Capital structure, ownership identity and financial performance of commercial banks listed at the Nairobi Securities Exchange In Kenya

Abstract

Sound financial health of a bank is the guarantee not only to its depositors but is equally significant for the shareholders, employees and the whole economy as well. Financial performance provides an avenue for the evaluation of business activities in objective monetary terms. Despite the good overall financial performance of banks in Kenya, there are a couple of banks which were declaring losses and faced bailouts. The purpose of this research therefore was to investigate the moderating effect of ownership identity on relationship between Capital structure and financial performance of commercial banks listed at Nairobi Security Exchange. The study’s specific objectives were to determine the effects of debt and equity on financial performance, as well as to assess the moderating role of ownership identity on each of the relationships. The main theories of this study were modigliani and miller (mm) theory, trade off theory, market timing theory, pecking order theory agency cost theory. The study used explanatory research design. The target population of the study was all commercial banks listed at Nairobi Securities Exchange. A survey of all 11 listed commercial banks was conducted between the periods 2003 to 2018. Secondary data obtained from the audited financial reports of the banks were used in the study. Data analysis was conducted using STATA version 13software. The panel data was used to analyze both descriptive and inferential statistics. Descriptive statistical techniques specifically mean, standard deviation, minimum and maximum were used. Inferential statistics that is multiple regression analysis and correlation analysis were used to predict and explain the nature and significance of relationships between the independent and dependent variables. The study results were presented using tables and graphs. To check for random and fixed effects diagnostics the study used Hausman’s test. The recommendations were of significance to bank’s shareholders and management, investors and for policy implication. Capital structure was found to have significant effect on financial performance with its effect moderated by ownership identity. The study results specifically indicate a negative and significant effect of debt financing (β = -0.06745, P<0.05) on financial performance, while equity financing (β = 0.097163, P<0.05) indicated a positive and significant effect. Ownership identity moderates the relationship between; debt financing (β=-0.00201, P<0.05, ∆R 2 =0.025%), equity financing (β= 0.002, P<0.05, ∆R 2 =0.020%) and financial performance. Capital structure specifically debt financing decreases financial performance since its expensive to acquire and to service due to high interest rates paid on debt, while equity financing increases financial performance since owners are paid dividends which depend on the profitability of the bank. It is therefore in the best interest for banks to refrain from using more debt, but instead finance their operations using more equity financing. The study findings agrees with the trade-off theory, In contrast, the study disagrees with the Myres and Majluf (1984) pecking order hypothesis that debt is preferred to equity. Finally, the Modigliani and miller (mm) theory contradicts with the findings. The decision about which source of finance to use is vital and affects profitability of the bank as shown by the results. It is therefore recommended that banks should choose the right financial mix that maximizes the financial performance.