Effect of Equity Financing Options on Financial Performance of Non-Financial Firms Listed at the Nairobi Securities Exchange, Kenya

Abstract

Corporate finance managers worldwide have for a long time consistently sought to maximize shareholders’ wealth and their firm’s market value through their decisions on firm’s capital structure. However, both scholars and practitioners of corporate finance are yet to agree on the optimal mix of equity and debt that maximizes a firm’s financial performance. The purpose of this study was to examine the effects of equity financing options namely common stock (CS), retained earnings (REN) and total equity (TED) as ratios of total assets on the financial performance measured as return on assets (ROA) and return on equity (ROE) of Kenya’s listed firms. Utilizing panel econometric techniques namely pooled ordinary least squares (OLS), fixed effects (FE) and random effects (RE), the study analyzes the effects of equity variables as ratios of total assets on the financial performance of 40 non-financial firms listed at the Nairobi Securities Exchange between 2009 and 2015. The study’s empirical results show that CS ratio significantly and negatively affects ROA while REN ratio has a statistically significant and positive effect on ROA. Overall, TE ratio positively and significantly affects ROA. On the contrary, ROE is not significantly affected by the equity variables in the sample. While the non-significant effects of equity on ROE find support in Modigliani and Miller’s capital structure irrelevance theory, the positive effects of REN ratio and the negative effects of CS ratio on ROA, which are largely supported by the trade-off theory, may explain the pecking order theory’s prioritization of internal capital sources over debt and equity issuances. Thus, corporate finance managers should find a place for internal financing options particularly retained earnings to maximize equity holders’ returns on assets employed. Additionally, corporate finance managers should endeavour to minimize on the use of CS due to its negative effects on shareholder earnings on their assets. Nonetheless, a reasonable balance between CS and REN should be considered since the positive effect between TE and ROA is an appraisal for an optimum mix of equity financing options.