Effect of Capital Expenditure on Idiosyncratic Volatility of Stock Returns at the NSE in Kenya

Abstract

The Nairobi Securities Exchange (NSE) provides a platform for investors to stake their money for a return, for businesses to raise equity capital and for the government to mobilize resources to attain national development goals and fulfill Vision 2030 development blueprint in Kenya. Despite the importance of NSE both locally and regionally, volatility of stock returns in the market has been a common phenomenon for the past 8 years. This is evidenced by a continuous decline in the NSE 20 share index from 5,406 points in 2014 to 1,672 points in 2022. Studies have shown that at equilibrium, only systematic risk is priced since all the unsystematic risks can completely be eliminated through diversification and therefore do not affect the overall volatility of stock returns. However, empirical evidence shows that investors may fail to hold a fully diversified portfolio, leading to the need for idiosyncratic risk premium in the pricing of stocks, without which idiosyncratic risks will be major contributors to the overall volatility of stock returns at the NSE. Past literature has shown that for investors who do not hold fully diversified portfolios, firm-specific risks associated with high managerial strength, intangible assets, environmental disclosure, firm size, liquidity, dividend policy and cash flow to price all have a significant effect on firm-specific volatility of stock returns. The effects of Idiosyncratic risks associated with capital expenditure on firm-specific volatility of stock returns at the NSE have not been studied previously. This study sought to examine the effect of capital expenditure on firm-specific volatility of stock returns. The Efficient Market Hypothesis, Modern Portfolio Theory and Fama & French three-factor model informed the study. The research employed a quantitative approach with a correlational research design using secondary data. Firms forming the NSE 25 share index formed the target population (N = 25), with annual data for 10 years from 2010 to 2019, yielding 250 data points. Fixed effects dynamic panel data regression model was used to analyse data. The results showed a positive and significant relationship between Capital expenditure (CAPIT: β = 0.024737, p = 0.0000. Earnings Quality, the moderating variable, strengthened and had a positive and significant effect on the overall model and the relationship increasing R² from 74.2096% to 85.7798%. The study concludes that capital expenditure (CAPIT) is a significant positive predictor of stock return volatility is recommended that NSE-listed firms should decrease their capital expenditure, use more internal sources of finance and focus more on wealth maximization objectives to reduce the volatility of stock returns. These findings may be useful to policymakers and academia in designing models which capture firm-specific risks in stock pricing to reduce stock return volatility for firms at the NSE.