EFFECT OF FINANCIAL STRUCTURE ON FINANCIAL PERFORMANCE OF FIRMS LISTED AT EAST AFRICA SECURITIES EXCHANGES JOSEPH MUCHIRI MWANGI DOCTOR OF PHILOSOPHY (Business Administration) JOMO KENYATTA UNIVERSITY OF AGRICULTURE AND TECHNOLOGY 2016 Effect of Financial Structure on Financial Performance of Firms Listed at East Africa Securities Exchanges Joseph Muchiri Mwangi A Thesis Submitted in Partial Fulfillment for the Degree of Doctor of Philosophy in Business Administration in the Jomo Kenyatta University of Agriculture and Technology 2016 DECLARATION This thesis is my original work and has not been presented for a degree in any other University. Signature …………………………….. Date ………………………………… Joseph Muchiri This thesis has been submitted for examination with our approval as university supervisors: Signature …………………………….. Date ………………………………… Dr. Willy Muturi JKUAT, Kenya. Signature …………………………….. Date ………………………………… Dr. Patrick Ngumi ICPAK, Kenya ii DEDICATION This work is dedicated to all who may have contributed in one way or the other to my achievement so far. Special dedication however to my mum, wife Martha and son Levi for both financial and moral support. iii ACKNOWLEDGEMENT The reality of this enormous task could not have been achieved were it not for the almighty God and a number of persons who I honour and respect. My most sincere gratitude first goes to my supervisors Dr. Willy Muturi and Dr. Patrick Ngumi for their unquantifiable support and encouragement even in times of desperation. Second is to all my other lecturers at JKUAT for their value addition during the course. Last but not least is to my PhD colleagues who offered their moral capital through the journey. iv TABLE OF CONTENTS DECLARATION ............................................................................................................ ii DEDICATION ............................................................................................................... iii ACKNOWLEDGEMENT ............................................................................................ iv TABLE OF CONTENTS ............................................................................................... v LIST OF TABLES .......................................................................................................... x LIST OF FIGURES ...................................................................................................... xii LIST OF APPENDICES ............................................................................................. xiii ABBREVIATIONS AND ACRONYMS.................................................................... xiv DEFINITION OF KEY TERMS ................................................................................ xvi ABSTRACT................................................................................................................. xvii CHAPTER ONE ............................................................................................................. 1 INTRODUCTION .......................................................................................................... 1 1.1 Background of the Study......................................................................................... 1 1.1.1 Financial Structure ............................................................................................ 2 1.1.2 Financial Performance ...................................................................................... 4 1.1.3 East Africa Securities Exchanges ..................................................................... 4 1.2 Statement of the Problem ........................................................................................ 6 1.3 Research Objective ................................................................................................. 8 v 1.3.1 Specific Objectives ........................................................................................... 8 1.4 Research Hypotheses .............................................................................................. 9 1.5 Justification of Research. ........................................................................................ 9 1.6 Scope of the Study ................................................................................................ 11 1.7 Limitations of the Study ........................................................................................ 11 CHAPTER TWO .......................................................................................................... 12 LITERATURE REVIEW ............................................................................................ 12 2.1 Introduction ........................................................................................................... 12 2.2 Theoretical Literature Review .............................................................................. 12 2.2.1 Modigliani and Miller Capital Structure Irrelevance Theory ......................... 12 2.2.2 Modigliani and Miller Capital Structure Relevance Theory .......................... 14 2.2.3 The Static Trade-Off Theory .......................................................................... 16 2.2.4 Dynamic Trade-Off Theory ............................................................................ 17 2.2.5 Pecking Order Theory ..................................................................................... 18 2.2.6 Agency Cost Theory ....................................................................................... 20 2.2.7 Information Signaling Theory ........................................................................ 22 2.2.8 Life Cycle Theory ........................................................................................... 23 2.3 Conceptual Framework ......................................................................................... 25 2.3.1 Long and Short Term Debts............................................................................ 27 2.3.2 Equity .............................................................................................................. 29 2.3.3 Gross Domestic Product Growth rate ............................................................. 29 vi 2.4 Empirical Literature Review ................................................................................. 30 2.4.1 Debt and Financial Performance..................................................................... 30 2.4.2 Equity and Financial Performance .................................................................. 35 2.4.3 Gross Domestic Product (GDP) Growth ........................................................ 37 2.5 Critique of the Existing Literature ........................................................................ 38 2.6 Research Gaps ....................................................................................................... 39 2.7 Summary ............................................................................................................... 39 CHAPTER THREE ...................................................................................................... 40 RESEARCH METHODOLOGY ................................................................................ 40 3.1 Introduction ........................................................................................................... 40 3.2 Research Design .................................................................................................... 40 3.3 Target Population .................................................................................................. 41 3.4 Sample and Sampling Technique .......................................................................... 43 3.5 Data and Data Collection Procedures ................................................................... 43 3.6 Data Analysis, Interpretation and Presentation ..................................................... 43 3.6.1 Diagnostic Tests .............................................................................................. 45 CHAPTER FOUR ........................................................................................................ 51 RESULTS AND DISCUSSIONS ................................................................................. 51 4.1 Introduction ........................................................................................................... 51 4.2 Summary Statistics ................................................................................................ 51 4.3 Diagnostic Tests Results ....................................................................................... 58 4.3.1 Multicollinearity ............................................................................................. 58 4.3.2 Serial (Auto Correlation) Correlation ............................................................. 58 vii 4.3.3 Heteroscedasticity ........................................................................................... 60 4.3.4 Stationarity ...................................................................................................... 61 4.3.5 Hausman Specification ................................................................................... 62 4.3.6 Normality ........................................................................................................ 64 4.4 Granger Causality ................................................................................................. 64 4.4 Regressions Statistics