European Journal of Business and Management www.iiste.org ISSN 2222-1905 (Paper) ISSN 2222-2839 (Online) Vol.9, No.22, 2017 71 Capital Structure, Firm Efficiency and Firm Value: The Case of Listed Non-Financial Firms in Kenya John N. Njagi * Prof. Josiah Aduda Dr. Sifunjo. E. Kisaka Dr. Cyrus Iraya School of Business, University of Nairobi, P.O. Box 30197 - 00100, Nairobi, Kenya Abstract This study examined the influence of a firm’s efficiency on the relationship between capital structure and firm value. The study analyzed thirty non – financial firms listed at the Nairobi Securities Exchange for a period of six years from 2008 to 2013.Capital structure was parameterized as the ratio of retained earnings to total capital, ratio of debt to total capital and ratio of equity to total capital of the firm. Efficiency is measured as the distance from the best practice frontier in the industry. The firm’s efficiency is measured by operational efficiency, cost efficiency and profit efficiency. Firm value is measured by its inputs and outputs. The inputs to the firms production are financing costs (FINC), distribution costs (DISTC), tax liability (TAX), and administrative expenses (ADEXP). The outputs are earnings per share(EPS)and the share price (SP).This study applied panel data analysis using fixed effects model. The results showed that cost efficiency negatively influences the relationship between capital structure and firm value as measured by the SP through increase in distribution costs, administrative costs in financing efficiency improvements in the firm’s core processes. Further Operating efficiency negatively and statistically significantly affects the relationship between firm value and capital structure through the increase in financing costs, distribution costs, administration costs and taxation costs. The results showed that profit efficiency negatively and insignificantly influences the relationship between capital structure and firm value as measured by the SP. Consequently it has a positive but statistically insignificant effect on financing costs, distribution costs, administrative costs and taxation costs. Moreover, capital structure has a positive and statistically significant effect on firm value but firm efficiency insignificantly influences the relationship between capital structure and firm value. This study does not investigate the reverse relationship like Margaritis and Psillaki (2007). Keywords: Capital Structure, Firm Efficiency, Firm Value, Listed Non-Financial Firms, Nairobi Securities Exchange 1. Introduction There is plenty of theoretical literature that examines the relationship between capital structure and firm value (Harris and Raviv, 1991; Shleifer and Vishny, 1997). However, there are far much fewer empirical studies that demonstrate the application of these theories to real life situations within corporations (Rajan and Zingales, 1995; Beattie, et al., 2006). As correctly noted by Margaritis and Psillaki (2007) the main problem is the measurement of the relevant variables that are known to affect capital structure and firm value that are closely related to the definition of agency costs. Consequently, there is no conclusive evidence in support of the agency cost hypothesis. Like Margaritis and Psillaki (2007) this study employs the X-efficiency measures of firm efficiency to illuminate the capital structure firm values nexus. However, it disaggregates the firm efficiency measure variable into cost efficiency, operational efficiency and profit efficiency. Furthermore, it extents Margaritis and Psillaki (2007) study by examining how capital structure and firm efficiency influence firm value. It also decomposes firm value into its inputs and outputs. For the last two decades there have been numerous reports on mismanagement, maladministration and financial irregularities among firms listed at the Nairobi Securities Exchange (NSE)in Kenya (NSE Handbook, 2014).Performance of firms listed at the NSE has been dismal to the extent that some have lately called for financial bailout(NSE Handbook, 2014). This has been attributed to capital structure decisions as well as other factors within and outside the firm. Some firms at the NSE have faced distressing situations following their dismal performance and have been under constant pressure to improve their market value or be delisted. Other firms have performed exceedingly well despite financing their investments using risky short term debt. This means that apart from capital structure there are other factors that influence the market value of the firm. These factors are suggested in the literature: firm size, age, product market, ownership, firm productivity and efficiency, institutional factors, industry type and corporate governance (Harris and Raviv, 1991; Shleifer and Vishny, 1997). There are equally very few studies that have analyzed the relationship between capital structure and firm value in Kenya. Akoten, et al. (2006) studied the impact of access to credit on the profitability and growth of Micro and Small Enterprises (MSEs) and reported a limited impact. Moyi (2013) examined the impact of access to credit on sales growth among Small Enterprises(SEs) and found a positive impact. Nkurunziza (2010) examined the effect of credit on growth and convergence of firm size in Kenyan manufacturing sector and reported a positive result. Thus, empirical evidence is mixed and scanty. Also, none of these studies examined the nexus between capital structure, firm efficiency and firm value. Therefore, this study contributes to the capital structure and firm value