JEFMS Journal

ABSTRACT:

Firm financial performance is essential for corporate survival and prosperity. Financial leverage may be used to enhance corporate financial performance, but it can also occasion financial distress and bankruptcy if not carefully managed. At the Nairobi Securities Exchange, a number of firms face poor financial performance, and financial distress, commonly associated with excessive leverage and bankruptcy. The purpose of this study was to determine the effect of debt-Equity ratio on financial performance of listed companies at Nairobi Securities Exchange. The study was grounded on dynamic tradeoff and pecking order theories. Positivist research paradigm with explanatory design using linear regression model on panel data obtained from a survey of 38 listed companies at Nairobi Securities Exchange over the period 2010 to 2019 was used. The data was mined from financial statements filed at the Nairobi Securities Exchange. Controlling for Firm size, Sales growth and operational efficiency, the study found Debt Equity ratio (ꞵ= -.1633009 p= 0.000) negatively related to Return on Equity and statistically significant at 0.05. The study recommended reduction in long-term or short-term debt or both or increase in equity finance for overall reduction in debt-equity ratio to enhance Return on Equity. Further, the study recommends deepening of Kenya’s capital market to permit optimal capital structure adoption by firms. The study contributes to knowledge by establishing the state of financial leverage at Nairobi Securities Exchange, to policy by establishing the need for deepening of capital market at NSE and to theory by confirming the relevance of dynamic tradeoff and pecking order theories at the bourse. The study scope was limited to firms listed at NSE. A similar study covering East Africa capital market is recommended. Further, a study to explore the limiting factors in Kenya’s capital market is recommended.

KEYWORDS:

Debt-Equity Ratio, Return on Equity, Financial Leverage, Financial Performance

REFERENCES:

1) Abubakar, A. (2015). Relationship between financial leverage and financial performance of deposit money banks in Nigeria. International Journal of Economics, Commerce and Management, 3(10), 759-778.

2) Agca, S., & Mozumdar, A. (2004). Firm size, debt capacity, and corporate financing choices. Debt Capacity, and Corporate Financing Choices (December 2004).

3) Ahmad, N., Salman, A., & Shamsi, A. (2015). Impact of financial leverage on firms’ profitability: An investigation from cement sector of Pakistan. Research Journal of Finance and Accounting, 6(7), 2222-1697.

4) Al Momamni, M. A., & Obeidat, M. I. (2017). Towards More Understanding of the Financial Leverage Controversy The Evidence of the Industrial Firms at Amman Stock Exchange. International Journal of Economics and Financial Issues, 7(4), 189-198.

5) Aliyu, A. A., Bello, M. U., Kasim, R., & Martin, D. (2014). Positivist and non-positivist paradigm in social science research: Conflicting paradigms or perfect partners. J. Mgmt. & Sustainability, 4, 79.

6) Ang, J. S., Daher, M. M., & Ismail, A. K. (2019). How do firms value debt capacity? Evidence from mergers and acquisitions. Journal of Banking & Finance, 98, 95-107.

7) Aras, G., & Crowther, D. (2008). Governance and sustainability: An investigation into the relationship between corporate governance and corporate sustainability. Management Decision, 46(3), 433-448.

8) Barney, J. (2002). Gaining and Sustaining Competitive Advantage 2nd edition Prentice Hall. Upper Saddle River, NJ, 4(1), 1-22.

9) Bethlehem, G. (1978). Debt, Debt Capacity and Financial Performance. South African Journal of Economics, 46(3), 159-165.

10) Bonazzi, G., & Iotti, M. (2014). Interest coverage ratios (ICRs) and financial sustainability: Application to firms with bovine dairy livestock. American Journal of Agricultural and Biological Sciences, 9(4), 482.

11) Booth, L., Aivazian, V., Demirguc‐Kunt, A., & Maksimovic, V. (2001). Capital structures in developing countries. The Journal of Finance, 56(1), 87-130.

12) Byoun, S. (2008). How and when do firms adjust their capital structures toward targets? The Journal of Finance, 63(6), 3069-3096.

13) Crane, D., Laurence, M., & Langstraat, L. (2005). Crop Insurance And Risk Management Primer.

14) Fischer, E. O., Heinkel, R., & Zechner, J. (1989). Dynamic capital structure choice: Theory and tests. The Journal of Finance, 44(1), 19-40.

15) Fosu, S. (2013). Capital structure, product market competition and firm performance: Evidence from South Africa. The quarterly review of economics and finance, 53(2), 140-151.

16) Frank, M. Z., & Goyal, V. K. (2008). Trade-off and pecking order theories of debt Handbook of empirical corporate finance (pp. 135-202): Elsevier.

17) Furrer, O., Alexandre, M. T., & Sudharshan, D. (2007). The impact of resource‐strategy correspondence on marketing performance—financial performance tradeoffs. Journal of Strategic Marketing, 15(2-3), 161-183.

18) Graham, J., & Harvey, C. (2002). How do CFOs make capital budgeting and capital structure decisions? Journal of applied corporate finance, 15(1), 8-23.

19) Hess, D., & Immenkötter, P. (2014). How much is too much? Debt Capacity and Financial Flexibility. Debt Capacity and Financial Flexibility (March 2014).

20) Huang, R., & Ritter, J. R. (2005). Testing the market timing theory of capital structure. Journal of Financial and Quantitative Analysis, 1, 221-246.

21) Jensen, M. C., & Meckling, W. H. (1976). Theory of the firm: Managerial behavior, agency costs and ownership structure. Journal of Financial Economics, 3(4), 305-360.

22) Kayo, E. K., & Kimura, H. (2011). Hierarchical determinants of capital structure. Journal of Banking & Finance, 35(2), 358-371.

23) Kim, S. (2003). Research paradigms in organizational learning and performance: Competing modes of inquiry. Information Technology, Learning, and Performance Journal, 21(1), 9.

24) Kombo, D. K., & Tromp, D. L. (2006). Proposal and thesis writing: An introduction. Nairobi: Paulines Publications Africa, 5(1), 814-830.

25) Kraus, A., & Litzenberger, R. H. (1973). A state‐preference model of optimal financial leverage. The Journal of Finance, 28(4), 911-922.

26) Kueng, P. (2000). Process performance measurement system: a tool to support process-based organizations. Total Quality Management, 11(1), 67-85.

27) Lemmon, M. L., & Zender, J. F. (2010). Debt capacity and tests of capital structure theories. Journal of Financial and Quantitative Analysis, 45(5), 1161-1187.

28) Leon, S. J. (2013). The impact of Capital Structure on Financial Performance of the listed manufacturing firms in Sri Lanka. Global. Journal of Commerce & Management Perspective, 2(5), 56-62.

29) Li, H.-x., Wang, Z.-j., & Deng, X.-l. (2008). Ownership, independent directors, agency costs and financial distress: evidence from Chinese listed companies. Corporate Governance: The international journal of business in society, 8(5), 622-636.

30) Long, M. S., & Malitz, I. B. (1985). Investment patterns and financial leverage Corporate capital structures in the United States (pp. 325-352): University of Chicago Press.

31) Maher, M., & Andersson, T. (2000). Corporate governance: effects on firm performance and economic growth. Available at SSRN 218490.

32) Margaritis, D., & Psillaki, M. (2010). Capital structure, equity ownership and firm performance. Journal of Banking & Finance, 34(3), 621-632.

33) Martis, R. N. (2013). Capital Structure and Firm’s Financial Performance, An Empirical Analysis of the S&P500. Master. University Van Tilburg.

34) Masavi, J. M., Kiweu, J. M., & Kinyili, J. (2017). CAPITAL STRUCTURE AND FINANCIAL PERFORMANCE OF AGRICULTURAL COMPANIES LISTED IN NAIROBI SECURITIES EXCHANGE, KENYA.

35) McConnell, J. J., & Servaes, H. (1995). Equity ownership and the two faces of debt. Journal of Financial Economics, 39(1), 131-157.

36) Memon, M. A., Ting, H., Cheah, J.-H., Thurasamy, R., Chuah, F., & Cham, T. H. (2020). Journal of Applied Structural Equation Modeling.

37) Modigliani, F., & Miller, M. H. (1963). Corporate income taxes and the cost of capital: a correction. The American economic review, 53(3), 433-443.

38) Muhammad, H., Shah, B., & ul Islam, Z. (2014). The impact of capital structure on firm performance: Evidence from Pakistan. 산경연구논집 (IJIDB), 5(2), 13-20.

39) Mukras, M. S. (2015). Financial leverage and performance of listed firms in a frontier market: Panel evidence from Kenya.

40) Myers, S. C. (1977). Determinants of corporate borrowing. Journal of Financial Economics, 5(2), 147-175.

41) Myers, S. C. (1984). The capital structure puzzle. The Journal of Finance, 39(3), 574-592.

42) Myers, S. C., & Majluf, N. S. (1984). Corporate financing and investment decisions when firms have information that investors do not have. Journal of Financial Economics, 13(2), 187-221.

43) Narang, M. Impact of capital structure on firm performance: A study of listed firms on national stock exchange.

44) Naz, F., Ijaz, F., & Naqvi, F. (2016). Financial performance of firms: Evidence from Pakistan cement industry. Journal of Teaching and Education, 5(01), 81-94.

45) Neely, A., Gregory, M., & Platts, K. (1995). Performance measurement system design: a literature review and research agenda. International journal of operations & production management, 15(4), 80-116.

46) Omollo, B. A., Muturi, W. M., & Wanjare, J.(2018) Effect of Debt Financing Options on Financial Performance of Firms Listed at the Nairobi Securities Exchange, Kenya.

47) Orlitzky, M., Schmidt, F. L., & Rynes, S. L. (2003). Corporate social and financial performance: A meta-analysis. Organization studies, 24(3), 403-441.

48) Ozdagli, A. K. (2012). Financial leverage, corporate investment, and stock returns. The Review of Financial Studies, 25(4), 1033-1069.

49) Penman, S. H., Richardson, S. A., & Tuna, I. (2007). The book‐to‐price effect in stock returns: accounting for leverage. Journal of accounting research, 45(2), 427-467.

50) Roberts, M. R., & Leary, M. T. (2004). Do Firms Rebalance Their Capital Structures? Paper presented at the Econometric Society 2004 North American Summer Meetings.

51) Rubinstein, M. (2002). Markowitz's" portfolio selection": A fifty-year retrospective. The Journal of Finance, 57(3), 1041-1045.

52) Salamba, J. J. (2015). Impact of capital structure on performance of Smes in Tanzania: A case of smes in Dodoma municipality. Mzumbe University.

53) Salim, M., & Yadav, R. (2012). Capital structure and firm performance: Evidence from Malaysian listed companies. Procedia-Social and Behavioral Sciences, 65, 156-166.

54) Schulz, T. (2017). The impact of capital structure on firm performance: an investigation of Dutch unlisted SMEs. University of Twente.

55) Škare, M., & Golja, T. (2014). The impact of government CSR supporting policies on economic growth. Journal of policy modeling, 36(3), 562-577.

56) Škare, M., & Hasić, T. (2016). Corporate governance, firm performance, and economic growth–theoretical analysis. Journal of Business Economics and Management, 17(1), 35-51.

57) Skopljak, V., & Luo, R. H. (2012). Capital structure and firm performance in the financial sector: Evidence from Australia. Asian Journal of Finance & Accounting, 4(1), 278-298.

58) UDEH, S. N., NWUDE, E., ITIRI, I., & AGBADUA, B. (2016). The Impact of Debt Structure on Firm Performance: Empirical Evidence from Nigerian Quoted Firms. Asian Economic and Financial Review, 6(11).

59) Wanjere, M., Ogutu, M., Kinoti, M., & Iraki, X. (2021). Foreign Direct Investment and Local Firm’s Performance. European Journal of Business and Management Research, 6(6), 216-222.

60) Wardlow, G. (1989). Alternative modes of inquiry for agricultural education. Journal of Agricultural Education, 30(4), 2-7.

61) Yapa Abeywardhana, D. (2016). Impact of capital structure on firm performance: Evidence from manufacturing sector SMEs in UK. Impact of Capital Structure on Firm Performance: Evidence from Manufacturing Sector SMEs in UK (July 31, 2016).

62) Yazdanfar, D., & Öhman, P. (2015). Debt financing and firm performance: an empirical study based on Swedish data. The Journal of Risk Finance, 16(1), 102-118.

63) Zeitun, R., & Tian, G. G. (2014). Capital structure and corporate performance: evidence from Jordan. Australasian Accounting Business & Finance Journal, Forthcoming.