Harambee University

Faculty of Business and Economics

Group Assignment for the Course Investment Analysis and Portfolio

Name ID

1.
2.
3.

Instructor

January 2022

Adama, Ethiopia
Financial Risk and Financial Performance: Evidence and Insights from Commercial and
Services Listed

Companies in Nairobi Securities Exchange, Kenya

Susan Kerubo Onsongo 1,* , Stephen M. A. Muathe 2 and Lucy Wamugo Mwangi 1

1 Department of Accounting and Finance, School of Business, Kenyatta University,

Nairobi P.O. Box 43844-00100, Kenya; [email protected]

2 Department of Business Administration, School of Business, Kenyatta University,

P.O. Box 43844-00100 Nairobi, Kenya; [email protected] Correspondence:

Received: 15 May 2020; Accepted: 3 August 2020; Published: 11 August 2020

Abstract

In Kenya, the last few years has seen the performance of companies listed under the commercial
and services segment on the Nairobi Securities Exchange (NSE), experience mixed fortunes. The
study sought to assess the implications of financial risk on the performance of these companies.
The study applied explanatory research design. The target population were the 14 companies
listed under this segment of NSE. Secondary panel data contained in published annual reports
for the period 2013–2017 was collected. Panel regression model was applied with the random
e_ect model being used based on the Hausman specification test. Findings showed that credit
risk had an insignificant positive e_ect on return on equity (ROE) while liquidity risk had a
significantly negative e_ect on ROE and operational risk had a positive insignificant e_ect on
ROE. The positive coe_cients from the data analysis indicated that commercial and service
companies at NSE were able to take in more credit to boost performance of these companies
however the negative coe_cients shows that within the period of study these companies
experienced high liquidity problems in that the current liabilities exceeded the current assets.
Thus, concluding that these companies were unable to pay all their obligation when they were
due.

Keywords: financial performance; financial risk; commercial and services companies; Nairobi
Securities Exchange

Purpose of the Study

The performance of the global economy has been a_ected by crises like the unforeseen Covid-19
pandemic that hit the world in 2019 and led to economic slowdown. The previous global
economic crisis was financial crisis of 2008–2009 that was attributed to excessive risk appetites
by financial institutions (Agarwal 2011). The crisis led to erosion of the investor trust in the
ability of public firmsto manage risks e_ectively (Capgemini and Merrill Lynch GlobalWealth
Management 2009). However, a study byWani and Ahmad (2013) in the United Kingdom on
nonfinancial firms indicated that “the 2008–2009 financial crisis did not significantly a_ect
established risk management practices and firms’ commitment to financial risk”.

Bansal et al. (1992) and Holton (2004) described risk as the unexpected change or
unpredictability of returns. Arif and Showket (2015) and Fali et al. (2020) enriched the
description of risk by stating that financial risk is the probability of a firm collapsing when the
company uses debt to satisfy financial commitments when the cash balance is inadequate. This
risk is normally influenced by causes beyond the firm’s control (Oliver 2001; Harvey 2008).
Statement of the Problems
In Kenya, the last few years has seen the performance of companies listed under the commercial
and services segment on the NSE experience mixed fortunes in terms of financial performance.
The national airline carrier, Kenya Airways (KQ), which is listed under the commercial and
services segment reported the country’s worst ever corporate results in history of $258 million
US Dollars for the year 2015–2016 (Kenya Airways 2016; Okoth and Achuka 2016). Whereas
Longhorn Publishers which is also listed under commercial and services segment has been
reporting good results in terms of profits (NSE 2013, 2014, 2015, 2016, 2017; Longhorn
Publishers 2018).
Objective of the Study
The study was guided by the following specific objectives
 To determine the eect of credit risks on the performance of commercial and services
companies on NSE, Kenya;
 To establish the eect of liquidity risks on the performance of commercial and services
companies on NSE, Kenya;
 To examine the eect of operational risks on the performance of commercial and services
companies on NSE, Kenya.
Materials and Methods
In this study, the risk factor was broken down to credit risk, liquidity risk and operational risk.
Credit risk was proxied by debt to income ratio (Elder 2016); liquidity risk was proxied by
current ratio (Kamau and Njeru 2016); while cost to income ratio was the proxy for operational
risk (Mathuva 2009; Muriithi 2016;Wangalwa and Muturi 2018). A multiple panel regression
model was suitable for thisresearch because of the independent variables, time factor and cross-
sectional dimensions (Aiken et al. 1991; Wooldridge 2010).
The researcher adopted an explanatory research design. According to Maigua and Mouni (2016),
the main advantage of explanatory designs is, it allows connection of thoughts to apprehend
reason and eect. The researcher was able to explain what was going on as it exists, and the
researcher had no control over the variables. The researcher explored and explained the e_ects of
financial risks on the performance of companies in the commercial and services segment at NSE.
Target Population
The study target population consisted of the fourteen companies (14) listed in Table 2 under the
commercial and services segment of the Nairobi Securities Exchange for the period covering
2013 to 2017. These firms are geographically based in Nairobi, the capital city of Kenya.
Sampling Design
The population size was small and manageable; the study therefore did not sample the
companies.
However, when retrieving the data, only ten out of the fourteen firms’ independent audit
financial statements were available. The missing four was suspended during the period of study
hence ten companies became the target population (NSE 2017).
Research Data and Variable Construction
The researcher extracted data from published companies’ annual financial reports and NSE
handbooks for the years 2013 to 2017. This was secondary data that was readily available from
the firms’ website as well as from the Nairobi Securities Exchange handbooks. The key
advantage of using secondary data were that it may already were used in previous research,
making it easier to use to carry out further research (Mugenda and Mugenda 2003; Grant and
Osanloo 2014). The researcher developed a document review guide. The use of the document
review guide as a research instrument to collect secondary data have was used and validated by
other researchers (Saunders et al. 2009; Bandalos 2018). According to Mwangi et al. (2014)
when a census approach of study is taken, the validity of the collected data are improved because
the collected information is specific rich to the population and thus legitimate. The benefit of this
instrument was that it provided the researcher with a systematic approach of categorizing the
data, examining and assessing it and finally developing valuable data.
Furthermore, this instrument of research was applied in previous studies (Witkin and Altschuld
1996; Mugenda and Mugenda 2003; Muathe 2010; Mwangi et al. 2014; Musau 2018). Data
extracted for the period 2013 to 2017 was used with the financial years of the companies ending
in dierent months.
To increase the scope of data collected, the researcher focused on longitudinal data of same
sample over the study period (Gujarati 2003).
Results
The section is structured as follows: descriptive statistics, results of the hypotheses testing and
discussion of results.
Descriptive Statistics
As indicated in Table 4, the mean value for ROE was 0.0254313 with a standard deviation of
0.2514351 and minimum and maximum values of 􀀀0.5670951 and 1.156945, respectively. The
negative minimum value observation for ROE reflects that some companies were operating at a
loss.
Hypotheses Testing Results
The three hypotheses were analyzed using panel multiple regression to establish the statistical
significance at 95 percent confidence level (_ = 0.05). The outcome in Table 5 showed that F
statistics value was 78.57 with a p-value of 0.0000 which is less than 0.05. This indicated that
financial risks indicators had significant eects on return on equity of commercial and services
listed companies in Nairobi Securities Exchange in Kenya.
Discussion
The declining trend of performance in commercial and services listed companies between the
years 2013 and 2017 triggered the desire for the researcher to undertake this study. The study
aimed to investigate the eects of financial risks specifically operational, liquidity and credit risks
on performance of commercial and services companies listed on the Nairobi Securities
Exchange.
First, the study sought to evaluate the influence of credit risk on the performance of commercial
and ser-vices companies on NSE, Kenya. The study findings showed that credit risk had a
positive insignificant e_ect on ROE. The null hypothesis that credit risk had no significant eect
on return on equity of commercial and services companies on NSE was not rejected at 5% level
of significance.
The results were consistent with Mutua (2016) who investigated eect of credit risk management
on Savings and credit cooperatives in Kenya and found that credit risk had a positive correlation
between financial performance as measured by ROE.
The study’s second objective sought to establish the influence of liquidity risks on the
performance of commercial and services companies on NSE, Kenya. The study findings showed
that liquidity risk had a negative and significant eect on ROE. The negative coecient shows that
commercial and service companies at NSE within the period under study experienced high
liquidity problems in that the current liabilities at several levels within the years exceeded the
current assets, thus being unable to pay all their obligation when they were due. This may have
resulted in the reduction in return on equity of the companies. The third objective of the study
was to determine the influence of operational risks on the performance of commercial and
services companies on NSE, Kenya. Operational risk had a positive insignificant eect on
performance indicators, namely return on equity. Meaning any changes to the cost-to-income
ratios acting the generated revenues of the companies.
Conclusions
The study concluded that, for companies to generate more revenues, they needed to manage their
financial risks as proxied by ratios. Operational risk that was proxied by cost to income ratio
indicated that higher cost-to-income ratios implied that companies were not e_cient in
controlling costs. They therefore needed to implement cost cutting initiatives to manage
expenses. Increased cost-to-income ratios should be an immediate indicator to firms of emerging
problems in the cash flow. The study noticed that liquidity proxied by current ratio negatively
influenced performance of commercial and services listed companies on NSE in Kenya. The
negative coecient of liquidity risk showed these companies experienced high liquidity problems
in that their current liabilities exceeded the current assets. Thus, concluding that these companies
were unable to pay all their obligation when they were due. This would adversely aect the
company’s performance.
Based on the research results, credit risk, liquidity and operational risks are critical, and
companies need to pay attention to them. Companies engaging in risk projects can either lose or
gain. Informed decisions need to be adhered to in such scenarios. Consequently, managers of
companies need to come up with strategies capable of managing these by taking into
consideration return on shareholder’s equity when dealing with firms’ performance of the
company. The study also recommends that policy makers and regulators review the external
eects of systematic risk on firms’ performance.
For future research studies, further considerations can be made on how financial risk aects other
Non-financial performance metrics when evaluating the eectiveness of a company’s
performance, management and operations.