Abstract:
Good capital structures are critical for the survival of any business firms in any economic
arrangement or set up. The current study’s purpose was to investigate the effect of capital
structure on profitability of non-financial firms listed at Nairobi Stock Exchange (NSE). The
study tested the null hypotheses that there is no relationship between short term debt-equity
ratio, long term debt-equity ratio and equity on profitability of non-financial firms listed at
NSE. The theoretical basis of the study was on agency theory, static trade off theory, pecking
order theory and MM capital structure irrelevance theorem. Descriptive research design was
applied in this research study. The study applied the epistemology philosophy based on
positivist paradigm. The target population for this study was all the listed non-financial firms
in the NSE as at 31st March 2015. Data for these 41 companies for five years (2010 – 2014)
was used in the study. Secondary data applied in this study was collected from the audited
financial statements of the companies, NSE and the Capital Markets Authority. Panel data
regression (fixed effects) model was applied in analysis. Stata statistical software was
utilized. The study findings indicate that short term debt equity ratio negatively and
significantly affects ROA, ROE and ROCE. Long term debt equity ratio has a negative effect
on return on assets and return on equity but has an insignificant effect on ROCE. Equity has a
positive and significant relationship with ROE and ROCE but has an insignificant effect on
ROA. The following recommendations are made. First, though short term debt is a source of
quick liquidity for the firm during emergencies, they bring shocks and added riskiness to the
firm and hence managers should apply these sources of financing with caution. Secondly,
managers should establish the level of debt of debt to equity that is optimum for the firm and
seek to achieve this optimum level. Firms should however, mostly rely on retained earnings
for expansion and growth. Thirdly, the study recommends that managers in non-financial
firms should effectively manage the amount of borrowed capital in the firms’ capital structure
since high debt levels will mean more interest payments and thus cash outflows.
