Effects Of Capital Structure On Financial Performance Of Commercial Banks In Kenya

ABSTRACT

The rationale of this study was to provide insights into the relationship between capital

structure and financial performance of Kenya’s banking industry. The pioneer work on

capital structure by Modigliani and Miller (1958) despite of the unrealistic assumptions

has been source of inspirations for scholars. Their propositions state that the market

value of any firm and its cost of capital are independent of its capital structure in

presence of perfect market conditions. The general objective of this study was to assess

the effect of capital structure on financial performance of commercial banks in Kenya.

The Specific Objectives was to assess the effect of debt on financial performance of

commercial banks in Kenya, to assess the effect of internal equity on financial

performance of commercial banks in Kenya, to assess the effect of external equity on

financial performance of commercial banks in Kenya and to assess the effect of

preference share on financial performance of commercial banks in Kenya. The financial

performance was measured using EBIT (earnings before interest and tax). The target

population was the banking industry. A census was conducted. Secondary data was

used. Data was drawn from a sample of the registered banks by the Central Bank of

Kenya in Kenya. According to the central bank of Kenya, there were 43 licensed

commercial banks in Kenya. The study also used annual reports that were available

from their websites and in the Central bank of Kenya website. Data was obtained for a

ten year period from 2005 to 2014. Data analysis was done using SPSS software version

21 for efficient data representation. The model equation shows that growth in debt

would affect financial performance positively leading to improvement in profitability.

If there is an increase in debt levels, the EBIT is expected to increase by 17.6% per unit

measure. The study also shows similar effect on retained earnings and preference shares

on commercial banks’ financial performance. If there is a unit increase in retained

earnings and preference shares, the EBIT will tend to increase by 21.8% and 0.8%

respectively, indicating that debt and retained earnings are more significant in

predicting financial performance than preference shares which have insignificant factor

at 95% confidence level. On the other hand, ordinary shares show different effect, that

a unit increase would affect financial performance negatively by decreasing

performance at a rate of -1%.