Financial Structure Annual Volatility, Stock Liquidity, and Ordinary Equity Security Returns of Public Limited Companies in Kenya

Abstract

Investors are always concerned about the returns they expect to obtain from public companies yet it is always difficult to pinpoint how various factors influence those returns and the resultant investment strategy of the investors in equity securities. In the context of this study, it is not clear how the annual volatility in the financial structure of public companies in Kenya affect the stock returns of those companies and whether and how stock liquidity affects that relationship. Financial structure relates to the proportions of short-term liabilities; long term debt; internal equity and external equity. The annual volatility is the rolling standard deviations of those proportions on a yearly basis. The study’s main objective of this study is to evaluate the effect of financial structure annual volatility on ordinary equity security returns of public companies in Kenya. The specific objectives are evaluating the effects of annual volatility in long-term debt, internal equity, external equity and short-term debt proportions of the financial structure on ordinary equity security returns of public companies in Kenya, and how the relationship is moderated by the liquidity of the stocks. The research was conducted from 67 public companies listed at the Nairobi Securities Exchange (NSE) for the period of eleven years from 2012 to 2022. The study was based on the efficient market hypothesis, asymmetric information hypothesis, the random walk theory, the risk dichotomy theory, firm market activity hypothesis the market timing theory and capital structure irrelevance theory. The study adopted the Philosophy of Positivism, a methodology that looks for quantifiable observations that lead to statistical analyses in the scientific research paradigm. The study adopted a causal or explanatory research design based on a census of all the listed firms at the NSE. Secondary data was obtained from the Nairobi Securities Exchange with respect to liquidity and prices and the annual financial statements of the firms with respect to annual financial structures. The study adopted central tendency, dispersion and distribution descriptive statistics, panel regression evaluation and multiple correlation to carry out the research analysis. Bivariate as well as multiple linear panel regression were adopted after finding the fixed effects panel regression models to be suitable for the regression. A 3-year moving standard deviation was conducted for every financial structure proportion to measure volatility while holding period returns were used to indicate stock returns. In testing the panel regression model, normality; autocorrelation; heteroscedasticity; Akaike Information Criterion; multicollinearity; stationary; cointegration and Granger-causality test were undertaken. The findings reveal that short-term financial structure annual volatility; long-term debt structure annual volatility; internal equity structure annual volatility and external equity structure annual volatility all had a positive effect on security returns of public companies in Kenya. This applied to the overall market as well as its various eleven segments. Further, stock liquidity had a positive moderating influence on this relationship. The conclusion arrived at emphasizes on the significance of long-term debt management, internal equity optimization, and external equity dynamics for maximizing equity security returns in Kenya’s capital market. Recommendations are provided for investors, companies, policymakers, and further research initiatives to enhance financial management practices, mitigate risks, and empower stakeholders in the dynamic landscape of equity markets. Finally, areas of further research are identified, including investigations into macroeconomic influences, corporate governance practices, market conditions, and financial intermediaries’ roles in shaping equity security returns, aiming to deepen understanding and inform decision-making in Kenya’s financial market.