Financial leverage, CEO power and the financial performance of companies listed at the Nairobi securities exchange, Kenya.

Abstract

Firm financial performance is essential for corporate survival and prosperity. Financial leverage may be used to enhance corporate financial performance, but it can also occasion financial distress and bankruptcy if not carefully managed. At the Nairobi Securities Exchange, a number of firms face poor financial performance, financial distress, and weak governance, commonly associated with excessive leverage and bankruptcy. Recent corporate finance research show increasing importance of variables, omitted in prior studies, with more practical significance to practicing managers including debt slack and corporate governance. In spite of the profound impact of a firm’s chief executive officer’s influence power on both firm’s financial leverage and financial performance little has been done to establish the role of chief executive’s power on the relationship between the two. The purpose of this study was to determine the moderating effect of Chief Executive Officer Power on the relationship between financial leverage and financial performance of listed companies at Nairobi Securities Exchange. The specific objectives of this study were to determine the effect of: Debt, Debt-Equity ratios, and interest coverage on firm financial performance and to determine the conditional effect of Chief Executive Officer Power on the relationship between Debt, Debt-Equity ratios and interest coverage on firm financial performance. The study was grounded on dynamic tradeoff, pecking order, agency and upper echelon theories. Positivist research paradigm with explanatory design using linear regression model on panel data obtained from a survey of 38 listed companies at Nairobi Securities Exchange over the period 2010 to 2019 was used. The data was mined from financial statements filed at the Nairobi Securities Exchange. Controlling for Firm size, Sales growth and operational efficiency, the study found Debt ratio (ꞵ = .006; p= 0.755) and Chief Executive Officer Power (ꞵ= .060, p= 0.008) positively related to Return on Equity; the latter statistically significant at 0.05. Further, Interest coverage ratio (ꞵ=-.022; p= 0.335) and Debt Equity ratio (ꞵ=-.235, p= 0.000) were negatively related to Return on Equity with the latter statistically significant at 0.05. Chief Executive Officer Power was found to significantly moderate the relationship between Debt/Equity ratio and Return on Equity(∆R2 = +0.150; ꞵ = .103, p=0.000 ) with scope for lower levels enhancing Return On Equity while dampening at higher levels, but insignificant for Debt ratio(∆R2 = +0.009; ꞵ=.0028859, p=0.694), and Interest cover(∆R 2 = +0.001; ꞵ= -.008, p= 0.538). The study concluded that while interest bearing long-term debt was characteristic under-utilized by firms at Nairobi Securities Exchange, it was the reverse for total and by extension short-term debt. Further, Chief Executive Officer Power had significant conditional effect on firm financial performance: higher levels attenuating while lower levels dampening negative relationship between financial leverage and firm financial performance. The researcher therefore recommended low Chief Executive Officer Power configuration mandate, judicious uptake of long-term and reduction of short-term debt to enhance Return on Equity. The study contributes to knowledge by developing a tool for measurement of Executive power; to policy by providing empirical evidence for regulation of executive power and to theory development by introducing executive power contingency to theories relating financial leverage to firm financial performance.