Cash Flow Volatility and Firm Market Value of Companies Listed at the Nairobi Securities Exchange

Abstract

Market value of a public company is the also called company market capitalization and is a function of share prices in the market and the number of issued shares. The prices of a company depend on investor perception about the value of the company. Numerous factors influence such investor perceptions. It is not clear if cash flow volatility is value relevant for companies listed at the Nairobi Securities Exchange (NSE). This lack of clarity arises from the conflicting theoretical and empirical evidence on the effect of cash flow volatility on market value and this creates a dilemma to investors in equity securities in their buy, hold and sell decision. It is for this reason that the overall objective of this study is to examine the effect of cash flow volatility on market value of public companies in Kenya. The objectives are specifically with respect to operating, investing, financing and implicit cash flows and how they affect firm market value as well as how this effect is moderated by the financial performance of those companies as indicated by Return on Equity (ROE). Market value was measured using the capitalization ratio while the cash flow volatilities were based on the 3-year moving standard deviations of the respective cash flow ratios. The relevant theories that try to explain the interlinkage between cash flow volatility information with share prices and therefore market values are the efficient market hypothesis, the functional fixation theory, the random walk theory, the MM value relevance theory and the free cash flow theory. The research was undertaken as a census quantitative descriptive study based on a census of all the 66 listed companies. From this, 45 had all the relevant data and were used in the analysis. Secondary data was collected from the NSE and annual financial statements of the companies listed at the NSE. The study was based on the positivism philosophy owing to the quantitative nature of the panel data regression analysis that was done over a 12-year period spanning January 2011 through December 2022. Since 3-year moving standard deviations were applied to establish cash flow volatility, the actual number of years reduced to 10 (2011 and 2022 had no center values on the moving basis). This resulted in 450 firm-year observations. Relevant diagnostic tests of normality, heteroscedasticity, collinearity, stationarity, and model specification were done before the hypotheses tests were using P-value and the t-statistic at 95% confidence interval. Based on the fixed effects models both for the bivariate analysis of each of the independent variables and capitalization ratio, the findings revealed that the volatilities of cash flows from operations; investing, and financing activities had a negative effect on firm market value of the companies listed at the NSE. Further, the implicit cash flow volatility had no significant effect of the market valuation of those companies. From the moderating perspective, it was established that ROE had a positive moderating influence on the effect of volatilities of all the categories of cash flows (operating, investing, financing and implicit) on the market values of firms listed at the NSE. The study supports the EMH, Random Walk and MM value relevance theories for operating, investing and financing cash flow volatilities and the functional fixation theory for the implicit cash flow volatility. Since the study finds cash flow volatility to be a priced information risk factor at the NSE, it recommended that more disclosures on information about cash flows should be reported in the financial statements of listed companies in Kenya to aid investors in decision making. Since the study only focused on companies listed at the NSE, it is recommended that further studies on non-listed companies could be carried out to corroborate findings from this study and bridge the literature gaps left unfilled by this study.