An Investigation into the presence of market timing in configuration of capital structures by companies listed at the NSE

Abstract

The study sought to examine whether over or undervaluation of securities drove capital structure decisions with a focus on companies that offered corporate debt and rights issues for the period between 2006-2016. Main study objective aimed at establishing presence of market timing in security issuance by companies listed at the Nairobi Securities Exchange (NSE). The study was anchored on four theories; Market timing, trade-off, pecking order and the irrelevance theories. Market timing theory assumes that no optimal capital structure exists for firms and that over or undervaluation of securities and conditions existing in the financial markets are the driving forces in securities issuance decisions. Trade off theory explains how corporations are usually financed partly with debt and partly with equity and that firms determine the type and amount of financing to use by trading-off the costs and benefits of both debt and equity. The pecking order theory assumes presence of information asymmetry between managers and investors in a firm. Equity and debt market timing are enabled by presence of private information asymmetry and public information asymmetries respectively. The pecking order further addresses other aspects of capital structure including ranking of types of financing used by firms and determinants of capital structure; tangibility of assets and firm growth. The “irrelevance theory” contradicts market timing theory by assuming market efficiency and that firms cannot increase firm value by switching between debt and equity. It addresses capital structure determinants such as profitability, non-debt tax shield and liquidity. Study methodologies utilised by the study were; an event study methodology, unbalanced panel data regression analysis and descriptive statistics for both primary and secondary data. Findings from the study indicate that corporate debt and rights issuing firms underperformed similar size non-issuing companies in the 30-day event window.MBR which is a measure and proxy for market timing was found to statistically and significantly influence market and book leverage which are measures and proxies of capital structure. Finance managers were found to have similar views with regard to both equity and market timing. The study found out that managers of listed/ intending to be listed firms, look at the actions and success of securities issuance decisions taken by other listed/ intending to be listed companies in making their financing decisions in such a way that if for example corporate debt issue has been successful, managers would issue corporate debt resulting in a sort of clustering of the security issues. If security issuance choices taken by the listed companies were unsuccessful the finance managers would re-strategize to other ways of financing such as borrowing loans from commercial banks or use other alternatives such as retained earnings until market conditions becomes favourable. The study concludes that there is presence of market timing in security issuance by the listed firms at the NSE. Further, the study concludes that a relationship exists between market timing and capital structures of quoted companies at the NSE. Presence of market timing in securities issuance enables listed companies to minimise overall cost of capital, resulting in shareholder wealth maximization through increased profitability of the firm, which is the ultimate goal for any finance manager.