Effect of Capital Structure on Financial Distress of Non-Financial Companies Listed in Nairobi Securities Exchange

Abstract

situation does not only lead to loss of investors’ wealth but also erode confidence in the capital market. This study sought to investigate the effect of capital structure on financial distress of non-financial companies listed in NSE. Different from the previous studies that have mainly determined the effect of capital structure based on financial performance measures such as profitability, liquidity and firm value, this study focused directly on financial distress. In accomplishing this overall objective, the study sought to establish the effect of financial leverage, debt maturity, equity structure and asset structure on financial distress of non-financial firms. In addition, the study investigated the moderating effect of firm size and the listing sector on the relationship between capital structure and financial distress of the firms. The study employed secondary data extracted from audited financial statements and annual reports of individual companies for the ten - year period covering 2004 – 2013 (both years inclusive). The study was undertaken using quantitative research design. A census of all the 41 non-financial companies listed in NSE as at December 2013 constituted target population. Descriptive statistics and panel regression analysis techniques were used to analyze the data. F-test was used to determine the significance of the overall model; while significance of individual variables was determined by t-test. The study concluded that financial leverage, asset tangibility and external equity have a significant negative effect on financial distress of non-financial firms. Nevertheless, internal equity and long term debt play a significant role in mitigating financial distress in non-financial firms. The study further concluded that the firm size and the listing sector have significant moderating effect on the relationship between capital structure and financial distress. Based on these findings, the study recommends that in financing their firms, corporate managers should adopt appropriate mix of different capital sources necessary to mitigate financial distress of the firms. Particularly, long term debt and internal equity should be employed while debt should be applied sparingly. In addition, corporations should avoid maintaining large proportions of their asset investment in illiquid (fixed) form as this ties up significant portion of productive capital. At policy level, the study recommends that policy makers should initiate policies aimed at lowering the cost of debt financing and at the same time encourage non-financial firms to plough back much of their profits to finance the operations.