An Empirical investigation into the determinants of capital structure of SMEs in Nairobi, Kenya

Abstract

This study examined whether capital structure theories from the developed world were applicable to Kenyan SMEs given the differences in economic development. The research design was quantitative. Financial data covering a three year period from 2004 to 2006 for forty three SMEs in the trade, hotel, retail and manufacturing sectors, were collected from the 2008 baseline survey by the Kenya Institute for Public Policy, Research and Analysis, KIPPRA. A panel data regression model was used to this data. In addition, a survey was done on the same population in order to triangulate the data from the secondary data analysis to enhance the reliability of the data. The dependent variable was the ratio total liabilities to total assets. Independent variables were size, asset structure and profitability and age with industry, ownership and growth as control variables. Profitability, asset structure and size were found to be key determinants of the capital structure of SMEs. The debt ratio was negatively related to age when turnover measured size but was positively related to age when total assets were used to measure size. The relationship was between the debt ratio and age was not statistically significant at 5% in both cases. The debt ratio was negatively related to size and to profitability but it was positively related to asset structure. This relationship between the debt ratio and size, profitability and asset structure was significant at 5%. Turnover was found to be a more robust measure of size than total assets for the sample in this study while the negative relationship between the debt ratio and profitability concurred with pecking order theory. The significance of asset structure underlined the importance of collateral in SME finance. The questionnaire Survey confirmed that profitability, assets and size were important determinants of capital structure. Profitability was found to be important to the SMEs as it is not an objective measure. The survey also found that while SMEs operated bank accounts, banks were their least preferred source of debt and there was no relationship between capital structure and Asian/African ownership, industry sector and growth.