Evaluating The Effect Of Corporate Leverage On Profitability Of Nairobi Securities Exchange Listed Manufacturing And Allied Companies

Abstract

Financing decision involves deciding on the optimal mix of debt and equity to finance operations and specifically investment projects. This is because each of the two stated financing options has both advantages and disadvantages on the growth and overall performance of a company. Therefore, in deciding on the use of leverage, company managers need to weigh both pros and cons in order to maximize on the firm value. The study therefore sought to evaluate the effect of corporate leverage on profitability of manufacturing and allied companies listed at the Nairobi Securities Exchange (NSE). In specific, the study evaluated the effect of total, long term and short term leverage levels on profitability within the same scope. The research employed an explanatory non-experimental research design. A census was done since only 7 companies were listed under the manufacturing and allied segment for the entire study period of 5 years between FY 2010 to 2014. Depending on the quantitative nature of data required for the study, secondary data, which is also publicly available, was entirely used as it enhanced validity and accuracy of the findings. The panel data were analyzed using descriptive statistics, financial ratio, correlation and multiple regression analyses respectively. In regard to testing the research hypotheses, validity and accuracy was based on a confidence level of 95% at ±5 confidence interval. Analyzed data was presented using tables and figures that were generated with the help of SPSS version 21. The study established that total leverage has a statistically significant negative effect on profitability with DR coefficients of -0.989 (0.000) and -2.668 (0.000), and DER coefficients of -0.152 (0.000) and -0.471 (0.000) for both ROA and ROE models respectively. It was also established that short term leverage has a significant negative effect on profitability with CDR coefficients of -0.689 (0.000) and -1.614 (0.001) for ROA and ROE models respectively. However, findings revealed that long term leverage has negative but not statistically significant effect on profitability with CPR coefficients of -0.527 (0.243) and -1.832 (0.172) as measured by both ROA and ROE respectively. The study therefore concluded that in general, corporate leverage negatively affects profitability of NSE listed manufacturing and allied companies. Based on the findings, the study therefore recommends that profit oriented companies should use less short debt to finance their operations. In addition, long term debt should only be considered if the marginal cost of debt is less than the marginal rate of return. Besides adding to the stock of knowledge for the benefit of future researchers, this study is meant to benefit company managers, shareholders and other stakeholders as it disseminates pertinent information and policy implications on the subject matter hence empowering them to make sound decisions.