Cost of Capital, Firm Size and Financial Distress

Abstract

Financial distress (FD) is a global muddle that adversely affects firms and economies. Kenya documents substantive evidence of FD across economic sectors. This indicates a missing link between financial surveillance and business management. Past research concentrates on FD modeling and capital structure effects on performance. This study explored the influence of cost of capital on FD and the moderation effect of firm size. The study was anchored on Modigliani and Miller’s second proposition and Trade-off theory. Retrospective longitudinal research design was adopted targeting all non-financial firms listed in Nairobi Securities Exchange (NSE). Hierarchical panel regression analysis explored the multi-dimensional financial data collected from audited financial statements, daily stock prices and market indices from year 2006 to 2015. Findings show cost of capital to relate significantly and negatively with FD. Cost of equity (Ke) rises with cost of debt (Kd). Interaction term cost of capital*firm size has no effect on FD. Kd and Ke significantly influence FD positively and negatively respectively. Interaction Kd*firm size has a positive insignificant influence on FD while interaction Ke*firm size has a negative significant effect on FD. The study recommends diligent capital budgeting to ensure firms only invest in feasible ventures surpassing the cost of capital.

Keywords: Cost of Capital, Firm Size, Financial Distress.

DOI: 10.7176/RJFA/10-18-05

Publication date:September 30^th 2019