THE RELATIONSHIP BETWEEN CAPITAL STRUCTURE AND CORPORATE TAXES FOR COMPANIES LISTED IN THE NAIROBI SECURITIES EXCHANGE

Abstract

Purpose: The purpose of this study was to analyze the relationship between capital structure and corporate taxes for companies listed in the Nairobi securities exchangeMethodology: The study used descriptive survey research design. This study used Secondary data sourced from annual audited financial statement of the firms listed on Nairobi Securities Exchange. The population of the study consisted of companies listed on the NSE. Purposive sampling was used to select respondents from the sampling frame. A sample size of 46 listed companies for the year 2001 to 2011 were selected through random sampling. Data was analyzed using Statistical Packages for Social Sciences (SPSS) to derive descriptive results.Results: Finding indicated that the relationship between debt equity ratio and taxes profit ratio was negative and significant and that debtequityratio has a significant effect on taxesprofitratio.The findings pointed out that the existence of tax shield in a perfect capital market conditions cannot be reached, in an imperfect financial market, the capital structure changes will affect the company's value. The findings also pointed that firm which follows the trade-off theory sets a target debt to value ratio and then gradually moves towards the target. Accordingly, the findings agreed pointed that the value of the firm will increase or the cost of capital will decrease with the use of debt due to tax deductibility of interest charges. Findings also pointed that a firm facing a low enough tax rates would also use equity, because investors pay more taxes on debt interest than on equity income. In conclusion, the findings pointed that the more profitable the firm the lower is the debt ratio.Unique contribution to theory, practice and policy: The study is recommended for commercial banks to issue corporate bonds as this would form a cheap source of finance and also the use of corporate bonds entails the enjoyment of the interest tax shield and consequently improving the shareholder’s wealth. The study also recommended that commercial banks should engage strategic investors. Further to that, the study recommended that the equity share holder should be substituted for debt shareholding in future, this is because an increase in debt shareholding arising out of substitution would be beneficial to the commercial bank because it will result into interest tax saving.