Determinants of the Use of Financial Derivatives among Firms Listed at Nairobi Securities Exchange

Abstract

This study sought to investigate the determinants of derivative use among firms listed at the Nairobi Securities Exchange. Specifically, the study tests the effects of firm value, debt, underinvestment, managerial ownership and tax incentive on use of financial derivatives. The study also tests if industry and firm size have moderating effect on the determinants of derivative use. Each of the variables was analyzed using proxies identified through examination of existing theoretical framework. The study employed exploratory research design. Purposive sampling was applied to the target population of firms listed at the Nairobi Securities Exchange in order achieve appropriate sample for the study. Banks, Financial Institutions and Investment firms were eliminated from the sample because most of them are market makers and their stimulus to use financial derivatives is unlike the motivations of non-financial firms. A total of 31 companies were included in the sample. Both primary and secondary data was used in the study. Primary data was obtained through a survey of firms listed at Nairobi Securities Exchange by means of questionnaires mailed to managers involved in risk management. A total of 62 questionnaires were administered and 57 were returned making the response rate to be 91.9%. Secondary data was generated from annual reports of firms listed in the Nairobi Securities Exchange from 2008 to 2012, total dataset of 155 firm-year observations. Data was analyzed using both descriptive and inferential techniques. Independent sample t-test was used to test differences in means between groups and Pearson’s correlation was used to test for correlation between the variables. Binary Logistic Regression was applied since the dependent variable is dichotomous, small, discreet and non-continuous. Moderating effects of industry and firm size on determinants of financial derivative use were analyzed by including interaction term in the model. The findings reveal that Firm Value, Underinvestment and Managerial Ownership are statistically significant determinants of derivative use among firms listed at the Nairobi Securities Exchange. Evidence shows that Debt and Tax Incentive are statistically insignificant. From the findings, the study concludes that firms utlize financial derivatives in risk management for the goal of maximizing firm value. Firms facing underinvestment with growth opportunities but scarce funds employ derivative to provide debt capacity. Managerial risk aversion is important as managers with stake in their firms utilize financial derivatives in managing corporate risk. Findings further reveal that Industry has a moderating effect on determinants of derivative use while Firm Size has no moderating effect on determinants of derivative use. The study contributes important evidence for Kenya on the usage of derivatives and risk management by publicly quoted firms and confirms extant theories on use financial derivatives. The important limitation of the study was the absence of organized derivative trading at the Nairobi Securities Exchange limiting the quality of data publicly available. The study’s recommendations include; requirements for disclosures of firms’ risk management techniques, investors’ evaluation of growth opportunities versus available finance of firms in making investment decisions and allocation of ownership stakes to managers in public firms to motivate management to undertake effective risk management programmes.