Effect of Foreign Exchange Exposure on Value of Nonfinancial Firms Listed at Nairobi Securities Exchange, Kenya

Abstract

The study investigates the effects of exchange rate exposure on firm value for nonfinancial firms listed at Nairobi Securities Exchange-NSE for period 2001-2016. Specifically the study undertakes to determine the effect of contemporaneous exchange rate changes on firm value of nonfinancial companies, secondly, establish the effect of unexpected exchange rate movements on firm value of nonfinancial companies, thirdly examine the effect of lagged changes in exchange rates on firm value of nonfinancial companies, fourthly establish the effect of changes in exchange rate exposure on firm value as moderated by the market twenty share index of nonfinancial companies at the Nairobi Securities Exchange of the twenty one (21) firms. In line with the financial theory, any change in an exchange rate should affect the value of a firm or an industry. However, earlier research did not fully support this theory, which is surprising in view of the considerable exchange rate fluctuations over the last two decades. Therefore, the study aimed to identify the sensitivity of nonfinancial companies stock returns to exchange rate movements over these periods. An accepted way to measuring exchange rate exposure at the company level can be to exploit the information content in the stock prices. The use of one all-comprising exchange rate indicator fails to address the complexity of the extra-market exchange rate exposure of individual companies. Descriptive research design was used. The study adopted a two staged methodology. The first stage involved the determination of the foreign exchange exposure. At this point the REER is determined as the weighted average of the seven major currencies used by Kenya. The unexpected foreign exchange changes were determined using the ARIMA and GARCH model. The second stage of analysis involves a panel model where different aspects of foreign exchange exposure are regressed on firm value. The findings of the study reveal that contemporaneous exchange rate changes and unexpected exchange rate changes both have a significant negative influence on firm value. This underscores the need for hedging to protect the firm from adverse exchange rate effects. The results were however inconclusive on the effects of lagged changes in exchange rates on firm value. The 20 share index was found to moderately significantly influence the relationship between exchange rate exposure and firm value (share capital gains). The study recommends increases efforts toward exchange rate risks monitoring and mitigation, specifically the usage of derivatives in hedging. It is further recommended that the government through central bank continually monitors the exchange rate movements due to its influence on firm value, share prices and capital gains.