RESEARCH PROPOSAL PROJECT:

THE ROLE OF FINANCIAL RATIOS IN SIGNALING FINANCIAL DISTRESS: EVIDENCE

FROM THE KENYAN LISTED COMMERCIAL BANKS:

WRITTEN BY FRED MMBOLOLO

ABSTRACT:

Financial distress has recently been witnessed on a wide-scale all over the world and has
been more rampant in Africa continent. A financial distress translates to lack of adequate
financing to meet the necessary expenditure leading them to bankruptcy and eventually to
their closure. This problematic issue has of late tremendously increased in nature and
remedies have to be found to arrest the current situation since Commercial Banks that are
quoted on Nairobi Stock Exchange contribute to the growth of the economy.

The intention of this research study will be to assess the effects of financial distress on the
financial performance of Commercial Banks listed on the Nairobi security exchange.

The study specific objective will be to:

(i) Investigate whether financial statement information can adequately classify

potentially failing and non-failing Banks in the normal economic
circumstances.
(ii) Determine the effect of liquidity on financial performance of listed
Commercial Banks,
(iii) Establish the effect of solvency on financial performance of listed
Commercial Banks
(iv) Analyze the effect of financial health on financial performance of the listed
Commercial Banks.
(v) Examine whether financial statement ratios can be adequately used to signal
business failure in the Kenyan context in normal economic circumstances

This will be one the pioneer study in examining the predictive ability of financial
statements in normal economic circumstances

The previous empirical results done on listed Commercial Banks indicate that financial
statement information can be used to adequately signal business failure in normal
economic circumstances. Given this, the empirical results of this study could be used as
an encouragement for future researchers who are interested in finding the best predictors
of business failure by developing a ratio-based prediction model and evaluating its
accurateness.
Table of Contents
Chapter 1.............................................................................................................................................................................4
1.1 Introduction:..............................................................................................................................................................4
1.2 Background to the research......................................................................................................................................5
1.3 Research problem:....................................................................................................................................................6
1.3.1 Research questions:...........................................................................................................................................6
1.3.2 Research objective:............................................................................................................................................6
1.4 Justification for the research:....................................................................................................................................7
1.5 Significance of the study...........................................................................................................................................7
1.6 Limitations of the Study............................................................................................................................................7
1.7 Assumptions of the Study..........................................................................................................................................8
1.8 Operational Definitions of key Terms Financial distress...........................................................................................8
1.9 Key Terms..................................................................................................................................................................8
CHAPTER TWO..................................................................................................................................................................13
2.0 Literature review.....................................................................................................................................................13
2.1 Credit Risk Theory...................................................................................................................................................13
2.2 Pecking order theory of financing...........................................................................................................................14
2.3 Shiftability Theory...................................................................................................................................................16
2.4 Gambler’s Ruin Theory............................................................................................................................................17
2.5 Solvency and Financial Performance......................................................................................................................17
2.6 Altman’s theory.......................................................................................................................................................19
2.7 Deakin’s theory.......................................................................................................................................................20
2.8 Edmister’s theory....................................................................................................................................................21
2.9 Blum’s theory..........................................................................................................................................................21
CHAPTER THREE RESEARCH METHODOLOGY...................................................................................................................24
3.1 Introduction.............................................................................................................................................................24
3.2 Research Design..............................................................................................................................................24
3.3 Population..............................................................................................................................................................24
3.4 Sample....................................................................................................................................................................25
3.5 Data Collection........................................................................................................................................................25
3.6 Data Analysis...........................................................................................................................................................26
Chapter four......................................................................................................................................................................28
4.0 Timescale.........................................................................................................................................................28
Chapter five.......................................................................................................................................................................30
5.0 RESOURCES......................................................................................................................................................30
BIBLIOGRAPHY..................................................................................................................................................................31

Chapter 1

1.1 Introduction:
Kenya’s financial system has improved significantly over the last years and has become
the largest in East Africa. In comparison with other East African economies, Kenyan
banking sector is credited for its size and diversification. Kenya provides or has a variety
of financial institutions and markets unlike others in the region. However, there have been
constraints in the growth of the sector especially in the 1980s and 1990s due to factors
like non-performing loans and weaknesses in corporate governance leading to a number
of commercial banks failing (Beck et al., 2010). Kenya’s financial sector continues to face
challenges among them being financial distress.

Financial distress is one of the most significant threats for many firms globally despite
their size and nature. The term financial distress is used in a negative connotation to
describe the financial situation of a company confronted with a temporary lack of liquidity
and with the difficulties that ensue in fulfilling financial obligations on schedule and to the
full extent (Outecheva, 2007). According to Brownbridge (1998), banks are financially
distressed when they are technically insolvent and or illiquid. Insolvency is the inability of
a business to have enough assets to cover its liabilities. A situation where a firm’s
operating cash flows are not sufficient to satisfy current obligations and the firm is forced
to take corrective action.

This study is motivated by the need to understand how financial performance of

commercial banks is affected by financial distress. This will enable banks to take
corrective measures in due time if they find themselves in distress to avoid the
devastating results. It is very important to ensure the growth of the banking sector in
Kenya to ensure it is not crippled by factors such as financial distress which can be
predicted and appropriate measures taken to ensure Kenya remains at the top in East
Africa banking sector and beyond.
There are a number of reasons why business entities disappear from the market place.
They may be financially distressed or liquidated or they be acquired by another company.
Given that business failure can cause significant trauma (i.e. high costs and heavy losses)
to these stakeholders, its prediction is highly beneficial.

This motivates researchers to find a tool to detect unfavorable symptoms before the entity
disappears. Fitzpatrick (1931) and Merwin (1942) were the first researchers who
attempted to identify the potential of financial ratios as indicators of financial distress.

Subsequently, Altman (1968) introduced the more complex and sophisticated approach of
multivariate analysis using financial ratios as a tool to signal financial distress.

1.2 Background to the research

There has been improvement in the Kenyan banking sector which is reflected in the
liquidity ratios which have been above minimum statutory requirement and the earnings
measures which have improved steadily (Becks et al., 2010). However, according to the
number of banks that failed due to financial distress over the last decades all over the
world, it is safe to say that financial distress affects profit or operating cash flows
negatively.

Tan (2012) in his study on the impact of financial distress on firm’s performance using the
regression analysis and using financial leverage as a proxy for financial distress found out
that financially distressed firms underperform. This means that firm’s performance
deteriorates during financial distress.

Irungu (2013) notes that banks loan risks continue to rise despite profits. Profit of
commercial banks in Kenya rose by a fifth in 2012 and non-performing loans (NPLs)
increasing by 13.33 per cent to 61.6 billion shillings. Despite the rise in profit, banks
should take precautions when lending money as NPLs could easily lead banks to financial
distress leading to failure just like it has in the past.

Ogilo (2012) asserts that the magnitude and the level of loss caused by credit risk as
compared to other kind of risks is so high making it the most expensive risk in financial
institutions. This is because its severity is such that it can cause high level of loan losses
and even bank failure. He thus points out that loans are the largest source of credit risk to
commercial banks in Kenya. He adds that banks should be aware of the need to identify
measure and control credit risk. This has given rise to the risk management guidelines
and the risk based supervision approach of supervising financial institutions.

It is believed that formalization of attempts to detect financial symptoms of unsuccessful

business began in the 1930s (for instance, in the studies of Fitzpatrick (1931) and Merwin
(1942). The frequently quoted studies in this filed are Beavers’s (1966) study and
Altman’s (1968) study. These two financial ratio-based studies aim to introduce and/or
develop an appropriate instrument for signaling business failure before the unfavorable
event happens. The dissolution types include: dissolved, defunct, bankrupt and others.

1.3 Research problem:

The problem addressed in this research is:

‘Whether financial statement information can be adequately used to predict financial

distress for quoted Kenyan Commercial Banks in normal economic circumstances’.

1.3.1 Research questions:

(i)To assess the impact of financial distress on financial performance of commercial banks
in Kenya

(ii) Can financial statement information be used to discriminate between potentially failing
and non-failing Commercial Banks in the context of normal economic circumstances?

The research question is developed in response to the research problem. In addition, the
question helps determine more clearly the research boundary.

1.3.2 Research objective:

With reference to the research problem and question above, the objective of this study is
to:

(i) Investigate whether financial statement information can adequately classify

potentially failing and non-failing Banks in the normal economic
circumstances.
(ii) Determine the effect of liquidity on financial performance of listed
Commercial Banks,
(iii) Establish the effect of solvency on financial performance of listed
Commercial Banks
 (iv) Analyze the effect of financial health on financial performance of the listed
Commercial Banks.

This will be one the pioneer study in examining the predictive ability of financial
statements in normal economic circumstances

1.4 Justification for the research:

Company dissolution is a serious problem in Kenya and adversely affects the economy
and stakeholders of the failed Commercial Banks. Since business failure is a persistent
problem and a critical sub-set of those Commercial Banks, that is, Commercial Banks
listed on the Nairobi Stock Exchange. The rationale for excluding non-listed companies
is because of data accessibility constraints. This study sought to establish the existence
of financial distress in Commercial Banks listed in the Nairobi Stock Exchange during the
period 2019. It also focused on financial distress with emphasis on liquidity, solvency and
financial health.
Little research has been done signaling symptoms on financial distress in emerging
markets like Kenya. Most studies, in the past, focused on finding the best predictors for
failure by using financial statement ratios and non-financial factors. Also the previous
studies concentrated on the financial crisis period. To take into account seasonal and/or
cyclical changes, quarterly financial statements were employed in this study.

1.5 Significance of the study

The research study is important for education purposes and government used in
implementation of laws and regulation of financially distressed Commercial Banks. This
is done by addressing issues that affect Commercial Banks quoted in NSE of which
most of them help the government attain its economic stability. The study also helped to
sensitize management of companies on early detection of financially distressed firm and
help in saving investors funds, directors and employees of the firm.

1.6 Limitations of the Study

The study will be limited to manufacturing companies listed in Nairobi securities
exchange hence the findings may not be generalized to all Commercial Banks. Data
collection will be done using secondary data which may be limited in terms of its
reliability.

1.7 Assumptions of the Study

The researcher assumed that the secondary data obtained from Audited financial
statements show a true and fair view of the Commercial Banks listed in NSE. Financial
distress will be assumed to be the major contributor in financial performance while
holding other factors constant.

1.8 Operational Definitions of key Terms Financial distress

Financial distress is where a firm's operating cash flows are not enough to fulfill existing
bond i.e. such a trade credit or interest expense and the firm is forced to take corrective
action.

1.9 Key Terms

Financial performance

Firm performance can be perceived from two different standpoints either performing or
non- performing. Performing encompasses of market share productivity and profitability,
whereas, non-performing encompasses of customer satisfaction, innovation, workflow
improvement and skills development.
Stock market

The stock market refers to the collection of markets and exchanges where regular

activities of buying, selling, and issuance of shares of publicly-held companies take place
and prices stocks are determined or established. There are two types of markets i.e.
Physical location Exchange like the NYSE and the American Stock Exchange (AMEX),
Nairobi Stock Exchange ( NSE ) and the several other stock exchanges.
Liquidity
Liquidity defines the extent to which an asset or security can be speedily bought or sold in
the market at a price reflecting its inherent value. In other words: the ease of converting it
to cash.
and after taking into consideration of the financial obligations corresponding to that period.
Debt to Equity Ratio
The debt to equity ratio is a financial, liquidity ratio that associates a company's total debt
to its shareholders and owners’ equity. It is a ratio that measures the degree to which
operations are financed by creditors (debt) rather its shareholders and owners’ equity.
Current ratio
The current ratio is a liquidity ratio that measures a company's ability to pay short-term
obligations or those due within one year. It tells investors and analysts how a company
can utilize its current assets (cash, Debtors, stock) on its balance sheet to meet short
obligations (suppliers, bankers, creditors) which are usually less than a year’s debt.
Quick ratio
The quick ratio or acid test ratio is a liquidity ratio that evaluates the ability of a company
to pay its current liabilities when they become due with only quick assets. Quick assets
are current assets that can be converted to cash within 90 days or in the short-term in
other words it calculates the company’s capability to meet short term debt obligations with
its cash equivalents immediately.
CHAPTER TWO

2.0 Literature review

A number of ‘failure’ definitions are used in the literature. For instance, Altman and Hotchkiss
(2006,p4) define ‘failure’ as existing when ‘the realized rate of return on invested capital is
significantly and continually lower than prevailing rates on similar investments’.

Beaver (1966, p71) defines ‘failure’ as the ability of a firm to pay its financial obligations as they
mature.

2.1 Credit Risk Theory

This theory will be first introduced by Merton an American professor in 1974. The
theory states that an attempt must be made in any firm to describe default processes
in the credit risk aspects in terms of structural and reduced form models. Structural
model focuses on factors such as asset and debt amounts to determine the period of
default. Structural model provides a relationship between credit quality and financial
conditions of the firm. In Merton‟s reduced model, a firm defaults at the time of
serving the debt and its asset is below its outstanding debt. This will be opposed by
Black and Cox (1976) who argued that defaults occurs as soon as the value of the
firms asset fall below a certain threshold contrary to Merton default which can occur
at any time (Elizalde, 2006). The assumption of this theory rest on the inexistence of
transaction costs, bankruptcy costs, taxes or problems with the value of assets,
continuous time of trading, unlimited borrowing and lending at a constant interest
rate if no restrictions on the short selling of assets causes the value of the firm to
change in its capital structure.
The criticism is that it directly applied pricing option developed to make necessary
assumptions to adopt dynamics of assets value process, interest rates, based on
numerical feasible, and solutions to express debt values. The relevance to financial
distress is that, it can be used to analyze the firm‟s value before the maturity of the
debts, and if the firm‟s value falls down to minimal levels before the maturity of debt
but is able to improve and meet debt payment.

Delianedis and Geske (2011) adopted this theory to explain the proportion of the
credit spread in corporate bond data set. The small credit risk is attributable
13
 to taxes, liquidity and market risk factors. This included financial distress component
in Merton model finding that jumps residual spread to explain the entire financial
performance.

Warui (2017) analyzed credit risk management strategies and performance of

commercial banks in Kenya. He adopted the credit risk theory and found that credit
risk is amongst critical factors to think about for any financial institutions involved in
any lending activity. The study adds that financial institutions have to find
themselves in making decision on giving credit to potential borrowers, despite
effectively growing their balance sheet and effectively increasing their returns and
cautions to any losses incurred.

However, the study used traditional methods of evaluating credit risks whose
problem lays in the extensive dependence on historical data without quantitative
methods. Thus, the findings lie only on nonpayment throughout the period of
financial institution and not only at credit maturity of the institution, but also financial
distress which calls for a study characterized by asset models where the loss is
exogenously short.

2.2 Pecking order theory of financing

This pecking order of financing will be proposed by Myers in 1984. Myers highlighted
that Commercial Banks with excess cash reserves are less likely to use external
capital providers leaving financial managers with more discretion over bankruptcy
decisions.

Therefore it identified the significance of sources of cash stating that there is a

difference between using cash as a method of payment and paying with internal
funding. In this pecking order of financing, cash offered requires external funding
which shall have significantly higher returns than debt offers which uses internally
generated funding. Adam (2016) adopted this theory to describe how debt helps
managers using cash holding to explain acquisition returns in the University of
Colorado. The study showed that there is relatively positive returns for cash offers
however, do not make up for negative reactions shareholders have when the bidder
is cash rich. The assumption lies on investors‟ believe that managers make worse
investment decisions when they have excess cash reserves, and that these poor
investments arise from agency costs. This theory relies only to the use of cash
holdings to explain acquisition of returns and fails to explain cash holdings affecting
financial performance in answering the question of financial distress.
This theory is relevant to this study, because it states that debt reduces agency costs
which are associated with financial distress by requiring managers to use cash flows
to make interests from principal payment rather than accumulating excess cash. In
addition to reducing excess use of cash, debt provides monitoring of managers
through threat of bankruptcy.
Michael (2017) employed the theory to answer the question how debt helps
managers. The study adds that managers make better investments when they
cannot exclusively rely on internal financing and therefore answers this financial
distress by studying acquisitions, which are large observable outcomes of financing
process. Finding forms the investigation of cumulatively abnormal returns in an
acquisition stocks at the announcement using cash support.
Tomu (2012) provides general framework for handling time varying cost of capital,
leverage, and capital values in dynamic free cash of capital structure. This enabled
efficient market analysis of the current theories of capital structure. The costs of
financial distress and risk premium of debt in the cash flow model. The study
provides a new focus at cost of tax shield from the point of view of risk return
relations. The cost of tax shield is not constant, but depends on leverage and is
mostly between cost of assets and cost of debt. Moreover, the model of the firm
value and capital structure in presence of risk, taxes, growth and optimal leverages
existing for each combination of financial distress factors, the risk enhanced cash
flow theory can explain both observations of capital structure. It is evidence which
resists this theory‟s highly leveraged low growth firms and moderately leveraged
profitable firms.
2.3 Shiftability Theory
Shiftability Theory will be proposed by Dodds in 1982. The theory states that liquidity
is maintained if it holds assets that can be shifted or sold to other investors for cash
or lenders for cash. The arguments indicate that a firm‟s liquidity can be enhanced if
it has assets to sell or stands ready to purchase the asset offered for discount. This
identifies and states that shiftability or transferability of assets is the basis for
improving liquidity. Obilor (2013) adopted the theory to explain the impact of liquidity
management on the profitability of banks in Nigeria. The theory will be analyzed
using short term funds, cash balances, bank balances treasury bills and profit after
tax. Findings shows that liquidity management is a crucial problem in profitability
hence recommended for optimal level of liquidity to maximize profitability. The theory
has not been adopted to explain financial distress in terms of financial performance
which will be addressed by this study.
The assumption of the theory is that liquidity is always for sell and stands ready to
purchase the asset offered. Theory further assumes that highly marketable security
held by a firm is an excellent source of liquidity. Eljelly (2004) contends that
Commercial Banks ensure convertibility without delay and appreciable loss that
assets must meet liquidity management theory involved in obtaining funds from
depositors and other creditors from market. In determining the value of financial
distress for particular Commercial Banks, there is need to seek answer on
depositors‟ funds, creditors‟ funds and mix of funds for any firm. Although, the
assumption has been made, the criticism analyzes management examining the
activities involved in supplementing the liquidity need through use of borrowed
finance. It only supplements liquidity can be derived from liabilities of the firm
balance sheet.
2.4 Gambler’s Ruin Theory
Gambler Ruin theory will be developed by Feller, W in 1968 who based it on the
probability theory where a gambler wins or loses money by chance. The gambler
starts out with a positive, arbitrary, amount of money where the gambler wins a dollar
with probability p and loses a dollar with a probability (1-p) in each period. The game
continues until the gambler becomes broke.

The firm can be thought of as a gambler playing repeatedly with some probability of
loss, continuing to operate until its net worth goes to zero (bankruptcy). In context of
the firm‟s financial distress, a firm would take the place of a gambler. The firm would
continue to operate until its net worth goes to zero implying bankruptcy. The theory
assumes that a firm has a given amount of capital in cash, which would keep
entering or exiting the firm on random basis depending on firm’s operations. In any
given period, the firm would experience either positive or negative cash flow.

Over a run of periods, there is one possible composite probability that cash flow will
be always negative. Such a situation would lead the firm to declare bankruptcy, as it
has gone out of cash. Hence, under this approach, the firm remains solvent as long
as its net worth is greater than zero. This net worth is calculated from the liquidation
value of stockholders‟ equity. With an assumed initial amount of cash, in any given
period, there is a net positive that a firm’s cash flows will be consistently negative
over a run of periods, ultimately leading to bankruptcy (Aziz & Dar, 2006). The major
weakness of this theory is that it assumes that a company starts with a certain
amount of cash. The two main difficulties with this theory are firstly when predicting
bankruptcy is that the company has no access to securities markets and secondly is
that the cash flows are results of independent trials and managerial action cannot
affect the results.

2.5 Solvency and Financial Performance

Leonard, (2012) in his studies fixated on liquidity, solvency, profitability and efficiency

as his objectives. Data was accumulated utilizing secondary data for a period of five

years and analyzed utilizing profit regression model for 47 banks in Kenya and the

findings were that non-performing loans, liquidity, solvency, cash flow, profitability
and efficiency were paramount in detecting corporate failure in banking industry. In

his study he only fixated on banking industry rather manufacturing companies listed

in NSE and he never used ratio analysis to analyze Solvency and financial

performance.
 2.6 Altman’s theory
Altman (1968) is the pioneer who introduced multivariate approaches into the field, resulting in a
methodological change in ratio–based modeling of business failure (Balcaen & Ooghe 2006; and
Hossari 2005). In 1968, Altman developed the Z score model (a five variables model). Samples of 33
bankrupt and 33 non–bankrupt firms in the US during the period 1946–1965 were compared. The
firms were in the same industry (manufacturing) and were of similar assets size. A total of 22
variables (financial ratios) were selected on the basis of frequent use in previous studies as the best
indicators of predicting
corporate failure. The Z score model (a five variables model) is as follows:
Z 1.2X1 1.4X2 3.3X3  0.6X4 1.0X5 ......
Where:
X1 =Working Capital/Total Assets
X 2 =Retained Earnings/Total Assets
X 3 =Earnings before Interest and Taxes/Total Assets
X 4 =Market Value of Equity/Book Value of Total Liabilities
X 5 =Sales/Total Assets
Z =Overall score
Zones of discrimination:
Z > 2.99: Safe zone
1.81 < Z <2.99: Zone of ignorance or Grey zone
Z <1.81: Distress zone
Source: Altman (1968, p. 594 and 606)
Altman’s (1968) findings are very encouraging with 95 per cent predictive
accuracy of the total sample for one year prior to bankruptcy. Later, the model
will be modified to use for privateCommercial Banks and for non–Commercial Banks. To
apply the model to non–listedCommercial Banks, Altman (1993) revised a numerator of the
fourth variable ( X 4 ) to book value of equity from market value of equity. This
results in a slight change to all of the weighting factors and zones of
discrimination as follows:

Z' 0.717X1  0.847X2 3.107X3  0.420X4  0.998X5 ......(3.2)

Where:
X1 =Working Capital/Total Assets
X 2 =Retained Earnings/Total Assets
X 3 =Earnings before Interest and Taxes/Total Assets
X 4 =Book Value of Equity/Total Equity
X 5 =Sales/Total Assets
Z' =Overall score
Zones of discrimination:
Z' > 2.90: Safe zone
1.23 < Z' <2.90: Grey zone
Z' <1.23: Distress zone
Source: Altman (1993, pp. 203-4)

2.7 Deakin’s theory

Deakin (1972) employs the same 14 ratios that Beaver (1968a) used in his study. A sample of 32
failed US firms matched with 32 non–failed US firms between 1962 and 1966 were selected in this
study. The matching is based on three criteria: industry classification, asset size, and year of financial
data

available. The 14 ratios were selected to represent a set of predictors in this study. The results
suggest that the overall predictive accuracy of the model is 97 per cent when using the last financial
statement prior to failure.

Edmister (1972) conducted his study focusing on financial ratio modelling for small business firms’
failure. The sample will be derived from the data of the Small Business Administration and Robert
Morris Associates between 1954 and 1969. A sample of 42 US firms Banks were selected and a total
of seven financial ratios were chosen.
 2.8 Edmister’s theory
Edmister’s (1972) findings indicate that the seven–ratio discriminant function correctly classifies 39
out of 42Commercial Banks. That is, the overall predictive power of the model is 93 per cent.

2.9 Blum’s theory

In Blum’s (1974) study, a matched sample of 115 US failed and 115 US non– failed Commercial
Banks during the years 1954–1968 is used in his study. The matching criteria are industry, sales,
number of employees, and fiscal year.

Blum’s (1974) discriminant function constitutes 12 variables. The results suggest that the overall
predictive accuracy of the model stands at approximately 94 per cent using one–year statements
prior to failure.

Bei and Liu (2005) used paired sample design with 62 Chinese listed companies consisting of 31
failed and 31 non–failed companies in the development of a discriminant function. A total of 30
financial ratios were selected based on their use in previous studies. To search for an optimal set of
financial ratios, a forward stepwise approach will be used in this study and the final model contained
3 ratios. The overall classification accuracy of the model is up to 79 per cent

Business failure:

A number of ‘failure’ definitions are used in the literature. For instance, Altman and Hotchkiss
(2006,p4) define ‘failure’ as existing when ‘the realized rate of return on invested capital is
significantly and continually lower than prevailing rates on similar investments’.

Beaver (1966,p71) defines ‘failure’ as the ability of a firm to pay its financial obligations as they
mature.

Financial distress:

Researchers identify distressed companies based on several financial dimensions. ‘Financial

distress’ conditions are represented by business restructuring or reorganization.
(Routledge & Gadenne, 2000), failure to pay annual listing fees (Jones & Hensher, 2004), debt
default criteria (Kahya & Theodossious, 1999), going private for a publicly listed company (Queen &
Roll, 1987), liquidation and acquisition (Coats & Fants, 1993) and the like.

Specification of population:

Population when it comes to sampling, refers to any group of units that have something in common
and are examined by researchers (Black, 1999, Cavana, Delahaye & Sekaran, 2001; Davis,2005 and
Zikmund, 2003).

According to Queen and Roll (1987,p 9) for a publicly listed company, bankruptcy is not the only
route to mortality. A firm may go private, be acquired and the like. Firm mortality could be an
occasion for mourning on the part of other interested groups such as employees, managers, clients,
suppliers.

Sample selection:

The term of sample refers to a ‘smaller set of cases’ a researcher selects from a larger pool and
generalizes to the population’ (Neuman, 2006 , p219).

Stated simply by Zikmund (2003:p369), a sample is a sunset or some part of a larger population’.

Methodology adopted for research on the impact of culture on risk management

disclosures : an exploratory study of international banks:

Methodology is the analysis of how research should or does proceed. It includes discussions on how
theories are generated and tested, what kind of logic is used, what criteria they have to satisfy, what
theories look like and how particular theoretical perspectives can be related to particular research
problems (Blaikie, 1993).

The selection of the methodology for this study will be guided by Patton’s (1990) view that the
methodology must be designed to complement and be appropriate to the nature of the study.

A paradigm according to Biklan and Bogdan (1982:30) is “a loose collection of logically held-together
assumptions, concepts and propositions that orientate thinking and research”. A paradigm is a set of
assumptions linked together in an investigation of the world, determining problems worthy of
exploration with appropriate methods (Deshpande, 1983).

There are mainly two philosophical bases or paradigms used in business research, the positivist
approach and the interpretivist approach.

Positivist research is generally associated with quantitative data. Positivist research belongs to the
natural sciences where assumptions are made about all people sharing the same meaning when
interacting socially with others.

This paradigm is based on the formulation of hypotheses that are then proved or disproved during the
course of research. Quantitative data is collected using a precise non-flexible procedure and
analyzed using statistical quantitative methods. A good test for the robustness of quantitative
research is if other researchers can replicate the research and obtain similar results.

Blaikie (1993) suggests the ontology of positivism is that the world is made up of discrete, observable
events and only what is experienced by your senses can count for reality. He suggests that the
epistemology of positivism is that knowledge is derived from sensory experience for example by
conducting experiments. Positivists construct theories and try and disprove them.

Interpretivist research is generally associated with qualitative research. Interpretivist research

assumes that people experience social and physical meaning in differing ways and is interested in
understanding the “lived” experience of individuals or groups of individuals”.

It involves the development of complex descriptions centered on how people think, react and feel in
certain contextually specific situations. The developed descriptions are then analyzed by the
researcher.

Blaikie (1993) suggests interpretivism follows an ontology which holds that social reality is a product
of processes through which meaning is socially constructed through situations and actions. In this
epistemology, knowledge is constructed from everyday concepts and meanings.

In terms of ontology, positivists take the view that the social world exists independently of the
observer whereas interpretivists hold that the social world is constructed and arises out of the social
interaction. In terms of epistemology the question that needs to be clarified is the relationship
between the researcher and their subjects.
Data Analysis and presentation

CHAPTER THREE RESEARCH METHODOLOGY

3.1 Introduction

This chapter describes the research design, population of study, the basis of sampling, the data
collection as well as the data analysis techniques to be used to achieve the objectives of study.

3.2Research Design

A research design is a framework or a blue print for conducting a research. It provides a clear plan on
how the research will be conducted and helps the researcher in sticking to the plan. The research will
be conducted using a descriptive research design which sought to assess the effect of financial
distress on performance of commercial banks.

3.3 Population

A population is the entire set of elements from which a sample is drawn. The population included all
the nine commercial banks lised on Nairobi Stock Exchange (see Table 1) licensed and regulated by
the Central Bank of Kenya as mandated under the Banking Act cap 488 in Kenya.

Target Population

NUMBER BANKS

1 Kenya Commercial Bank

2 Barclays Bank of Kenya
3 Equity Bank
4 Co-operative Bank
5 Diamond Trust Bank
6 Standard Chartered Bank Ltd.
7 I & M Holdings Ltd.
 8 CFC Stanbic Holdings Ltd
9 HF Group Ltd.

Source: Nairobi Securities Exchange 2019

3.4 Sample

A sample is a segment of the population under study. All the nine banks were selected which
meaning the whole census will be appropriate as this constituted hundred percent of all the listed
commercial banks in Kenya which ensured data accuracy and validity.

3.5 Data Collection

Secondary data will be used in this study which will be extracted from past financial reports of the
banks under study and the annual supervision reports from the Central Bank of Kenya. That is,
income statements, statement of financial position and statements of changes in equity. The data will
be collected in the form of current assets and liabilities, total assets, retained earnings, earnings
before interest and taxes, book value of equity, total assets and total liabilities.
 3.6 Data Analysis

Data analysis is a systematic process which applies statistic techniques to evaluate

data through inspecting, transforming and modeling data to draw useful information for
decision making. Data will be analyzed using multivariate analysis with the aid of
Microsoft Excel. The data collected will be summarized in tables. The period of analysis
covered five financial years from 2008 to 2012. Financial distress will be calculated
using Altman Z score model as shown below. Mamo (2011) used the model to predict
financial distress in commercial banks in Kenya and found the model to be 90% valid.
Bwisa (2010) also evaluated Altman’s model applicability in prediction of financial
distress in Kenya and found the model to be 80% applicable.

The main objective of any statistical investigation is to assess relationships that make it
feasible to predict one or more variables in terms of other variables. The data will be
analyzed using the software of Statistical Package for Social Science (SPSS) version
21 and Microsoft Excel. The computed data will be then analyzed using descriptive
statistics tools (Arithmetic Mean, Standard Deviation) and inferential statistics which
involves regression analysis and analysis of variance (ANOVA). Arithmetic mean will be
acclimated to set the average liquidity ratio, solvency and financial health for each
Commercial Banks for the period covered as average for each year for all the
Commercial Banks. Standard deviation will be acclimated to determine the spread of
data values above the mean. Interpretation of the data will be then done within the
frame of reference.

Liquidity will be measured by Current ratio (CR): This ratio measures the expeditious
short-term solvency position of a firm. A high expeditious ratio denotes that the
expeditious short term solvency position of a firm is good. A Current ratio of 2:1
considered a firm more rigorous and perforating test of the liquidity position of an
organization as compared to the current ratio of the firm. Expeditious ratio ER = current
assets divided by Current liability.

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Solvency will be quantified by: Debt to Total Assets [DTA]: This ratio shows the
percentage of assets that are being financed by creditors (in lieu of business owners).
Generally, no more than 50% of a business‟ asset should be financed by debt. It is
computed by dividing total debt by total assets. The degree of leverage of the
companies is denoted by this ratio. The higher the percentage of debt to total assets,
the more preponderant the jeopardy that the business may be unable to meet its
maturing obligations and vice versa is additionally true Debt to Total Assets =Total debt
divided by Total assets.

Financial performance will be quantified by Return on Asset ROA and Return on Equity
as major ratios that denote the profitability of Commercial Banks. ROA is a ratio of
Income to its total asset (Khrawish, 2011). It shows how efficiently the resources of the
company are acclimated to engender the income. It further designates the efficiency of
the management of a company in engendering net income from all the resources of the
institution (Khrawish,

2011). Wen (2010), state that a higher ROA shows that the company is more efficient
in using its resources. Return on equity is the ratio of net income after taxes divided by
total equity capital.

Regression analysis will be acclimated to determine the relationship between liquidity,

solvency and financial health. Multiple regression model will be also used.

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Chapter four

4.0 Timescale
The following schedule will be used by the current research:

Calendar Week Scheduled Activities

Weeks 1-3 The research proposal will be submitted to the supervisor for the
feedback and general recommendations. Further incorporation of
the recommendations will be done during this period as well.
Week 4 Design questionnaire, select interviewees, contact several selected
interviewees, test the questionnaire on those interviewees who
were contacted and incorporate their feedback to improve the
questionnaire.
Week 5 The rest of the interviewees will be contacted and proposed to
participate in the current research. All participants of the study will
be contacted and presented with the consent form to participate in
the interviews and possible questions. The interviews themselves
will be conducted using the principles of semi-structured interviews
addressing the context and the personality of the interviewee.
Weeks 6-10 The literature review and secondary material will be analyzed and
prepared for the study.
Week 11 Research instruments and methodology will be adjusted at this
stage taking into account the feedback from the supervisor.
Week 12 First draft of the literature review and methodology will be

28
 completed.
Weeks 13-14 Data involving both qualitative and quantitative methodologies will
be analyzed.
Week 15 Discussion and conclusion segments will be incorporated at this
stage considering the previous feedback and the results of the
study.
Week 16 Full draft of the dissertation will be completed.
Week 17-18 The last stages of the research will involve the preparation of the
paper including revision of the draft, improvement and adjustment
of the dissertation, grammar check and incorporation of the last
changes to the paper and submission for marking.

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Chapter five

5.0 RESOURCES
Since this topic is a present-day development, not much research has been done in
terms of Published book. Hence, the bulk of my Secondary Data materials will be
sourced and gotten from journals and meeting papers. The primary data will be gotten
from the internet and interface with applicable personnel.

A list of the accessed resources is listed in the references section below.

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