Bi-directional relationship between capital structure and financial performance of firms listed on the Nairobi Securities Exchange

Abstract

Capital structure decisions are common across firms, yet capital structure theories lack a consensus on how much of debt capital firms should use to finance their operations. The main objective of this study was to investigate the bi-directional relationship between capital structure and financial performance of firms listed on the NSE. The study used canonical correlation technique to determine the bi-directional relationship between capital structure and performance. The result revealed that dominant capital structure indicator to be used in an analysis to predict performance is the total debt to the total asset ratio. In the case of performance, the two variables that relate to capital structure are book value to market value ratio and asset turnover ratio. The results support the conclusion that a bidirectional relationship exists between capital structure and debt capital.