The Relationship between Capital Structure and Performance of Firms in the Construction and Allied Sector, Kenya

Abstract

The purpose of this study was to determine the relationship between capital structure and the firm’s performance on five companies in the construction and allied sector listed on the Nairobi Stock Exchange. The study aimed at determining the relationship between return on assets (ROA) and capital structure, relationship between return on equity (ROE) and capital structure and relationship between gross profit margin and capital structure. The study employed a quantitative research method in gathering, analyzing, interpretation, and presentation of information. The researcher adapted a descriptive research design which helped in looking at the strength of relationship between return on assets, return on equity and gross profit margin and capital structure of construction and allied companies. The study utilized secondary data that was obtained from the financial statements of the companies. The sample size was 5 construction and allied companies. From the findings of the study, company size contributes immensely to the return on assets. When a company is large in size, it highly attracts many operations hence stimulate the generation of income which enhances the return on assets. The study also found that when a company has more assets, the tendency of borrowing funds reduces hence records lower leverage. The study reveals that there is a relationship between return on assets (ROA), profit, debts and total assets. The study showed that there is a strong negative relationship between return on assets and debts. This study found no relationship between debts and return on equity but there was a negative indication. The study also found no relationship between profit and debts, but there was a strong positive relationship between total equity and profit. The study found a negative relationship between long term debts and return on equity. It is explained that when a company has so much debts, it incurs a lot of expenses (debt expense) in settling debts obligations. These expenses reduce the profits which would enhance the return on equity of shareholders. The study found that there is a strong relationship between gross profit margin and total equity. The study also found out that there is no relationship between gross profit margin and debts. The study further found that for equity and debt finances, a positive relationship existed but a negative relationship between debt financing and performance. The study found that total equity has a strong positive relationship with gross profit margin while debts have a negative relationship with the same gross profit margin. The study concludes that total debts have a significant negative impact on manufacturing companies’ performance. The study found out that capital structure has a significant influence on a firm’s performance. The study concludes that there is a negative relationship between debt equity ratio and return on equity. It is concluded from the study that the successful selection and use of the debt-to-equity ratio is one of the key elements of firms’ financial strategy. The study recommends the manufacturing companies to use the pecking order theory to balance their capital structure. This would enhance the companies’ return on assets, return on equity and gross profit margin.