THE EFFECT OF THE LEVEL OF DIVERSIFICATION ON CORPORATE LIQUIDITY FOR FIRMS LISTED AT THE NAIROBI SECURITIES EXCHANGE SAMSON M. ONGALO A RESEARCH PROJECT SUBMITTED IN PARTIAL FULFILMENT OF THE REQUIREMENTS FOR THE AWARD OF THE DEGREE OF MASTER OF BUSINESS ADMINISTRATION, UNIVERSITY OF NAIROBI OCTOBER, 2014 i DECLARATION I declare that this project is my original work and has not been submitted for examination in any other university. Signed ………………………………………Date…………………………………… Samson M. Ongalo D61/8909/2005 Supervisor This project has been submitted for examination with my approval as the university supervisor Signed ………………………………………Date…………………………………… Mr. Mirie Mwangi Lecturer Department of finance and accounting University of Nairobi ii ACKNOWLEDGEMENT This research project could not have been possible without the valuable input of a number of groups whom I wish to acknowledge. First and foremost, great thanks to God for His grace and the gift of life during the period of the study. Special appreciation goes to my supervisor Mr. Mirie Mwangi I wish to sincerely acknowledge his professional advice and guidance in the research project. Thanks to the entire academic staff of the school of business for their contribution in one way or another. I am thankful to the NSE staff for the invaluable assistance during the period of data collection. To my family and friends for their moral support and encouragement during the study, to all of you, kindly accept my appreciation for your great support. iii DEDICATION I wish to dedicate this project to my family especially to my kids who encouraged me when writing this project at the same time expecting their needs to be met. Shekynah, I want a watch, Ayanna doesn’t want to be sorried for while Baraka is going to step on you again. iv TABLE OF CONTENTS DECLARATION............................................................................................................... ii ACKNOWLEDGEMENT ............................................................................................... iii DEDICATION.................................................................................................................. iv TABLE OF CONTENTS ..................................................................................................v LIST OF TABLES ......................................................................................................... viii LIST OF ABBREVIATIONS ......................................................................................... ix ABSTRACT ........................................................................................................................x CHAPTER ONE ................................................................................................................1 INTRODUCTION..............................................................................................................1 1.1 Background of the Study ...............................................................................................1 1.1.1 Corporate Liquidity .................................................................................................2 1.1.2 Level of Diversification of Unrelated Businesses ..................................................3 1.1.3 Relationship between Level of Diversification of unrelated businesses and Corporate Liquidity ..........................................................................................................6 1.1.4 Nairobi Securities Exchange ...................................................................................7 1.2 Research Problem ..........................................................................................................9 1.3 Research Objective ......................................................................................................11 1.4 Value of the Study .......................................................................................................11 CHAPTER TWO .............................................................................................................12 LITERATURE REVIEW ...............................................................................................12 2.1 Introduction ..................................................................................................................12 2.2 Theoretical Framework ................................................................................................12 2.2.1 Irving Fisher's Theory of Investment ....................................................................12 2.2.2 Liquidity Preference Theory .................................................................................13 2.2.3 Modern Portfolio Theory ......................................................................................15 2.3 Determinants of the Level of Corporate Liquidity ......................................................16 2.3.1 Line of Credit ........................................................................................................16 2.3.2 Liquidity Index......................................................................................................17 2.3.3 Level of Inflation ..................................................................................................17 2.3.4 Interest Rates .........................................................................................................18 2.3.5 Government Deficit ..............................................................................................18 v 2.4 Empirical Studies .........................................................................................................19 2.5 Summary of the Literature Review ..............................................................................23 CHAPTER THREE .........................................................................................................25 RESEARCH METHODOLOGY ...................................................................................25 3.1 Introduction ..................................................................................................................25 3.2 Research Design...........................................................................................................25 3.3 Population of the Study ................................................................................................26 3.4 Sample Technique ........................................................................................................26 3.5 Data Collection Methods .............................................................................................26 3.6 Data Analysis ...............................................................................................................27 3.6.1 The Analytical Model ...........................................................................................27 3.6.2 Significance Testing..............................................................................................28 CHAPTER FOUR ............................................................................................................29 DATA ANALYSIS, RESULTS AND DISCUSSION ....................................................29 4.1 Introduction ..................................................................................................................29 4.2 Response Rate ..............................................................................................................29 4.3 Descriptive Statistics ....................................................................................................29 4.4 Correlation Analysis ....................................................................................................31 4.5 Regression Analysis and Hypothesis Testing ..............................................................32 4.5.1 Analysis of Variance .............................................................................................33 4.5.2 Test for Coefficients .............................................................................................34 4.6 Discussion of Research Findings .................................................................................35 CHAPTER FIVE .............................................................................................................38 SUMMARY, CONCLUSION AND RECOMMENDATIONS ...................................38 5.1 Introduction ..................................................................................................................38 5.2 Summary of Findings ...................................................................................................38 5.3 Conclusion ...................................................................................................................39 5.4 Recommendations ........................................................................................................41 5.5 Limitations of the Study...............................................................................................42 5.6 Suggestions for Further Research ................................................................................43 vi REFERENCES .................................................................................................................45 APPENDICES ..................................................................................................................51 APPENDIX I: Data for Government deficits and interest rates .................................51