FACTORS DETERMINING DEBT AND EQUITY CHOICES OF A FIRM IN KENYA

FACTORS DETERMINING DEBT AND EQUITY CHOICES OF A FIRM IN

KENYA

BY

1) CP123/60453/11- PATRICK MUTIE MUSYOKA

2) CP123/60041/12- JONES OGINDA NYABICHA

3) CP123/60105/12- JOSEPHINE NDUNGWA MUINDI

4) CP123/60126/12- GILBERT KIPSANG KOSGEI

5) CP123/60131/12- SARAH MORAA OIRA

6) CP123/60074/12- JAMES WAKORI MACHARIA

7) CP123/66631/13- EVANS RONALD MUTHAMA

8) CP123/66557/13- PETER NABUNABA WAFULA

9) CP123/60100/12- GRANTON MWAMBINGU

10) CP123/66680/13- CAROLINE WACERA MAINA

A RESEARCH PROJECT SUBMITTED IN PARTIAL FULFILLMENT OF THE

REQUIREMENT FOR THE COMPLETION IN AWARD OF THE BACHELOR OF

COMMERCE DEGREE AT EGERTON UNIVERSITY BANKING AND FINANCE

OPTION, FACULTY OF COMMERCE.

EGERTON UNIVERSITY

MAY 2015.

i

DECLARATION & APPROVAL

DECLARATION

This Research Project is our own original work and has not been presented for a degree

qualification in any other University or Institution of higher learning.

REG’ NO NAME SIGN DATE

CP123/60453/11 PATRICK MUSYOKA ---------------------- ----------------------

CP123/60105/12 JOSEPHINE MUINDI ---------------------- ----------------------

CP123/60041/12 JONES NYABICHA --------------------- ----------------------

CP123/60131/12 SARAH OIRA ---------------------- ----------------------

CP123/60100/12 GRANTON MWAMBINGU ---------------------- ----------------------

CP123/60126/12 GILBERT KOSGEI ---------------------- ----------------------

CP123/66680/13 CAROLINE MAINA ---------------------- ----------------------

CP123/60074/12 JAMES WAKORI ---------------------- ----------------------

CP123/66557/13 PETER WAFULA ---------------------- ----------------------

CP123/66631/13 EVANS MUTHAMA ---------------------- ----------------------

APPROVAL

This Research Project has been submitted for Examination with my approval as the

University Supervisor

SIGNED………………………………………….. DATE………………………………

DR.FREDRICK M. KALUI

Faculty Commerce

Egerton University

ii

COPYRIGHTS

© 2015 [email protected]

All rights reserved. No part of this project may be reproduced, stored in any retrievable

system or transmitted in any form or means of electronics, hard copy, photocopying or

otherwise without prior written permission of the authors or Egerton University.

iii

DEDICATION

This project is dedicated to our families who have been patient and understanding, parents

and all friends of good will who were source of inspiration and support in the course of our

studies for their guidance, prayers, encouragement and financial support. May the good Lord,

God Almighty bless them abundantly.

iv

ACKNOWLEDGEMENT

The BCOM programme has been a long, demanding and challenging journey and the

successful completion has been as a result of support received from many people. We are

indebted not only to those who gave us the inspiration, support and encouragement to pursue

degree course but also to everybody who gave us guidance and assistance on what has been

suggested in this project. Special thanks go to our supervisor Dr.Fredrick Kalui, Faculty of

Commerce, Egerton University Nairobi City Campus for his continued advice throughout the

project period. Our families, brothers and sisters, relatives and friends thanks a lot for your

support. All our classmates and others who in one way or the other gave us support please

receive our heartfelt thanks. Above all, special thanks to the Almighty God for the gift of life

and good health, lack of which we would not have made it this far.

v

ABSTRACT

The choice between debt and equity financing has been directed to seek the optimal capital

structure. Several studies show that a firm with high leverage tends to have an optimal capital

structure and therefore it leads to good performance while the Modigliani-Miller theorem

proves that it has no effect on the value of the firm. The importance of these issues has only

motivated the researchers to examine the relationship between firm size, asset structure

profitability, attitude of top management and corporate tax to debt and equity financing

choice of a firm in Kenya.

The firms financing choice was informed by; return on capital employed (ROCE) which

measures firms profitability , current ratio which measured asset structure, total assets which

measured firm size and corporation tax paid. The period of study was 2009-2013. It was

important to note that during the period of study, Kenya experienced a lot of political anxiety

due to the political climate informed by the general election which was due 2013 March,

leading to uncertainty in the securities market. This presented an interesting period of study

considering the ups and downs of trade cycles. The population of the study consisted of all 60

listed firms duly registered with Capital Market Authority of Kenya as at 2013.Secondary

data used was obtained from the Nairobi Securities Exchange handbook and also in firm’s

publications. Data analysis was done by use of regression analysis model with the help of

statistical package for social science software. The results obtained revealed that there was a

relationship between dependent variable (debt and equity) and independent variables

(profitability cost of capital, firm size, asset structure, corporation tax and attitude of top

management).

vi

TABLE OF CONTENTS

DECLARATION & APPROVAL ............................................................................................. I

DECLARATION ....................................................................................................................... I

COPYRIGHTS ......................................................................................................................... II

DEDICATION ......................................................................................................................... III

ACKNOWLEDGEMENT ....................................................................................................... IV

ABSTRACT .............................................................................................................................. V

CHAPTER ONE ...................................................................................................................... 1

INTRODUCTION ..................................................................................................................... 1

1.1 Background to the Study ...................................................................................................... 1

1.2 Statement of the Problem ..................................................................................................... 5

1.3 Objective of the study .......................................................................................................... 5

1.3.1 General objective .............................................................................................................. 5

1.3.2The specific objectives of the Study .................................................................................. 5

1.4 Research Questions .............................................................................................................. 5

1.5 Importance and Value of the Study ..................................................................................... 6

1.6 Scope and justification of the study ..................................................................................... 6

1.7 Limitation of the study ......................................................................................................... 7

1.8 Definition of Operational Terms .......................................................................................... 7

CHAPTER TWO ..................................................................................................................... 9

vii

LITERATURE REVIEW .......................................................................................................... 9

2.1 Introduction .......................................................................................................................... 9

2.2 The effects of firm’s size on its debt and equity choices ..................................................... 9

2.3 The effect of firm’s profitability on debt and equity choice .............................................. 10

2.4 Business Finance ................................................................................................................ 10

2.4.1 Debt Financing. ............................................................................................................... 11

2.4.2 Equity Financing ............................................................................................................. 12

2.4.3 Viability of Financial Decision ....................................................................................... 13

2.5 Firm’s Asset Structure ....................................................................................................... 13

2.5.1 Liquidity Risk ................................................................................................................. 14

2.6 Firms Tax Rate ................................................................................................................... 15

2.7 Empirical Studies ............................................................................................................... 15

2.8 Theoretical Review ............................................................................................................ 17

2.8.1 Trade-Off Theory of Capital Structure ........................................................................... 17

2.8.2 Pecking Order Theory of Capital Structure .................................................................... 18

2.8.3 Agency Cost Theory ....................................................................................................... 18

2.8.4 Information Asymmetry Theory ..................................................................................... 19

2.8.5 Capital Structure Theory ................................................................................................. 20

2.9 Conceptual framework ....................................................................................................... 21

CHAPTER THREE ............................................................................................................... 22

RESEARCH METHODOLOGY............................................................................................. 22

3.1 Introduction ........................................................................................................................ 22

3.2 Research Design................................................................................................................. 22

3.3 Population of the Study ...................................................................................................... 22

viii

3.4 Sampling Design ................................................................................................................ 23

3.5 Data Collection .................................................................................................................. 24

3.6 Data Analysis ..................................................................................................................... 24

The Regression Equation ......................................................................................................... 24

3.7 Reliability and Validity of Tests ........................................................................................ 25

CHAPTER FOUR .................................................................................................................. 26

DATA ANALYSIS AND PRESENTATION OF FINDINGS ............................................... 26

4.1 Introduction ........................................................................................................................ 26

4.2 Background Information of the Study Respondents .......................................................... 26

4.2.1 Respondents Genders ...................................................................................................... 28

4.2.2 Respondents age bracket ................................................................................................. 28

4.2.3 Level of Education .......................................................................................................... 29

4.2.5 Respondents position in their work place ....................................................................... 30

4.3 Factors Affecting Debt and Equity Choices of Firms in Kenya ........................................ 31

4.3.1 Attitude of the Top Management .................................................................................... 31

4.4 Discussion of findings........................................................................................................ 32

4.5 Effect of Various Factors on Debt and Equity Choices ..................................................... 32

4.6 The Relationship between Independent Variables on Debt and Equity Choice ................ 33

4.7 Effects of Various Variables on Debt and Equity Choices of a Firm in Kenya ................ 34

4.7.1 Relationship between profitability, debt and equity choice ............................................ 35

4.7.2. Relationship between corporate tax and debt and equity choices .................................. 36

4.7.3. Relationship between asset structure and debt and equity choices ................................ 36

4.7.4 Relationship between firm size and debt and equity choices ......................................... 36

ix

CHAPTER FIVE .................................................................................................................... 38

SUMMARY, CONCLUSION & RECOMMENDATION...................................................... 38

5.1 Introduction ........................................................................................................................ 38

5.2 Summary and Conclusions ................................................................................................ 38

5.3 Policy Recommendations................................................................................................... 39

5.3.1 Use Equity rather than Debt ............................................................................................ 40

5.3.2 Consider the Firms Asset Structure ................................................................................ 40

5.4 Limitations of the Study..................................................................................................... 40

5.5 Suggestions for Further Studies ......................................................................................... 41

REFERENCES ....................................................................................................................... 42

APPENDIX I: QUESTIONNAIRE COVER LETTER ........................................................... 46

DEBT AND EQUITY CHOICES QUESTIONNAIRE .......................................................... 46

APPENDIX II: QUESTIONAIRE ........................................................................................... 47

APPENDIX III: RETURN ON CAPITAL EMPLOYED MEASURING PROFITABILITY 49

APPENDIX IV: LIQUDITY RATIO MEASURING THE ASSET STRUCTURE OF A

FIRM ........................................................................................................................................ 50

APPENDIX V: CORPORATE TAX MEASUREMENT OF THE FIRMS ........................... 51

APPENDIX VI: THE FIRM SIZE MEASUREMENT ........................................................... 52

APPENDIX VII: LISTED FIRMS ......................................................................................... 53

TARGET POPULATION OF QUOTED FIRMS. .................................................................. 53

x

LIST OF FIGURES

Figure 2.1 Conceptual Framework………………………………………………………….21

Figure4.1 Respondents Gender……………………………………………………………..28

Figure4.2 Respondents Age Brackets…………………………………………………….....29

Figure 4.3 Level of Education…………………………………………………………...….29

Figure 4.4 Respondents years in employment………………………………………...…….30

Figure 4.5 Respondents position in their workplace……………………………………...…31

xi

LIST OF TABLES

Table 3.1 Target Population.................................................................................................23

Table 4.1 Demographic Data………………………………………………..………….…27

Table 4.2 Attitude of top management.………...………………….………………..…......31

Table 4.3 Descriptive statistics of debt…………………………………….……..…..…...32

Table 4.4 Descriptive statistics of equity………………………………………..….…..…32

Table 4.5 Pearson Correlation on equity…………………………………………..…..…..33

Table 4.6 Pearson Correlation on debt…………………………….………………….…..33

Table 4.7 Regression Results for Factors affecting Debt Financing Choice....………..….34

Table 4.8 Regression Results for Factors affecting Equity Financing Choice………...….38

1

CHAPTER ONE

INTRODUCTION

1.1 Background to the Study

Firm’s development and growth plays a very strategic role in the development of economic

and social standards of residents of any country especially developing countries like Kenya. It

is important to understand that numerous factors contribute to why firms established in

developing countries fail to start or progress in their respective industries. It is important for

firms to be able to finance their activities and grow over time if they are ever to play part in

strategic role of solving the micro and macro-economic issues in the country as well as

providing sufficient returns to shareholders/investors in form of dividends and capital gain.

In the Kenyan setting, corporate governance is one of the upcoming and critical aspects in

terms of development and implementation of corporate strategies and policies since it ensures

that managers maintain high professional code of ethics, this is so because shareholders are

many and they do not have much time, thus employ managers to run firms on their behalf.

Through corporate governance, managers are restricted to mismanagement of funds and

misstatement of accounts for personal benefits. Jensen (1986) concluded that firms which

have high liquidity levels and adequate working capital tend to have high agency costs since

this is a solution to agency problems.

Financing decisions involve how a company utilizes debt and equity to maximize

shareholders’ value with minimal risks, improve its competitiveness and expansion of its

capital structure. A firm establishes appropriate amount of funds needed, project appraisals

and analysis, raises the required funds through bonds, equity and working capital

management. Through appropriate financing mix, the firm’s value increases thus increase in

liability and equity side of the statement of financial position. It is important to understand

that firms in Kenya do have distinct policies from all other firms in developing countries.

This distinction is evident in the tax and bankruptcy codes, existing market for corporate

control and the role the capital market and money market do play. This difference

necessitates a thorough look at the issues from an inclination of Kenya as a developing

economy. This is so because study of multiple firms from same economy do not show a

significant variation in the data collected from them, this is according to Booth et al (2001).

2

Currently legislation in business industry globally is shifting from development strategies

towards a greater reliance on importance of research on functioning and financing in the

whole industry (Green, Murinde and suppakitjarak, 2002).

There is empirical evidence derived from research work to support the relationship between

size and capital structure that has shown a positive relationship between the two this is

according to (Al-sakran, 2001, Hovakimian et al 2004). The evidence holds that there is a

high likelihood of a small and medium enterprise to use equity as a source of finance because

most of them lack collateral to back debt instruments. For big firms they consider using high

debt relative to equity because they benefit from tax shield and also they do have large capital

base as well as collaterals to support debt instruments use. Casser and Holmes (2003) and

Hall et al (2004) established a direct relationship between the size of a firm and long term

debt ratio as well as indirect relationship between size of a firm and short term debt ratio.

Debt financed projects increases firm’s obligations while there is less risks faced when

projects are equity financed. From financing decision, the firm is able to invest in profitable

projects that generate return which in turn is paid in terms of dividends. Dhillon (1994)

claimed that shareholders are able to give out funds for future return in terms of dividends

thus increase in firm value in the future, from this argument, shareholders gain twice in terms

of rise in value of shares and dividend received.

Hall et al (2004) argued that growth is likely to place a greater demand of internal funds and

force the firm to debt acquisition. High growth firms will consider debt acquisition relative to

low growth firms this is so because the high growth firms are certain that they will be able to

pay the debts when they fall due compared to low growth firms which are in high risk of

agency problems. Growth rate of firms is boosted by availability of various investment

opportunities. These firms will hold less cash and have low level of net working capital since

funds are directed towards investments thus boosting growth. Increase in shareholders’ value

is achieved in two aspects. Firstly, by generating cash flow and dividing the distribution in

pie chart among stakeholders. It ensures that securities are provided to stakeholders to meet

their desire thus increase in shareholders’ wealth. Secondly it can be achieved, by

strengthening investment and operating decisions thus increasing confidence among

stakeholders.

3

It is important to note that the divided policy of a firm informs its capital structure. For firms

which pay high dividends they are forced to go for debt instruments in order to finance their

operation and growth; this is so because they lack enough internally generated funds to fund

their operation and growth. Esperanca et al (2003) For the firms which have a policy which

allow for a small amount to be paid as dividends allows the firm to exhaust the internal funds

before they consider debt acquisition and this enables the firm to have a relative low debt

ratio. Therefore there will be positive relationship between the dividend payment ratio and

the debt ratio. It is also important to appreciate that dividend payment is a sign of good

performance of the company though it becomes a challenge to a firm to decide how much to

pay and when to plough back profits to the business.

The period in which a business has been in operation also informs the capital structure which

the firm in question should adopt. A firm which has been in operational for a long period of

time is believed to have established itself as an ongoing business. This is so because statistics

have shown that most small and medium businesses in Kenya fail between 1 to 3 years of

their operation. The longer the business has been in operation the higher credit rating it is;

this gives it an advantage to acquire debts relative to a newly established firm. The

relationship between firm’s profitability and its capital structure is also a crucial concern to a

firm. A firm which is highly profitable will have enough money generated internally for its

operating need as well as it development compared to a firm which is characterized by low

profitability which may not have enough money to fund its operation and hence will consider

debt acquisition which will result to high debt ratio in the organization.

Institutional investors are crucial when it comes to firm’s ownership and financing decisions

since they have resources and knowledge. They invest heavily in organizations and allocate

adequate funds for agency in order to curb the problem of underinvestment by managers and

even firing managers due to declined performance. Hart and Grossman (1980) found in their

study that institutional investors allocate funds towards monitoring thus control the over and

under investment problems. Optimal investment is achieved if a firm institutes prudent

financing and dividend decisions since increase in share prices indicates growth in firm and

maximization of firm value. Also, Liang and Fenn (2001) argued that individual ownership to

wear two hats in terms of ownership and management. They put more effort in the firm to

ensure it grows and maintain high proportion of ownership in terms of shares. Dividend is

4

used as a tool to control managers’ action of under investing thus negative relationship

between dividend payout and ownership. In support, Verma (1994) examined that

institutional investors prefer dividends distributed in terms of cash to curb the agency

problems.

Financial Leverage determines the extent to which a firm has utilized equity, retained

earnings and debt to finance its operations. Firms establish optimal mix between equity and

debt since high level of debt tends to be costly in terms of repayment and interest thus

increase in the level of liquidation. Donaldson (1961) concluded that firms prefer retained

earnings to equity and to debt. Financial gearing (leverage) is used to describe the way in

which owners of the firm can use the assets of the firm to gear up the assets and earnings of

the firm. Employing debt allows the owner to control greater volume of assets than they

could if they invested their own money only. The higher the debt equity ratio, the higher the

firm equity and therefore the firm level of financial risk. Financial risk occurs due to the

higher proportion of financial obligations in the firms cost structure. The degree of financial

gearing indicates how sensitive a firm’s EPS is to changes in earnings before changes in

interest and taxes (EBIT). Other popular measure is debt to equity ratio, Interest covered ratio

and Debt ratio used as industry standard

The attitude of managers and directors will also inform the kind of capital structure that a

firm will adopt. This is so because if they are risk takers they will go for debt acquisition

relative to risk averse management which will consider use of equity as a means of financing

because it has less risk. It is also important to appreciate management buy-in. when there is

management buy-in, the top management will have special interest of a firm and the kind of

financing decision the firm adopts. This essential factor can inform an indirect or direct

relationship between debt ratio and top management perception. This is so because the

financing decision of a firm purely rests between the shareholders through the board of

directors of a given firm.

5

1.2 Statement of the Problem

Equity and Debt financing for a business is primarily made up of owners’ contribution and

funds from lenders. The choice of the combination of this funding is made by the managers

of the businesses who decide whether to borrow, plough back the profits the business has

made, ask the owners to raise more funds to expand the business or to increase the

shareholders’ payout of returns on their investment. The combination of the sources of

business funding is referred to as the capital structure of that business.

This research is aimed at determining how managers of the firms in Kenya combine the

different sources of funding for their businesses and the various factors determining the

financing decision choice. Given the unique characteristics of these economies to determine

whether there exists a relationship between the capital structure and the return on

shareholders’ funding for these firms, as well as the relationship between the macroeconomic

factors of the interest rate and the inflation rate with the capital structure and performance.

Analysis of how the return on borrowed funds compared with the return on assets financed

was also carried out to determine, whether the return on assets warranted the borrowing.

Studies have been done in developed countries and this need to be replicated in developing

countries like Kenya. The research intend to answer the research question, does the debt and

equity financing improve the growth and performance of firms in Kenya?

1.3 Objective of the study

1.3.1 General objective

The general objective of the study was to analyze the effect of various variables on debt and

equity choices of firms in Kenya.

1.3.2The specific objectives of the Study

i. To determine the effect of size of a firm on its debt and equity choice.

ii. To determine the effect of profitability on debt and equity choice.

iii. To determine the effect of attitude of top management on debt and equity choice.

iv. To determine the effect of asset structure on debt and equity choice.

v. To determine the effect of tax on debt and equity choice.

1.4 Research Questions

The following research questions were used as a guideline in the research work;

6

i. How does the size of a firm affect its debt and equity choice?

ii. How does profitability of a firm affect its debt and equity choice?

iii. How does the attitude of top management affect debt and equity choice?

iv. How does asset structure of a firm affect its debt and equity choice?

v. How does tax affect debt and equity choice?

1.5 Importance and Value of the Study

The findings of the study will enable shareholders to have an insight and more knowledge on

how to balance their investment portfolio in order to increase returns in terms of capital gain

and increase in share value, management will have insight information pertaining to

financing decisions and growth. They will be able to institute sound policies on financing

choices in order to increase shareholders’ value and minimize the cost of capital thus aid

them in making prudent decisions. The study will also enable government, regulators and

firms to come up with sound regulatory framework to aid firms in their operations. The

findings of the study will aid consultants in delivery of advisory services to their clients

pertaining to financing and growth strategies of the firms since the research is rich in policy

implications.

1.6 Scope and justification of the study

The target population of the study includes all the 60 quoted firms in Nairobi Securities

Exchange in Kenya as at 2013. Firms play a very crucial role in the economy performance of

any country because they inform the tax level and the gross domestic product (G.D.P) of a

country. This reason among other reasons brings the financing decision of a firm into focus;

this is so because for a firm to be successful, its financing decision should be out of question.

A proper financing choice leads to success of a firm and this ends up giving the existing

investor an indication of a growing economy as well as assuring potential investors of a

stable economy.

From the preceding discussion it is evident that matters to do with capital structure (financing

decision) are highly debatable. Green, Murinde and suppakitjarak, (2002) appreciates that

business industry legislation is shifting from developing of strategies to a more research

based approach. Kenya as a developing economy cannot afford to be left behind and hence

the need for an intensive and detailed research on the proper financing decisions of firms.

With total respect to researchers who have done tremendous research work on the debt and

7

equity choices of firms in Kenya, it is crucial to appreciate that because of ignorance, lack of

goodwill and technological challenges facing Kenya as an economy, the firms have not yet

implemented the findings of the previous research studies. Research findings on factors

affecting debt and equity choices of firms in Kenya at this point in time, will be very

instrumental to business entities to contribute towards achieving the blue prints of the vision

2030, as well as competing competitively in the globalized and dynamic business industry.

1.7 Limitation of the study

The researcher in this study expects numerous limitations which may have material effects on

the final finding of the study. The limitations include but are not limited to; variability in

measurements of the secondary data sources, incorporative responses in answering the

questionnaires, inadequate information and time frame.

1.8 Definition of Operational Terms

Debt: An amount of money borrowed by one party from another. Many firms or individuals

use debt as a method for making large purchases that they could not afford under normal

circumstances. A debt arrangement gives the borrowing party permission to borrow money

under the condition that it is to be paid back at a later date. Debt can be represented by bonds,

loans, mortgage and commercial paper as some examples of debt.

Equity: Equity is used when referring to an ownership interest in a business which will

include stockholders equity or owner’s equity. Occasionally, equity is also used to mean the

combination of liabilities and owner's equity.

Debt financing: it is away in which a firm raises working capital or capital expenditure by

selling bonds, bills, or notes to individuals and or institutional investors.

Equity financing: refers to the process of raising capital through the sale of shares in an

enterprise.

Cost of capital: is the cost of funds used to finance a firm. It may refer to cost of debt if the

firm is solely financed using debt or cost of equity if the firm is solely financed using equity.

Profitability: it is the state or condition of yielding profit or gain in a firm.

Size of a firm: the size of the firm is measured as the sales volume and it shows that large

firms’ transparency reduces the undervaluation of new equity issues and encourages the firm

to finance through their own equity.

8

Attitude: is defined as an expression of favor or disfavor toward a person, place, thing or an

event.

Asset structure: it is the existence of assets in tangible form or intangible form hence being

assigned a value in monetary terms.

Agency problem: refers to a conflict of interest inherent in any relationship where one party

in the relationship is expected to act in another’s best interest.

Business finance: refers to acquisition and conservation of capital funds in meeting financial

needs and overall objective of business enterprises.

Expertise: is defined as a special skill or knowledge.

Viability: refers to the ability of an instrument to maintain itself or achieve its potentiality

e.g. debt financing instrument.

Tax: it is a financial charge or other levy imposed upon a tax payer (individual or an

institution) by a state or the functional equivalent of a state top fund various public

expenditure.

9

CHAPTER TWO

LITERATURE REVIEW

2.1 Introduction

In this chapter, a literature review of various research objectives has been undertaken and is

relevant on a firm’s financing choices. It further presents a review of past studies and the

critical review and lastly it presents the general literature review of the subject matter.

2.2 The effects of firm’s size on its debt and equity choices

Alexander Kursher and Ilya .A (2005) of business school in Stanford University in their

research work on Firm size and capital structure noted that firm size has been empirically

found to be strongly correlated with the firm’s capital structure. They established that most

of firms in the United states of America they use their respective sizes as a control variable in

the capital structure the firm establishes. Strebulaev (2004) held that as the size of a firm

increases, fixed cost become less and less important. In particular, the ratio of fixed costs to

proportional cost in total issuance costs is larger for small firms and attenuates as the firm

size increases. Serkan et al (2011) also observed a statistically relationship between the firm

size and the common stock issue, they further observed that a significant linkage between a

firms size and personal debt. However, financing preferences for set up investment, ongoing

operation and future investments seemed to be independent from the size of the given firm.

Dalbor and Upneja (2002) suggested that long term debt usage shares a positive relationship

with the risk the firm is exposed to and the size. Over and above the risk and debt usage

relationship with the firm size the level of risks the firm engages into will also inform its

capital structure. It is important to appreciate that a firm’s growth is a process which takes

time. Therefore when a firm has attained a big size in the market it means that it has

established itself as an ongoing concern (Al-Sakran, 2001 and Hovakimian et al , 2004), this

enables it to acquire more debt at a considerable cost because it has built confidence with

financial institutions, this will not be the case with the small business enterprises in the

economy who have been in operation for a shorter period of time and information does not

give financial institution full confidence as they are extending fund to them.

10

2.3 The effect of firm’s profitability on debt and equity choice

Profitable firms are believed to face reduced expected cost of financial distress and find

interest tax benefits more important (Frank & Gayol,2009).Therefore, the tax benefits and the

bankruptcy costs perspective predict that profitable firms should use more debt. In addition,

the perception of agency costs is expected that the restraint provided by debt financing is

more valuable for profitable firms since these firms are prone to having stern free cash flow

problems (Jensen, 2009).On the other hand, Deensomsak, Paudyal &Pescetto (2004), argued

that they expect an inverse relationship between profitability and debt financing levels since

the pecking order theory suggests that managers prefer to finance investments internally

because of the informational asymmetry between managers and outside investors. Thus

profitable firms will prefer not to raise external funding in order to avoid potential dilution of

ownership and additional external monitoring. The theory of debt financing and profitability

therefore predicts both a positive relationship which supports trade-off theory and a negative

relationship which supports pecking order theory (Kayo and Kimura, 2011)

2.4 Business Finance

Business finance refers to the funds and monetary support required by an entrepreneur (firm)

for carrying out the various activities relating to his/ her business organization. It is needed at

each and every stage of a business life cycle. For instance, in starting a business, it is essential

for acquiring fixed assets, such as land, building, plant and machinery, etc as well as for

meeting the day-to-day expenses (working capital) in the form of payment of wages and

salaries, purchasing raw materials, etc. In order to successfully operate and expand the

business, funds are necessary for promoting and marketing the product; distributing it to the

prospective consumers; as well as for managing the firm's human resource base. Further, in

the changing business environment marked by increasing competition, additional funds are

desirable for continuous modernization and up-gradation of the business unit.

Good financial management is crucial not only when starting a business but also when

growing it, this makes it undeniably relevant to both managers and academicians (I.M

Pandey.2010). This is so because it is an essential part of the economic and non-economic

activities which leads to the efficient and effective decision making on matters of

procurement and utilization of finance with profitable manner(C.Paramasiran and

T.Subramanian.2004).In modern world, all activities are concerned with the economic

11

activities and very particularly to earn profit, this is not achievable if proper financial

management are not institutionalized(C.Paramasiran and T.Subramanian.2004).Therefore in a

nutshell financial management is geared at achieving maximum profit and maximum wealth

creation. Les R. dlabay Ed.D (2007) noted that getting your finances in order, means that

your business can work more efficiently and put you in a better position especially when you

are seeking for external funding for growth and development. Successfully managing your

finances can create sustainability and growth for your business. Any business has got two

sources of finance mainly debt financing and equity financing.

2.4.1 Debt Financing.

Issuance of debt instrument provides funds to a firm to finance its operations, in return debt

purchasers are promised stream of payment and a variety of other covenants in relation to

corporate behavior such as the value and risk of a firm’s assets. The covenants oblige the firm

to make the payment because if it does not, the covenant gives the debt purchaser the right to

repossess the collateral presented, present a bankruptcy petition before the industrial courts in

case of Kenya and as result remove the firm’s management from their positions. It should be

noted that the process presents barriers to the debt holders which bare them to champion for

proper management of their finances. This is so because some organizations are conservative

and complex to be easily understood (Brigham 2004) but this is mostly to small debt holders.

However large debt holders could enclose some of the information and contract enforcement

problems associated with diffuse debt. They are able to closely monitor activities of top

management because of their big investment to the firm for they can obtain control rights in

case of default or violation of the contract. However, the powers of the large investors in a

firm (creditors) are largely dependent on effectiveness and efficiency of legal and bankruptcy

systems in an economy (I.M Pandey 2010).If the legal system is not able to effectively

identify the violation of the debt contracts and provide the means to bankruptcy and

reorganize firms, then creditors could be disabled by lacking mechanism for exerting proper

management of their funds .Large creditors may also force a firm to forego some of its risk

ventures because creditors share the risk but not the profits of an investments (Myers and

Majlufs, 1984).

12

Choosing the right sources of financing a firm is a decision that will influence a company for

a lifetime. There are three types of capital employed to produce more wealth for a firm i.e.

fixed capital-used to produce the permanent or fixed assets of the business like land,

buildings and equipment, working capital-used to support the small company’s normal short

term operations like paying wages, salaries etc. Growth capital- used to help the firm to

expand or change its direction. Debt financing must be repaid with the interest that is carried

as a liability on the company’s balance sheet and it is normally expensive for small business

firms because of return or trade off. The sources of debt financing are from; commercial

banks (which gives short term loans ,intermediate or long term loans), asset based

lenders(discounting accounts receivables and inventory financing),savings and loans

associations, insurance companies, trade credits, credit unions, stockbrokerage houses,

commercial finance corporations, small business investment companies, local development

companies and small business administration, innovations and research institutions. The

internal methods of financing employed are like; factoring which is the selling of accounts

receivables outright, Leasing assets rather than buying them and credit cards.

2.4.2 Equity Financing

Beer et.al, (2008) defines equity financing as a medium to long term shareholders capital

investment in return of a share of ownership of the firm as well as a yearly proportion of the

firms profit in terms of dividends. According to Kisgen (2006), equity capital is the mode that

enables the equity holders to exert influence and monitor managerial decision continuously

through the board of directors. This gives them an opportunity to take immediate corrective

measures when they spot the initial signs of inefficient utilization of organizational resources.

The equity holders being the residual claimant in the organization have the powers to revise

the employment terms of the top management in the organization (Boateng 2004)

Coordination between the shareholders and top management of an organization decreases

instances of agency problems and effective achievement of the desired performance of an

organization. This kind of coordination is costly relative to price-based systems (Gibson,

2002).

Hall (2002) suggested that strategic assets should be financed using equity finance. Poor

relationship between shareholders and top management can result to agency cost; increased

organizational cost which can lead to poor performance of a firm. Graham (2000) discussed

13

the main cost of equity as tax cost, premium and floatation cost and adverse selection cost. A

collection of these costs affects the overall performance of a firm. Myers and Majluf (2004)

noted that a firm with a single ,all or nothing investment opportunity shows that a symmetric

information increases the cost of equity if the firm is pooled with those of lower quality

resulting to a decline in a firms performance. On contrary Booth, (2002) argued that use of

equity financing by a firm enables it to exert direct control of operation and management of a

firm. Equity financing represents the personal investment of owners in the business. It is

called risk capital because investors assume the risk of losing their money if the business

fails. It does not have to be repaid with interest like debt does and that an entrepreneur must

give out some ownership to outside investors. The sources of equity financing are like;

personal savings, friends and family members’ contributions, private investors, partners

contributions, corporations, venture capital and public stock sale/going public.

2.4.3 Viability of Financial Decision

Global investors have recently faced perfect storm in seeking to achieve their long term

financial goal of having the best choice of debt and equity in financing their firms operations.

Markets have continued to experience episodic, extreme bouts of volatility since the world

changing financial crisis began in the year 2008 in Europe as a result of fears over its

sovereign debt; Kupperman (2012) attributes this situation to yields of bonds by meagers,

which investors might otherwise look for a source of meaningful returns. Most of the firms in

Kenya are focusing and venturing in the international market which makes financing decision

a critical aspect in the success of the business. This leads to the pertinent questions which

firms have to put clear if at all it has to realize its financial goals; are they able to satisfy their

financial need in each market? When an attractive but limited investment opportunity arises,

how does the firm decide on the source of finance and do the top management dealing with

the specific markets equipped with the necessary information about that market (Keizi 2008).

This makes financing decision of great importance to continuity, development and

sustainability of any firm.

2.5 Firm’s Asset Structure

Jensen and Meckling (1976) pointed out the possibility of risk shifting strategies whereby

managers may shift to riskier investments at the expense of bond holders. This agency cost of

debt can be mitigated if the collateral value of asset is high; hence asset tangibility is likely to

14

have a positive relationship with the firm’s leverage level. In the case of bankruptcy a higher

proportion of tangible assets could be used to enhance the salvage value of the firm’s asset.

The lenders of finance are thus, willing to advance credit facilities to firms with high

proportions of tangible assets. Non-debt tax shield and firm’s assets are usually regarded as

proxies for asset tangibility (Harris and Raviv, 1991). Bradley, Jarrel and Kim (1984) argued

that use of non-debt tax shield as a proxy brings about a positive relationship between firm’s

leverage and non-debt tax shields. In contrast, Mutenheri and Green (2003) examined the

determinants of capital structure for firms in Zimbabwe. They observed an indirect

relationship between asset tangibility and leverage levels of firms for the pre-reform period

(1986-1990), however, a strong positive relationship was noted for the post-reform period

(1995-1999). The negative association in the pre-reform period could be attributed to lack of

proper contract enforcement systems associated with underdeveloped capital markets.

Firms with more liquid assets can use them as another internal source of funds instead of

debts leading to lower debt financing levels according to the pecking order theory (Oztein

and Flannery, 2012).In addition managers can manipulate liquid assets in favor of

shareholders against the interest of debt holders. Such manipulation increases the agency

costs of debt financing and reduces debt financing levels (Deesomsak et al., 2004)

2.5.1 Liquidity Risk

Drehmann and Nikolaou(2009) defined liquidity risk as the possibility over a specific time

period a firm will become unable to settle obligations with immediacy. It is a risk arising

from the firm’s inability to meet its obligations when they come due without incurring

unacceptable losses. This risk can adversely affect both the firms’ earnings and its capital

structure and therefore it becomes the top priority of the firm’s management to ensure the

availability of sufficient funds to meet the future demands of providers and borrowers at

reasonable costs. The vulnerability of the firm to liquidity risk is determined by the financing

risk and the market risk. Liquidity risk needs to be monitored as part of the firms –wide

process risk management, taking into account market risk and credit risk to ensure stability in

the balance sheet and dynamic management of liquidity risk. A firm should only attempt this

if it makes good business sense in its financing choice, not to use it as a means of keeping a

float. Jenkinson (2008) stated that a firm may lose confidence from its shareholders and its

reputation become at stake if their funds are at risk and not well managed. According to

(Brunnermeier and Pedersen, 2009) the market liquidity risk refers to the inability to sell

15

assets at or near the fair value, and in the case of a relevant sale in a small market, it can

emerge as a price slump.

The behavior towards liquidity is affected by a firm’s characteristic; a firm liquidity position

is affected by its size, status and the type of products they produce. Allen et al,(1989) the size

affects the attitude of the firm towards wholesale funding including the access opportunity

and the price of the finances obtained(Nyborg et al,2002).Firms size matters because of the

economy and the scope and scale concerning liquidity. Kashyap et al,(2002) a large firm

might have better access to the interbank markets because it has a larger networks of regular

counterparts or a wider range of collaterals. The product types they offer on both assets and

liabilities sides is able to affect the liquidity position thus firms take on demand of debt and

equity needs to hold higher liquidity buffers that can be mitigated if an imperfect correlation

holds.

2.6 Firms Tax Rate

Firms tax rate should influence debt financing since debt interest payments are typically tax

deductible, whereas dividend payments are not (Antonyk and Salzmann, 2014).It is therefore

logical that higher tax rates will imply greater interest tax shield benefits and consequently

induce more debt financing rather than equity financing. This reasoning is the main theme of

pioneering study by Modigliani and Miller (1963) and almost all researchers now believe that

firms taxes should be significant to the debt financing decision of a firm (Huang and Sang,

2006).According to DE Angelo and Masulis (1980), firms that have non-debt tax shield are

not to use fully the debt tax shield that comes from debt interest. In other words firms with

sufficient tax shield benefits from investments or depreciation deductions are likely to use

less debt financing (Kouki and Said, 2012). The argument is that non-debt tax shields are

substitutes for a debt related tax shield. Therefore, the relationship between non-debt tax

shields and debt financing should be negative (Lim, 2012).

2.7 Empirical Studies

The recent empirical studies were geared at establishing the capital structure of firms in

Kenya. Some of those studies are as outlined below;

16

The study conducted by Lucy Wamugo Mwangi,Muathe Stephen Makau and George

Kosembeito examine the relationship between capital structure and performance of non-

financial companies listed in Nairobi Securities Exchange(2014) .They sampled all the 44

non-financial companies listed in the Nairobi Securities Exchange as at December 2012,and

concluded that increased financial leverage has a negative effect on performance as measured

by Return On Capital of a non- financial companies listed in Nairobi Securities Exchange.

The study established that, as a company increases its financial leverage the performance as

measured by return on capital declines contrary to the expectations based on the theory.

Bernard Kamau Gachoka (2013) undertook a study with the objective of establishing the

effect of investment strategies on the financial performance of private equity funds investing

in Kenya. He sampled the 20 listed licensed investment funds in Kenya as at November 2013,

he concluded that venture capital had a positive and significant effect on performance of

private equity funds.

According to research of Evelyn Tempel (2011) to examine the influence of financial

leverage on investment of 68 Danish listed companies over the period 2006 to 2010

concluded that the relationship between long term debts and investment is positive to the

companies in industrial and material sector. However the positive relationship is not strong.

The research conducted by Jackline Adongo (2012) ,to establish the relationship between the

effects of financial leverage on profitability and risk of firms listed at Nairobi securities

exchange for the period 1st January 2007 to 31st December 2011.She concluded that there is a

weak, inversely and direct relationship between financial leverage, profitability and risk

respectfully

Kinyua (2005) did an empirical study on capital structure determinants for small and medium

sized companies in Kenya. The study covered 5 years from 1998 to 2002 and used correlation

and regression to analyze the data collected. The study concluded that; profitability, company

size, asset structure, management attitude towards risk and the lenders attitude toward the

firm in question are the key determinants of capital structure of a firm.

17

Ayot Kenrick Otieno (2013) carried out a research to establish the capital structure of listed

non-financial firms in the Nairobi securities exchange. He concluded that size does affect the

capital structure of a firm and the small and medium enterprises are disadvantage for that

reason he recommended that the government should establish a financial product to aid the

small and medium businesses compete effectively with the large enterprises in the economy.

2.8 Theoretical Review

The choices of equity and debt as a source of financing a business entity in different

economies of the world Kenya included has been one of the most controversial topics in

finance, this has triggered development of various theories on the same subject (Bradley et al,

1994). Myers (2001) also added weight in this controversial topic by noting that there is no

universal theory of debt-equity choices and there is no reason to expect one. The relevant

theories that have been advanced on debt and equity choices of a firm include;

2.8.1 Trade-Off Theory of Capital Structure

Trade off theory refers to the idea that a firm uses to balance between the debt and equity

levels in financing its operation by undertaking a cost benefit analysis of the instruments.

Myers (2001) in his research on capital structure noted that the trade-off theory justifies

moderate debt ratio. This theory narrows its focus to two concepts; cost of financial distress

and agency cost (Pandey, 2005). The theory states that a firm which employs debt instrument

to finance its operation accrues tax shield benefit, at the same time it exposes the firm to

financial distress costs including bankruptcy cost of debt and non-bankruptcy costs which

constitute; increased staff turnover, unfavorable credit terms by creditors, bond and stoke

holders infighting. This leads to marginal decrease in benefit as debt is increased while the

marginal cost increases, so that a firm that is optimizing its overall value will focus on this

trade-off when choosing how much debt and equity to employ in financing its firms’

activities. The theory holds that small firms will rely exclusively on a bank for debt capital.

Hackbarth et al (2007) for weak firms, bank debt dominates any mix of the market and bank

debt regardless of the priority structure. This argument contradicts the notion that small firms

avoid public debt because they lack access to those markets or face prohibitive costs for that

matter. Within the trade-off theory there is a “pecking-order” which hold that bank debts are

preferred to market debt due to the lower implied bankruptcy cost. Hackbarth et al (2007)

18

when the bank holds all ex-post, the desired level of debt tax shield can be achieved by only

the use of bank debt. While Myers (2001) noted that a firm will borrow up to the level where

the marginal value of tax shields is on additional debt is offset by an increase in the present

value of possible cost of financial distress.

2.8.2 Pecking Order Theory of Capital Structure

Pecking order theory was developed to further the capital structure understanding by Myers

and Majluf. Myers and Majluf, (1984) noted that firms have a particular preference order for

capital used to finance their operation that is, firms will prefer internal funds to external

sources of finance and in the event that the external funds are the option available, firms are

likely to consider the safest security first that is, the firm will start with debt, convertible debt

and then equity as the last resort. They further noted that the order of preference reflects the

relative costs of various financing option. Cash& Hughes (1994) on the other hand held that

within the overall pecking order theory, small sized enterprises when compared to the large

enterprises will depend more on holding excess liquid assets to meet discontinuities in

investment programs, depend more on short term debt including trade credit and overdraft,

rely to greater extent on hire purchase and leasing equipment. Therefore in case of small

enterprise financing, Cosh & Hughes (1994) proposed a refinement of the theory due to its

lack of information to assess risk both on individual and collective basis.

2.8.3 Agency Cost Theory

In a research by J.keithMurninghan of Kellogg school of management in north western

university, noted that agency problem is ubiquitous in organizations making employers

vulnerable to employees opportunistic behavior particularly the salaried ones(williamson1985

and Holmstrong 1979). Agency problem dates back 1776 when Adam Smith, (1776) in

wealth of nations noted that ‘being the manager of other people’s money than of their own, it

cannot be expected that you should watch over it with the same anxious vigilance with which

the shareholders watch over their own money. The first principle of economics is that every

agent is actuated only by self-interest (Edgeworth 1881). This quote relate to a central

premise in modern economics of business finance; Homo economicus pursue self-interest

(Sen 1995).This justify that agents will be self-interested, utility maximizers who will not

voluntarily protect or promote their principal’s interest, resulting to improper acquisition of

funds and investment.

19

Lawler, (1971) however hold that incentives and performance are rarely aligned. Agents are

motivated to put their interest before their principles interest. Williamson,(1984) expect that

agents will be opportunistic, possibly with guile by engaging in ex ante and ex post efforts to

lie, cheat, steal, mislead, disguise, obfuscate, feign, distort and confuse. Most organizations ‘

stake holders solve this problem mostly through close monitoring which prove burdensome,

costly and impractical due to several reasons(Eisenhardt Shapiro,2005), mainly information

asymmetry. This kind of solving agency problem leads to creation of new set of agents i.e.

Auditors, controllers, compliance officers and other kind of monitors must be

monitored(Shapiro,2005).Agency problem leads to poor investment decisions, dividend

policy and financing decisions of a firm as they are the primary roles of top

management(Booth,2002).

2.8.4 Information Asymmetry Theory

This theory endeavors top balance between choices of either equity or debt as a source of

finance based on information asymmetry, in most firms in different economies Kenya

included, the outsider and insiders do not have same quantities of information. Various

models have been championed on this regard; Ross (1977), Leland and Pyle (1977) and

Myers and Majluf (1984) all concurred on the fact that managers in any given firm always

have more information regarding their firm relative to others in the market. The short

comings associated with information asymmetry is that, if there is no flow of information

from the organization to the market then there is a high risk of the firm losing part of its share

in the market if not being forced out of the market (Leland and Pyle, 1977, Varian, 1992).

According to Akerlof (1970) and Leland and Pyle (1977), in absence of information flow, the

market may fail to exist or it may perform poorly for it will be regarded as to offer poor

quality goods and services while the firms which have solved the problem of information

asymmetry by proper dissemination of positive and negative information about it will be

regarded as a firm offering high quality products. Given that a firm may try signaling their

true value through its debt levels. Ross (1977) provided a model in which firms would signal

its value through its total debt employed. Ross argument is on the assumption that

management compensation depends on the value of the firm. The value of the firm is in turn

affected adversely by bankruptcy possibilities. Firms which are regarded to offer low quality

20

products should consider low debt use while firms believed to offer high quality products

should consider employing high debt because the market will support it pay off the debt when

due by buying theirs goods or services.

Ross also proposes a fee schedule that a penalty on the management if the firm goes

bankruptcy and its value falls to an extent it cannot cover the debt the firm has acquired. The

schedule also provides some benefits to the management by disseminating a true account of

information of what is taking place in the organization. Ross model implies that the firm will

increase with the leverage since increase in leverage increases the market perception of the

firm’s value. Leland and Pyle (1977) use a signaling approach similar to Ross but they

assume that the business is managed by the owner. They show that an entrepreneur’s

willingness to invest in his own project can serve as a signal of project quality, with value of

the firm increasing with the share of the firm held by the entrepreneur. Therefore the capital

structure of a firm will be related to a firm’s value. Thus the perceived firm value will

increase with an increase in the debt level, confirming the Ross model results. Ross also

established that firms with riskier return will have lower debt levels even in absence of

bankruptcy cost because creditors will have a negative attitude regarding the firm’s capacity

to pay off the debt when it falls due.

2.8.5 Capital Structure Theory

Brigham (2004), Capital structure brings into perspective the means a firm uses to finance is

operation. The means can be through use of debt instrument, share issuance or a combination

of both, David, (1979). Capital structure theory was pioneered by Modigliani and Miller

(M&M) they established that optimal financing mix does not exist and that, what matters in a

firm is the value of the firm’s asset and not the mix employed to finance the firms’ operation.

M & M argued that as more debt is added to the established capital structure of an entity, the

financial risk increases as a result the ordinary shareholders will require a higher return for

the additional risk that they have taken on. Therefore, the benefit of a cheaper debt will

exactly offset by the more expensive equity.

Their conclusion was based on the following assumptions; individual investors can borrow at

the same rate and terms as an entity, taxation is ignored, transaction cost are ignored and

financial distress costs are ignored. Although this statement did not rule out the possible

21

preference of a firm’s owner to a certain type of financing over the other, it had an effect to

the irrelevance of the value of the firm to the means of financing it given a perfect market

(Fischer, Heinkel and Zechner, 1989). Since then a number of theories have been advanced to

expound more on the capital structure, some of the numerous theories which have been

advanced are their arguments are ever debated include; trade off theory and pecking order

theory.

2.9 Conceptual framework

Figure 2.1 Conceptual framework

Independent variable

Dependent variable

Firms Size

Profitability

Attitude of Management

Asset Structure

Corporate Tax

Moderating variable

The figure sought to establish the relationship between independent variables; firm size,

profitability, asset structure, corporate tax and attitude of the management on dependent

variable choice of debt or equity of a firm in Kenya. In the analysis moderating variable,

expertise of a firm to choose the source of finance was also considered.

Debt and Equity

Expertise

22

CHAPTER THREE

RESEARCH METHODOLOGY

3.1 Introduction

This chapter defines the design of the study and the research methods which was used to get

responses from the target population. It further highlights the description of the study

population, the sampling procedures, data collection procedures and data collection

instruments and data analysis.

3.2 Research Design

In order to find the best financing choice for a firm in Kenya, this research study used a

Correlation and analytical research designs. This research design was used to collect a snap

shot of data and analysis of the relationship between the study variables. The design was

more appropriate because it enabled respondents to give their relevant information on the

issue of interest and findings to enable one to determine the best financing choice of a firm in

Kenya (Cooper &Schindler, 2003).

3.3 Population of the Study

According to Mugenda and Mugenda (2003), a population is well-defined as all set of people,

service, elements and events, group of things or households that are being investigated under

the study. Target population in statistics is the specific population about which information is

desired. The target population of interest in this study consisted of 60 listed firms in the

Nairobi Securities Exchange as at December 2013.

23

Table 3.1 Target Population

LEVEL TARGET

POPULATION

THE

SAMPLE

SIZE

PERCENTAGE

OF SAMPLE

POPULATION

Banking 10 3 15%

Insurance 6 2 10%

Construction & Allied 5 2 10%

Manufacturing & Allied 9 3 15%

Investment 4 1 5%

Agricultural 7 3 15%

Energy and Petroleum 4 1 5%

Telecommunication &Technology 2 1 5%

Automobiles and Accessories 4 1 5%

Commercial and Services 9 3 15%

TOTAL 60 20 100%

Source: Research data 2015

All items in any field of inquiry constitute a universe or a population. Complete enumeration

of all items in the population is known as a” census inquiry”. The researchers undertook a

sample study of 20 firms out of 60 targeted public firms as at 31st December 2013.It was

presumed that in the sample inquiry, all items were covered, thus no element of chance was

left and the highest accuracy was obtained. The researchers targeted financial

managers/controllers depending on the organizational structure of the firm.

3.4 Sampling Design

Due to variability of characteristics among items in the population, we applied probability

sample design in the sample selection process to reduce the distortion view risk of the

population and made inferences about the population based on the information from the

sample survey data. According to Mugenda and Mugenda (2003), a sample ratio of 0.3 was

used to obtain sample representation of all respondents. In this case, twenty (20) public listed

firms were subjected to the study. Only the sampled population was subjected to the data

gathering exercise to provide the necessary information to the study.

24

3.5 Data Collection

The two sources of data collection used were primary and secondary data. Primary data used

was obtained by administering questionnaires to the sampled firms through drop and pick

later and in some instances the researcher discussed the contents of the questionnaire with the

respondents and left them to be filled at their own time. Secondary sources were used to

provide information and data from published annual reports and financing sources of firms

spanning five years. In this study questionnaire and abstraction methods was used in data

collection. Primary data was used to collect data directly from respondents. It consisted of

questions on expertise and the attitude of top management. Abstraction method was used to

collect secondary data from published reports and statements provided by sampled firms. In

order to increase reliability of the findings, a combination of data from secondary and

primary sources was used.

3.6 Data Analysis

Regression was performed to establish the significant differences and relationship between

the independent variables (firm size, profitability, tax implications and asset structure) and

the dependent variables of debt and equity, observation of the data was also applied. SPSS

(statistical package for social scientist) software was used in the analysis of quantitative data.

The results from the annual financial reports and other documentations were presented in

form of tables, charts, graphs, and narrative statements.

The Regression Equation

𝐸𝑎𝑓 = 𝜶 + 𝑏1𝒙𝟏 + 𝑏2𝒙𝟐 + 𝑏3𝒙𝟑 + 𝑏4𝒙𝟒 + ℇ

𝐷𝑎𝑓 = 𝜶 + 𝑏1𝒙𝟏 + 𝑏2𝒙𝟐 + 𝑏3𝒙𝟑 + 𝑏4𝒙𝟒 + ℇ

Where:

𝑬𝒂𝒇= Equity of a firm

𝑫𝒂𝒇= debt of a firm

𝜶 = A constant

𝒙𝟏= Profitability of a firm

𝒙𝟐= Tax effect of a firm

25

𝒙𝟑= Asset structure

𝒙𝟒=Firm size

ℇ= Standard error

𝒃𝟏 , 𝒃𝟐, 𝒃𝟑& 𝒃𝟒=Are the beta coefficients

3.7 Reliability and Validity of Tests

Content validity and reliability was assured that each question in the questionnaire is valid

and correctly structured for ease of understanding. Moreover, the secondary data to be

reviewed had to be recent and up to date as well as containing relevant contents. To ensure

reliability, the researchers had to pre-test the questionnaires using three firms. The purpose of

the pilot study was to enable the researchers to improve on the reliability of the data

collecting instruments and to familiarize with their organization structure /administration.

Pre-testing was to provide a check on the feasibility of the proposed procedures for coding

data and showing up flows and ambiguities in the instruments of data collection. It yielded

suggestions for improving data collecting tools as per, Masibo (2005).

On the other hand the content validity of the two instruments of data collection was assured

by ensuring that each of the items in the questionnaire addressed specific content and

objectives of the study. Moreover, the instruments were given to three public firm experts

who assessed the concepts which the instruments were trying to measure. The end result was

that the instruments were appropriate in terms of content validity. The validity and reliability

of the tools for data collection were eventually ascertained and used to collect data from the

sampled respondents/firms.

26

CHAPTER FOUR

DATA ANALYSIS AND PRESENTATION OF FINDINGS

4.1 Introduction

The main objective of this study was to analyze the factors affecting debt and equity choices

of listed firms in Kenya. A total of 20 questionnaires were sent out, of which 19 of them were

satisfactorily filled and returned, this formed 95% response rate. In order to achieve the

objective of the study, the entire set of data was analyzed using the statistical package for

social scientist (SPSS). In this chapter we analyzed the results and concluded by giving a

summary and interpretation of the findings.

We assessed the validity and reliability of data by reviewing the interrelationship among

dependent variables (Debt and Equity) and the independent variables (firm size, profitability,

attitude of the top management, asset structure and corporate tax).

4.2 Background Information of the Study Respondents

This section presents a brief description of the demographic features of the sampled

respondents engaged in the study. The description is of immense importance for it will enable

the researchers to better understand their respondents as well as laying the platform for

detailed discussion of the results based on the stated objectives of the study. The

demographic features consist of the following: Response rate, Gender, age, level of

education, years of experience and the position held in the organization of interest.

27

Table 4.1 Demographic Data

Source: Research Data 2015

No Questions Answer categories Aggregate No

1. Issuance 1. Questioners issued

2. Questioners returned

20

19

2. Response rate 1. Responses

2. Non response

19

1

3. Gender respondents 1.Male

2. Female

12

7

4. Respondents Age bracket 1. 18-28 years

2. 28-38 years

3. 38-48 years

4. Above 48 years

2

3

9

5

5. Respondent’s highest education level? 1. Primary

2. Secondary

3. College Polytechnic

4. University

0

0

1

18

6. For how long have you been employed

(in years)?

1. Less than 1 year

2. 1-5 years

3. 5-10 years

4. Over 10 years

0

4

12

6

7. Respondents working in their current

organization?

1. Less than 1 year

2. 1-5 years

3. 5-10 years

4. Over 10 years

0

4

13

2

8. Respondents position 1. Top management

2. Middle management

3. Support staff

4

13

2

28

4.2.1 Respondents Genders

The questionnaires required the respondent to indicate his or her gender. It was established

that, of the total number of respondents 63% were men and 37% were women. This is

represented in the figure below:

Figure 4.1 Respondents Gender

Source: Research data 2015

4.2.2 Respondents age bracket

As researchers we were also interested with the distribution of age bracket of our respondents

from the sampled firms, the study found out that of the total respondents engaged 11% were

aged 18-28 years, 16% aged between 28-38years, 47% aged between 38-48 years and 26%

were above 48 years as illustrated in the figure below:

Figure 4.2 Respondents Age Bracket


18-28 years 28-38 years 38-48 yearsAbove 48

years

11%

16%

47%26%

63% Male

Female 37%

Respondents Gender

1st Qtr

2nd Qtr

29

4.2.3 Level of Education

We sought to establish the respondent’s highest level of education. The findings were as

follows: there was 0% of respondent with primary education has their highest level of

education, 0% with secondary education as their highest level, 5% with College Polytechnic

as their highest education level and 95% with university as their highest level, this is

demonstrated using the figure below.

Figure 4.3 Level of Education


4.2.4 Respondents Years in Employment

As illustrated below, majority of our respondents (53%) had work experience of between 5-

10 years, then 32% had worked for more than 10 years, 16% had worked for between 1-5

years and none (0%) of our respondents had a work experience of less than one year.

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

Primary Secondary College polytechnic University

0% 0%5%

95%

30

Figure 4.4 Respondents Years in Employment


4.2.5 Respondents position in their work place

In the last segment of the demographic data we sought to establish the various positions our

respondents hold in the sampled firms. The table below illustrates our findings.

Figure 4.5 Respondents position in their work place


0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

less than 1 year 1-5 years 5-10 years above 10 years

0%16%

53%

32%

21%

68%

11%

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

Top management Middle management support staff

31

4.3 Factors Affecting Debt and Equity Choices of Firms in Kenya

The general objective of the study was to determine the factors affecting debt and equity

choices of firm in Kenya. To achieve this end, we asked the respondents to indicate the extent

to which they believe attitude of the top management affect debt and equity choices of firms

in Kenya.

4.3.1 Attitude of the Top Management

The extent scales with very great extent (V.G.E), great extent (G.E), moderately (M), small

extent (S.E) and not at all (N.A) was used. The results are tabulated below in table 4.1

Table 4.2 Attitude of the top management

VARIABLE 1

(V.G.E)

2

(G.E)

3

(M)

4

(S.E)

5

(N.A)

1 To what extent does the attitude of top

management influence them to use

debt financing?

6

3

1

0

9


management inform them to use equity

financing?

3

3

0

1

10

3 To what extent does attitude of top

management fail to influence their

debt and equity choice?

3

0

0

2

14

4 To what extent does the top

management influence the financing

decision of a firm?

16

2

1

0

0


management vary when they are

making decisions on various issues?

1

1

3

3

11


The response showed that the attitude of the top management had a very great extent effect to

debt and equity choices of firms in Kenya. Eighty five percent (85%) had a view that the

attitude of the top management do affect debt and equity choices of firms in Kenya, 30% of

the total respondents noted that risk averse managers will consider using equity to debt, while

32

risk seekers (risk takers) management will consider more debt to equity and 15% of the total

number of respondents held that, the risk neutral managers do not have a specific form of

financing they value over the other.

4.4 Discussion of findings

4.5 Effect of Various Factors on Debt and Equity Choices

The following tables give a summary of the descriptive statistics (mean and standard

deviation).


The descriptive data show that firm size had an average score of 48468.35 and a standard

deviation of 84777.04126 indicating the spread away from the mean, the mean of asset

structure was 2.1287 and its standard deviation was 2.29343 which indicated a small

deviation from the mean. Profitability had a mean of 0.2431 and a small gap deviation shown

by a standard deviation of 0.19985.Corporate tax had a mean of 1084.11 and a standard

Table 4.3 Descriptive Statistics

Mean

Std.

Deviation

N

Equity 14540.4100 22183.27058 100

Firm Size 48468.3500 84777.04126 100

Asset Structure 2.1287 2.29343 100

Profitability .2431 .19985 100

Corporate Tax 1084.1100 1783.79000 100


Table 4.4 Descriptive Statistics

Mean Std.

Deviation

N

Debt 5846.3300 13523.87147 100

Firm Size 48468.3500 84777.04126 100

Asset Structure 2.1287 2.29343 100

Profitability .2431 .19985 100

Corporate Tax 1084.1100 1783.79000 100

33

deviation of 1783.79 which means that there is a gap between the two descriptive measures of

the data.

4.6 The Relationship between Independent Variables on Debt and Equity Choice

We sought to find out the relationship between the various independent variables (firm size,

asset structure, profitability and corporate tax) on debt and equity choices. The results are as

tabulated in table 4.5 below.

Table 4.5 Pearson Correlation

Equity Firm Size Asset

Structure

Profitability Corporate

Tax

Equity 1.000

Firm Size .754 1.000

Asset Structure -.201 -.149 1.000

Profitability .142 .061 -.266 1.000

Corporate Tax .758 .689 -.244 .546 1.000


Table 4.6 Pearson Correlation

Debt Firm Size Asset

Structure

Profitability Corporate

Tax

Debt 1.000

Firm Size .545 1.000

Asset Structure -.084 -.149 1.000

Profitability -.061 .061 -.266 1.000

Corporate Tax .348 .689 -.244 .546 1.000


The results established a positive relationship between firm size and equity as a choice of

0.754 as well as a positive relationship between firm size and debt as a financing choice of

0.545. Asset structure and equity were found to have a negative relationship of -0.201 while

asset structure and debt showed a negative relationship of -0.084. Profitability and equity

resulted to a positive relationship of 0.142, while profitability and debt showed a negative

relationship of -0.061. Corporate tax had a positive relationship with both debt and equity of

0.348 and 0.758 respectively. Firm size and profitability had a positive relationship of 0.061,

profitability and asset structure had a negative relationship of -0.266, asset structure and firm

34

size also showed a negative relationship of -0.149, corporate tax and firm size showed a

positive relationship of 0.689, corporate tax and asset structure showed a negative

relationship of -0.244 while corporate tax and profitability had a positive relationship of

0.546.

4.7 Effects of Various Variables on Debt and Equity Choices of a Firm in Kenya

We sought to establish the debt and equity choices of firms in Kenya and especially the firms

listed in the Nairobi securities exchange because they formed our target. To establish this end

return on capital employed (ROCE) was calculated for all the sampled firms with an end to

ascertain the specific firms profitability, on the other hand the financial position statements of

the 20 firms was also closely scrutinized to establish the specific firms total assets, liquidity

ratios and corporate tax which informed us on the; firm size, asset structures and corporate

tax respectively of the individual firms sampled. The below model was used to establish the

effect of the various factors on debt and equity choices.

𝑬𝒂𝒇 = 𝜶 + 𝑏1𝒙𝟏 + 𝑏2𝒙𝟐 + 𝑏3𝒙𝟑 + 𝑏4𝒙𝟒 + ℇ

𝑫𝒂𝒇 = 𝜶 + 𝑏1𝒙𝟏 + 𝑏2𝒙𝟐 + 𝑏3𝒙𝟑 + 𝑏4𝒙𝟒 + ℇ

The results were tabulated and discussed below;

Table: 4.7 Regression Results for Factors Affecting Debt Financing Choice

Model Unstandardized

Coefficients

Standardized

Coefficients

T

Sig. B Std. Error Beta

(Constant)

Profitability

Tax

Asset

structure

Firm size

4021.625

-9344.545

.542

-168.799

.080

2611.400

8190.465

1.244

527.024

.022

-.138

.071

-.029

.500

1.540

-1.141

.435

-.320

3.625

.127

.257

.664

.749

.000


35

Table: 4.8 Regression Results for Factors Affecting Equity Financing Choice

Model Unstandardized

Coefficients

Standardized

Coefficients

t

Sig.

B

Std. Error

Beta

(Constant)

Profitability

Tax

Asset structure

Firm size

10235.834

-30435.689

8.705

-598.107

.073

2754.066

8637.927

1.312

555.817

.023

-.274

.700

-.062

.279

3.717

-3.523

6.633

-1.076

3.144

.000

.001

.000

.285

.002


We sought to test the relationship of the independent variables (profitability, tax, asset

structure and firm size) on the dependent variables (debt and equity) by regression of

independent variables against the dependent variables each at a time, where t-test was used to

test the significance of each predictor variables (profitability, tax, asset structure and firm

size) in the model.

4.7.1 Relationship between profitability, debt and equity choice

The significance levels between firm’s profitability and the use of debt is indicated by t-value

of -1.141 and sig of 0.257 which indicates a low significance level compared to 0.05, while

the relationship between the use of equity financing and profitability is indicated by t-value -

3.523 and a sig level of 0.001 relative to the established significance level of 0.05 which is a

very high relationship.

This means that a firm which is highly profitable will not go for either of the two forms of

financing because it can be able to finance its operation by the use of the earned profit, this is

a strong argument mostly when we are referring to equity financing but at times the firm if it

is at extreme need of financing it will go for debt financing because it is convinced that the

internally generated fund can repay the debt instrument. This was in line with the argument

36

made by Deensomsak, Paudyal&Pescetto (2004), argued that they expect an inverse

relationship between profitability and debt financing levels since the pecking order theory

suggests that managers prefer to finance investments internally because of the informational

asymmetry between managers and outside investors. Thus profitable firms will prefer not to

raise external funding in order to avoid potential dilution of ownership and additional

external monitoring

4.7.2. Relationship between corporate tax and debt and equity choices

The Relationship between the use of both debt financing and equity financing and the

corporate tax level has a sig level of .664 and 0.00, This relationship is strongly significant to

the use of equity and less significance to the use of debt at a significance level of 0.00 and

0.664 respectively against significance level of 0.05. This means that tax levels is directly

proportional to the use of both forms of financing (debt and equity) but as tax goes up it

discourages use of equity financing.

The interpretation of the analysis of the data from the sampled firms was not consistent with

the observation made by Lim, 2012 that the relationship between non-debt tax shields and

debt financing should be negative.

4.7.3. Relationship between asset structure and debt and equity choices

There is a negative relationship between the use of debt and equity financing and the asset

structure of a firm indicated by t-values of -0.32 and -1.076 respectively, at the same time

there is less significance between the use of debt and equity choices indicated by significance

levels of 0.749 and 0.285 respectively against the significance level of 0.05. This means that

the liquidity level of a firm will not significantly influence the use of either of the two forms

of financing its operation.

The interpretation of the data was consistent with the observation made by Mutenheri and

Green (2003) that examined the determinants of capital structure for firms in Zimbabwe and

noted indirect relationship between asset tangibility and leverage levels of firms for the pre-

reform period (1986-1990).

4.7.4 Relationship between firm size and debt and equity choices

The data analysis shows a positive relationship between the use of debt and equity financing

and the firm size indicated by the t-value of 3.144 and 3.625 respectively. There is also a

strong significance of the use of debt and equity financing indicated by the significance levels

37

of 0.002 and 0.000 respectively against the established significance level of 0.05. This means

that a firm will increase the use of the two forms of financing as the firm size increases.

This statistical relationship concurred with the observation made by Serkan et al (2011) that

there is strong relationship between the firm size and the common stock issue, they further

observed that a significant linkage between a firms size and personal debt.

38

CHAPTER FIVE

SUMMARY, CONCLUSION & RECOMMENDATION

5.1 Introduction

The aim of this chapter is to link and apply the results obtained from the study, to solve and

answer the problems facing most firms in Kenya. It also helps in making financing choices by

the use of the two main sources of finance (debt and equity). The chapter will elucidate the

policy recommendation that the policy makers in various organizations can apply to better

their financing choices.

5.2 Summary and Conclusions

The main objective of this study was to establish the effect that various variables have on

debt and equity financing choice of firms listed at the Nairobi Securities Exchange. To

achieve this objective the researchers sampled firms listed under the Nairobi securities

exchange that exhibited the characteristics for the study. Secondary data was used in this

study. Data was collected through reviewing of documents such as annual published reports

and published books of accounts of the sampled companies.

The study establishes that it is of utmost importance for finance managers and the top

management of a firm to understand the various effects of the variables used in this study

such as; attitude of the top management, firm size, asset structure, corporate tax level and

profitability do have on the financing choice they choose to use.

The study established that profitability, liquidity and asset structure do have an indirect

relationship with the use of both debt and equity. This means that as the liquidity of a firm

goes down the firm will refrain from debt as well as equity use as a means of financing .This

is so because the firm is not able to adjust itself to pay off the debts as and when they fall due.

On the other hand it will not employ equity financing which brings in more diverse control

making the management of the firm difficult. Thus, it has to undertake long term measures so

as to correct the liquidity problem which can take quite a considerable period of time.

It also established that as the firm grows it will employ more of debts and more equity

finances. This is because as the firm grows it will need a lot of funds to finance its operations

as well as the development needs, such as new market analysis, new plants and machinery,

39

new premises and the high cost of employing the current technology. It will also need to have

a competitive edge in the market compared to its initial requirements.

The data showed that profitable companies will reduce their use of both debt and equity

because they are in a position to finance their operations with the internally generated funds.

If they have to employ external funding they will consider the use of debt because they are

convinced beyond reasonable doubts that they are able to pay off the debt value as and when

it falls due. They will not employ equity because this form of financing is believed and

proved to increase control spread of a firm which does not favor its management. Debt and

equity control engages the firm in a long term obligation of growing their capital gain as well

as paying the share holders dividend after every financial year.

The corporate tax level was found to have a strong relationship with the debt financing choice

of a firm and less significant relationship with the use of equity financing. This proved that

corporate tax level is directly proportional to both debt and equity financing choice. This

means that as the tax goes up it discourages the use of equity financing choice as it makes it

more expensive for the investors. The interpretation of the analysis of the data from the

sampled firms was not consistent with the observation made by Lim, 2012 that the

relationship between non-debt tax shields and debt financing should be negative.

The data analysis showed that the attitude of the top management has a great influence on

making decision on financing choice to be adopted by the firm in Kenya. From the data

collected a greater percentage are risk seekers and they supported debt financing as compared

to risk averse who supported equity financing in making their choices of financing a firm.

5.3 Policy Recommendations

It was considered to be very important when the finance managers/controllers are funding

their firm’s assets to understand the impact of various variables on their choice of debt and

equity financing. This was evident from the study and analysis arising thereof. This study

established that analysis of dependent variables and analysis of independent variables when

used well can help to boost firm’s competitive advantage and consequently profitability. In

addition the capital market analyst as well as investment analyst should advise the investors

as well as firms on the best financing choice to be taken based on the structure analysis.

Borrowing induces risk to the company and on the return on shareholders in terms of

reducing the amount of profit available to them. It also exposes their assets to dissolution in

40

the event they fail to pay debt in the stipulated time. When the firm’s returns are likely to fall

significantly, the use of debt increases their risk. Adequate emphasis should be put in place

on enabling those firms to employ more of shareholders funding than debt and thus reduce

the risk that is inherent in the increased use of debt. Based on the results of the study the

following recommendations were made.

5.3.1 Use Equity rather than Debt

The conclusion that debt financing does not always improve a firm’s performance leads to the

recommendation that firms should use shareholders funds as much as possible before they

undertake to borrow debts. This is to minimize the risks related to the use of debt financing

which includes interest on debt exceeding the return on assets they are financing. Firms must

therefore be encouraged or assisted to obtain equity by listing on exchanges. This can be done

by educating and sensitization of business owners of the benefits of listing as well as granting

of special fiscal measures to encourage them to list.

5.3.2 Consider the Firms Asset Structure

When a firm has exhausted its equity financing choice through shareholders funds and

chooses to finance its expansion of operations by borrowing, special conclusion must be

taken to ensure that the assets financed brings in a higher returns than the interest the firm is

required to pay on the debt. If this is not done, the firm will erode the reserves in order to

repay the debt as the assets financed will not be making enough returns to cover the debt.

5.4 Limitations of the Study

The researchers encountered quite a number of challenges related to the research and most

particularly this research under constrains of finances. In addition Nairobi Securities

Exchange analysts had to be pushed to us assist with data. This was done through many calls

and visits to remind them. Others wanted to be paid in order to give data. Others thought that

the information they were requested to volunteer was confidential.

Time allocated for the study was insufficient while holding a full time job and studying part

time. This was encountered during the collection of material as well as the data to make the

study a success. However, the researchers tried to conduct the study within the time frame as

specified.

41

5.5 Suggestions for Further Studies

Arising from this study, the following directions for future research in Finance were

recommended as follows:

First, the study focused on all the 60 listed firms in the Nairobi Securities Exchange.

Therefore, generalization could not adequately be extended to every listed firm as they have

varying industry risk, different management, and different asset structures. Based on these

facts among others, it is therefore recommended that narrow based study covering a specific

segment or firm be done to find out the impact of firm size, profitability, attitude of top

management cost of capital asset structure and corporate tax on debt and equity financing

choice.

Similar studies to this can also be conducted or replicated in a few years to assess if the

impact of firm size, profitability, attitude of top management cost of capital asset structure

and corporate tax on debt and equity financing choice on firms listed at the Nairobi Securities

Exchange has changed as the Nairobi Securities Exchange continues to change. Also debt and

equity financing on corporate strategy is also another area of interest which can be under the

area of further research and more intense study along that area can come in handy.

The study was done for the firms operating in Kenya and researchers suggested that a cross

sectional study be done for the other East African firms listed at the Stock Exchanges.

42

REFERENCES

Hall, G.C, P, J, Hutchinson & N.Michaelas 2004, “Determinants of Capital Structures of

European SMEs’’ Journal of Business Financial and Accounting 31(5/6); 711-28

Abor J. (2004),“International and Financing options of Ghanian SMEs’’ Acta Commercii,

4:60-72.

Caser, G and S, Holmes, (2003), “Capital Structure Financing of SMEs, Australian

evidence’’ Journal of Accounting and Finance, 43:123-47.

Green, C.J, P.Kimunyu, R.Manos and V.Murinde (2003), How Do Small Firms in developing

countries raise capital? Evidence from a large-scale survey of Kenyan micro and small scale

enterprises .Economic Research Paper No, 02/6.Centre for International, Financial and

Economic Research, Department of Economics, Loughborough University.

Abor, Joshua (2005): The Effect of Capital Structures of Profitability; An Empirical Analysis

of Listed firms in Ghana, Journal of Risk Finance Vol 6,No 5,2005,pp 438-445.

Baxter, N.D (1976) Leverage, Risk of Running and the Cost of Capital, Journal of Financial

Economics, 1976:305-360

Biermen, H, (1999) Corporate Financial Strategy and Decision Making to increase

shareholders value, Frank J., Fabozzi Associates, Pennsylvania, USA.

Brealey, Richard and Myers, SC (2003); Financing and Evaluation, Chapter 19, Principles of

Corporate Finance, 7th Edition McGraw Hill, London UK.

Jensen M, Meckling W; (1976), Theory of the firm, Managerial behavior, agency costs and

ownership structures, Journal Financial Economics 3,305-360

Harris, M. and Raviv (1991) Theory of Capital Structure; Journal of Finance 46,297-355

Kim E, McConnell J. (1977) Corporate Mergers and the coinsurance of corporate debt,

Journal of Finance, 32,349-365

Modigliani F, Miller M ;( 1958), The Cost of Capital, Corporate Finance and the Theory of

Finance, American Economics Review, 48(3), 291-297

Myers S,(1977),Determinants of Corporate borrowing, Journal of Financial Economics

5,146-175

43

Myers S, Majluf (1984), Corporate Financing and Investment decision when firms have

information that investors do not have, Journal of Financial Economics,13(2),187-221

Nickel; (1996) Competition and Corporate Finance, Journal of political Economy 104,724-

746.

Coleman, A.K., and Tetty, K.F.A. (2008).Impact of Macroeconomic variables on Ghana

stock exchange. Journal of Risk and Finance, 4,365-378

Maysami.R.C. and Sim, H.H. (2002).Macroeconomics variables and their relationship with

stock returns: error correction evidence from Hong Kong and Singapore. The Asian

Economic Review 44(1) 69-85.

Masila, M.J. (2010). The Determinants of stock market development; A case of Nairobi stock

Exchange .Unpublished project of University of Nairobi

Ross, S.A.(1976).The Arbitrage Theory of Capital Asset Pricing. Journal of Economic

Theory, 13,341-360

Alan Bryman and Emma Bell (2003).Business Research Methods, essential guidance on the

practice of business research and how to carry out a small-scale research project or

dissertation for the first time, Oxford University Press, 2003.

Donald R. Cooper (2003). Business Research Methods. McGraw-Hill/Irwin series Operations

and Decision Sciences .Business Statistics

Leuz, C. and Verrecchia, R.E (2005 Capital Allocation Choice) Firms and Cost of Capital,

Working paper, University of Pennsylvania

Berens, James .L and Cuny, C.J (1995) The Capital Structure Puzzle Revisited, The Review

of Financial Studies

Cook, Paul and Nixson, Fredrick (2000) Finance and Small and Medium Enterprises

Development, Paper No.14 Working Paper Series

Magara, M. (2012), Capital Structure and its Determinants at Nairobi Stock Exchange

unpublished Management Research Paper of the University of Nairobi.

Nairobi Securities Exchange (2009-2013) Handbook, Audited Financial Reports (2009-

2013). Nairobi NSE

44

Titman, S and Wessels (1988) The Determinants of Capital Structure Choice, Journal of

Finance, 430, 1-19.

Benito, A. (1999) The Capital Structure Decision of a firm, BENCO DE ESPANA, Madrid

Jensen M. (1986) Agency Cost of Free Cash Flow, Corporate finance and takeovers,

American economic review

Pandey IM, (1999) Financial Management 8th Edition New Delhi. Vikas publishing house

PVT ltd

Zeitun,R and Tian, G.G. (2007) Capital Structure and Corporate Performance : Evidence from

Jordan Australian Accounting Business and Finance journal. Vol. 1

Mugenda and Mugenda (1999), “Research Methods: Quantitative and Qualitative

Approaches.’’ African Centre for Technology Studies.

Glen, J. and Pinto, B. (1994), Debt or Equity? How firms in developing countries

choose.IFC Discussion paper No. 22.

Chen, J. (2004), Determinants of Capital Structure of Chinese-listed companies. Journal of

Business Research, 57, 1341-1351.

Shyam-Sunder, L. and Myers, S.C. (1999). Testing Static tradeoff against pecking order

models of capital structure. Journal of Financial Economics, 51, 219-244.

Ozkan, A (2001). Determinants of Capital Structure and adjustment to long run target:

Evidence from UK company panel data. Journal of Business and Accounting 28, 175-198.

Murinde, V. (2006) Capital Markets: Roles and Challenges paper prepared for the

International Conference on Accelerating Africa’s Development five years into 21st century,

Tunisia, Tunis.

Modgiliani, F, and Miller, M.H (1963). Corporate Income Taxes and the cost of Capital: A

correction. The American Economic Review, 53(3), 433-443.

Capital Markets Authority: (1999) Rules and Regulations on listed companies.

http://www.nse.co.ke.

http://www.nse.co.ke/

45

Bastos, D.D., Nakamura, W.T., and Basso, L.F.C (2009).Determinants of Capital Structure of

Publicly traded companies in Latin America: An empirical study considering macro-

economic and institutional factors. RAM Revista de Adminstracao Mackenzie, 10(6), 47-77.

Bradley, Jarell, G.A and Kim E.H (1984).On the existence of an optimal Capital structure:

Theory and evidence. The journal of Finance, 39,857-878

Brealey, R.A and Myers S.C. (1988). Principles of Corporate Finance, 3rd Edition. McGraw-

Hill publishing company. New York

46

APPENDIX I: QUESTIONNAIRE COVER LETTER

FACTORS DETERMINING DEBT AND EQUITY CHOICES QUESTIONNAIRE

Egerton University,

Faculty of Commerce,

Department of Accounting, Finance and Management Science,

P.O Box 536-20115,

EGERTON

Dear: Sir/Madam,

RE: REQUEST FOR RESEARCH DATA

We are undergraduate students at Egerton University, Faculty of commerce specializing in

banking and finance. In order to fulfill the degree requirements, we are undertaking a

management research project on the “Factors Determining Debt and equity choices of

firms in Kenya”. To achieve the above goal, we have identified your organization as one of

the institutions from where relevant data will be obtained. The information given to us will be

treated with confidentiality and will be used for academic purpose only. Suppose you have

any enquiries or comment regarding this project, you are free to contact us directly on the

contacts given below. Your cooperation will be highly appreciated.

Yours faithfully,

[email protected] Patrick Musyoka 0726383654 ------------------

[email protected] Josephine Muindi 0726617189 -------------------

[email protected] Jones Nyabicha 0722235281 -------------------

[email protected] Sarah Oira 0722686023 -------------------

[email protected] GrantonMwambingu 0720642960 -------------------

[email protected] Gilbert Kosgei 0720700075 -------------------

[email protected] Caroline Maina 0711911237 -------------------

[email protected] James Wakori 0727415604 -------------------

[email protected] Peter Wafula 0725787201 ------------------

evansmutha [email protected] Evans Muthama 0717170693 ------------------

Or email: [email protected]

mailto:[email protected]





mailto:evansmutha%[email protected]


47

APPENDIX II: QUESTIONAIRE

INSTRUCTIONS

Please answer all the questions honestly and exhaustively by ticking (√) the correct answers

in the space provided. All the information given will strictly be used for academic

purpose/research only and will be treated with utmost confidentiality.

SECTION A: DEMOGRAPHIC DATA

This section of the questionnaire refers to background or biological information. Although we

are aware of the sensitivity of the questions in this section, the information will allow us to

compare group’s respondents. Once again we assure you that your response will remain

anonymous. Your co-operation is much appreciated.

No Questions Answer categories Tick

1. Gender 1.Male

2. Female

[ ]

[ ]

2.

Age bracket

1. 18-28 years

2. 28-38 years

3. 38-48 years

4. Above 48 years

[ ]

[ ]

[ ]

[ ]

3.

Which is your highest education level?

1. Primary

2. Secondary

3. College Polytechnic

4. University

[ ]

[ ]

[ ]

[ ]

4.

For how long have you been employed

(in years)?

1. Less than 1 year

2. 1-5 years

3. 5-10 years

4. Over 10 years

[ ]

[ ]

[ ]

[ ]

`5. For how long have you been working in

your current organization?

1. Less than 1 year

2. 1-5 years

3. 5-10 years

4. Over 10 years

[ ]

[ ]

[ ]

[ ]

6. In what category are you working in? Top management

Middle management

Support staff

[ ]

[ ]

[ ]

48

SECTION B: DEBT AND EQUITY CHOICE OF A FIRM.

Perceptions: The following statements deal with the perceptions experienced from debt and

equity choice of a firm. Please, show the extent to which these statements reflect your

perception towards debt and equity financing choice to a firm. The questions are ranked on a

four likert scale ranging from 1.Very great extent (V.G.E) 2. Great extent (G.E), 3.Moderate

(M),4. Small extent (S.E) 5.Not at all (N.A), please tick one that corresponds with your likert

scale.

B. MANAGEMENT ATTITUDE

VARIABLE 1

(V.G.E)

2

(G.E)

3

(M)

4

(S.E)

5

(N.A)


management influence them to use

debt financing?

[ ]

[ ]

[ ]

[ ]

[ ]


management inform them to use equity

financing?

[ ]

[ ]

[ ]

[ ]

[ ]

3 To what extent does attitude of top

management fail to influence their

debt and equity choice?

[ ]

[ ]

[ ]

[ ]

[ ]

4 To what extent does the top

management influence the financing

decision of a firm?

[ ]

[ ]

[ ]

[ ]

[ ]


management vary when they are

making decisions on various issues?

[ ]

[ ]

[ ]

[ ]

[ ]


END OF QUESTIONNAIRE

Thank you in advance for your valuable information and co-operation.

49

APPENDIX III: RETURN ON CAPITAL EMPLOYED MEASURING

PROFITABILITY

50

APPENDIX IV: LIQUDITY RATIO MEASURING THE ASSET STRUCTURE OF A

FIRM

51

APPENDIX V: CORPORATE TAX MEASUREMENT OF THE FIRMS

52

APPENDIX VI: THE FIRM SIZE MEASUREMENT

53

APPENDIX VII: LISTED FIRMS

TARGET POPULATION OF QUOTED FIRMS.

BANKING

1. Barclays Bank Ltd Ord. 2.00

2. National Bank of Kenya Ltd Ord.5.00

3. Kenya Commercial Bank Ltd Ord.1.00

4. Housing Finance Co Ltd Ord.5.00

5. CFC Stanbic Holdings Ltd Ord.5.00

6. Standard Chartered Bank Ltd Ord.5.00

7. Equity Bank Ltd Ord.0.50

8. The Co-operative Bank of Kenya Ltd Ord.1.00

9. NIC Bank Ltd Ord.5.00

10. Diamond Trust Bank Kenya Ltd Ord.4.00

INSURANCE

11. Jubilee Holdings Ltd Ord.5.00

12. Pan Africa Insurance Holdings Ltd Ord.5.00

13. CIC Insurance Group Ord.1.00

14. British American Investments Company(Kenya) Ltd Ord.0.10

15. CFC Insurance Holdings

16. Kenya Re-Insurance Corporation Ltd Ord.2.50

CONSTRUCTION AND ALLIED

17. Bamburi Cement Ltd Ord.5.00

18. E.A.Portlant Cement Ltd Ord.5.00

19. E.A Cables Ltd Ord.0.50

20. Athi River Mining Ord.5.00

21. Crown Berger Ltd Ord. 5.00

MANUFACTURING AND ALLIED

22. British American Tobacco Kenya Ltd Ord.10.00

23. Carbacid Investment Ltd Ord.5.00

24. East African Breweries Ltd Ord.2.00

25. Mumias Sugar Co Ltd Ord.2.00

26. Unga Group Ltd Ord.5.00

54

27. Kenya Orchards Ltd Ord.5.00

28. B.O.C Kenya Ltd Ord.5.00

29. Eveready East Africa Ltd Ord.1.00

30. A. Baumann Co Ltd Ord.5.00

INVESTMENT

31. Centum Investment Co Ltd Ord.0.50

32. Olympia Capital Holdings Ltd Ord.5.00

33. City Trust Ltd Ord.5.00

34. Trans-Century Ltd

AGRICULTURAL

35. Kakuzi Ord.5.00

36. Limuru Tea Co Ltd Ord.20.00

37. Rea Vipingo Plantations Ltd Ord.5.00

38. Eaagads Ltd Ord.1.25

39. Sasini Ltd Ord. 1.00

40. Kapchorua Tea Co Ltd Ord.5.00

41. Williamson Tea Kenya Ltd Ord.5.00

ENERGY AND PETROLEUM

42. Kenolkobil Ltd Ord. 0.05

43. Total Kenya Ltd Ord.5.00

44. KenGen Ltd Ord. 2.50

45. Kenya Power & Lighting Co Ltd Ord.

TELECOMMUNICATION AND TECHNOLOGY

46. Access Kenya Group Ltd Ord.1.00

47. Safaricom Ltd Ord.0.05

AUTOMOBILES AND ACCESSORIES

48. CMC Holdings Ltd Ord.0.50

49. Sameer Africa LtdOrd.5.00

50. Car and General (k) Ltd Ord.5.00

51. Marshalls(E.A) Ltd Ord.5.00

COMMERCIAL AND SERVICES

52. Kenya Airways Ltd Ord.5.00

53. Nation Media Group Ord.2.50

55

54. Standard Group Ltd Ord.5.00

55. Express Ltd Ord.5.00

56. TPS Eastern Africa(Serena) Ltd Ord. 1.00

57. Uchumi Supermarket Ltd Ord.5.00

58. Hutchings Biemer Ltd Ord.5.00

59. Longhorn Kenya Ltd

60. Scan group Ltd Ord.1.00

Source: Research 2015, NSE

56

APPENDIX VIII: SAMPLED FIRMS.

BANKING

1. Barclays Bank Ltd Ord. 2.00

2. Kenya Commercial Bank Ltd Ord.1.00

3. Equity Bank Ltd Ord.0.50

INSURANCE

4. Jubilee Holdings Ltd Ord.5.00

5. CIC Insurance Group Ord.1.00

CONSTRUCTION AND ALLIED

6. E.A.Portlant Cement Ltd Ord.5.00

7. Athi River Mining Ord.5.00

MANUFACTURING AND ALLIED

8. British American Tobacco Kenya Ltd Ord.10.00

9. East African Breweries Ltd Ord.2.00

10. Eveready East Africa Ltd Ord.1.00

INVESTMENT

11. Trans-Century Ltd

AGRICULTURAL

12. Kakuzi Ord.5.00

13. Limuru Tea Co Ltd Ord.20.00

14. Sasini Ltd Ord. 1.00

ENERGY AND PETROLEUM

15. KenGen Ltd Ord. 2.50

TELECOMMUNICATION AND TECHNOLOGY

16. Safaricom Ltd Ord.0.05

AUTOMOBILES AND ACCESSORIES

17. Car and General (k) Ltd Ord.5.00

COMMERCIAL AND SERVICES

18. Nation Media Group Ord.2.50

19. Longhorn Kenya Ltd

20. Scan group Ltd Ord.1.00

Source: Research 2015, NSE

FACTORS DETERMINING DEBT AND EQUITY CHOICES OF A FIRM IN KENYA

Documents

Transcript of FACTORS DETERMINING DEBT AND EQUITY CHOICES OF A FIRM IN KENYA