shareholders wealth while minimizing financial and business risk of the firm. A traditional view on corporate finance assert that firms strive to maintain an optimal capital structure that balances the costs and value associated with varying degrees of financial leverage. The study was an empirical study of the firms listed on Nairobi Stock Exchange (NSE). The population consisted of all the 54 companies quoted at the NSE for the years 2005 to 2009. The study sampled all companies listed at the Nairobi Stock Exchange, excluding financial sector firms (banks, insurance firms, unit trusts and other funds companies). This study was facilitated by the use of secondary data. The study found out that half of the companies were unable to generate revenues that were commensurate with the total value of assets they had, it therefore, indicate that the management of most of the firms are inefficient in deployment of the firms’ assets to generate revenue. This indicates that firms’ assets could cover less than 18.6% of the firms debts for more than half the companies sampled. However, in the five regression analyses done size generally had a negative relationship with capital structure and agency cost which asserts the fact that as the size of a company increases, the agency cost would reduce.