European Journal of Business, Economics and Accountancy Vol. 4, No.

4, 2016
ISSN 2056-6018

EFFECT OF CAPITAL STRUCTURE ON FINANCIAL PERFORMANCE OF

FIRMS LISTED ON THE RWANDA STOCK EXCHANGE
1*
Jeannine Mauwa, 2*Prof. Gregory. S. Namusongeand & 3*Prof. Silas Onyango
1*
School of Business, Jomo Kenyatta University of Agriculture and Technology
P. O. Box 62000, 00200 Nairobi, KENYA
2*
School of Business, Jomo Kenyatta University of Agriculture and Technology
3*
School of Business, KCA University, KENYA

ABSTRACT

This study sought to appraise the effect of capital structure on financial performance of firms
listed on RSE. Both primary and secondary data were used by the study. The study adopted
descriptive research design and the population was all the six companies listed in the Rwanda
Stock Exchange (RSE). A census survey was conducted on all the six listed firms and
purposive sampling technique was used to sample the respondents to participate in the study.
Data was analyzed using descriptive statistics, correlation analysis and regression analysis
using SPSS version 20. The study findings indicated that capital structure is negatively
associated with ROA. Furthermore, capital structure is negatively associated with ROE. The
regression results indicated that the relationship between capital structure and both ROA and
ROE is negative and significant, Based on the study findings, the study concluded that, the
association between capital structures and both ROA and ROE is negative and capital
structure explains a larger change in ROA than in ROE. Furthermore, the relationship
between capital structure and both ROA and ROE is negative and significant. Generally, the
study concluded that capital structure is negatively and significantly related to financial
performance of firms listed at the RSE.The study recommends that firms listed at the RSE
should improve their capital structure and implement strategies that lead to a reduction in
liquidity ratio as it leads to improved financial performance. The firms should keep its
leverage level under control and have clear working capital management guidelines to avoid
bankruptcy

Keywords: Capital structure, financial performance, Rwanda stock exchange, ROA, ROE.

INTRODUCTION
Background and Research Gap

Financial aspect is a concern over the world. Panu, Andrew & Erik (2006) and Goergen
(1999) argue that there is a relationship between corporate governance, ownership and
financial performance. Furthermore, Sandra & Samuel (1999) indicated that there is a
positive association between financial performance and Corporate Social Performance
supporting the theory that slack resource availability and Corporate Social Performance are
positively related. According to the scholars, corporate social performance is also positively
associated with future financial performance, supporting the theory that good management
and Corporate Social Performance are positively related.

The Corporate sector growth is essential to economic development. And the corporate
finance pattern of the company is vital importance for the financial wellbeing of companies in
any sector. Corporate finance decisions affect the various areas of the corporate management,
which determine the wealth of investors. Public sector of Sri Lankan corporate finance
decisions accomplishments affects not only the financial soundness of the concerned Private

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Equity but also the financial health of the nation as a whole, while these are essentially public
investment decisions of the government and a number of Sri Lankan Government agencies
are involved in this process (Sritharan, 2014).In Ghana, studies have been done on how
dividend policy affects financial performance of the firm on Ghana Stock Exchange. Samuel
& Edward (2010) examined the relationship between dividend policy and financial
performance of banks in Ghana. The study used panel data constructed from the financial
statements of 16 commercial banks in Ghana for a period of 5 years, from 1999-2003. The
result was in tandem with earlier studies that dividend policy had an effect on firm value.

Rwanda is member of East African Community and has trade relationship with free
commerce, property and personnel movement with the members. Whatever happens to one as
far as development is concerned usually affect the other. They are more or less partners and
progress rather than competitors in business. Development programs in the communities’
countries often follow the same pattern eg. 2020 development in Rwanda and 2030 program
in Kenya. Even the program initiative and content are similar. Like many of their policies,
constitution and institution including financial system.

A Financial market is where securities are bought and sold at prices governed by the forces of
demand and supply. Stock exchanges impose stringent rules, listing requirements, and
statutory requirements that are binding on all listed and trading parties. In Kenya, There are
more than 50 businesses and companies listed in the Nairobi Stock Exchange, including
Sasini Tea and Coffee Ltd., Kenya Airways, Jubilee Insurance, Kenya Commercial Bank
Ltd., and Ken Gen Ltd. Most of the businesses in the exchange are in the financial or
industrial sectors, though agriculture and other commercial services are also represented.
Also listed are treasury bonds issued by the Government of Kenya. Occasionally, there are
also privately issued corporate bonds as well. Trading takes place 5 days a week (Monday to
Friday) but only between the hours of 10am and 12 noon. (Wikipedia 11/11/2014)

Problem Statement

Capital market consists of market for medium and long term funds. This is typicalized by
stock exchange like Rwanda stock Exchange. This is the trading floor for company securities
and it is divided into two. Market for initial securities called primary market and market for
traded securities called secondary market. In essence the market is where shares are issued
and traded among investors. The government of Rwanda has a goal to develop the economy
by 2020 therefore it has to encourage participation and growth of the stock market, thereby
facilitating the growth, flow, and regulation of the stock market. The government ensures that
investors are protected, it also advises and guides companies seeking capital and provide an
important infrastructure and conducive environment for business development.

Despite the government efforts, the capital market is not growing at the pace expected.
Should the slow development of the stock market persist then the growth and development
target for the year 2020 may be difficult to achieve. Need therefore arose to identify,
appreciate and work assiduously on the factors that determine financial performance of firms
listed on the Rwanda Stock exchange.

Studies conducted to examine the factors affecting financial performance of listed firms have
mostly looked at the variables used in the current study in isolation of each other thus
creating a conceptual research gap. No study has combined capital structure, dividend policy,
corporate governance and timely rendition of information to investigate financial

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performance of listed firms. For example, a study was conducted by Nikolaus (2015) to
examine the determinants of firm performance of Indonesian and Dutch firms over the period
of 2009-2013. The study however focused in Netherlands. Kungu, Ayako and Githui (2015)
conducted a study to analyze the factors affecting the performance of 41 non-financial
companies listed on the Nairobi Securities Exchange (NSE) using panel data over the period
2003 to 2013. The study however used panel data and looked at Nairobi securities exchange.
A study was conducted by Vintila and Nenu (2015) to analyse the determinants of corporate
financial performance ofBucharest Stock Exchange Listed Companies and it presented a
contextual research gap because it was conducted in Bucharest. Furthermore, Mwangi and
Murigu (2015) conducted a study to establish the factors that affect the profitability of
general insurers in Kenya and the study presented a contextual research gap since it focused
on insurance. Mwangi, Muathe and Koimbei (2014) also investigated the relationship
between capital structure and financial performance of non-financial companies listed in the
Nairobi Securities Exchange (NSE). The study however used only one variable which is
Capital structure. Another study was conducted by Vincent (2011) to investigate the effects
of ownership structure on performance of listed companies in Kenya but it only focused on
corporate governance. A study by Uwalomwa, Jimoh and Anijesushola (2012) investigated
the relationship between the financial performance and dividend payout among listed firms’
in Nigeria while focusing on dividend policy only. Velnampy and Vickneswaran (2014) on
the other hand examined the significant impact of capital structure (CS) and liquidity position
(LP) on profitability of listed telecommunication firms in Colombo Stock Exchange (CSE)
.The study also focused on capital structure and liquidity position only. It is due to these
conceptual research gaps that the current study combined the variables and also adds another
variable which is timely rendition of information beyond statutory time so as to obtain a more
comprehensive analysis of determinants of financial performance of listed firms. The study
also aimed to fill the contextual gaps arising as a result of different scopes under which the
reviewed studies were conducted since they were not conducted in Rwanda nor focused on
the firms listed on the Rwanda stock exchange. The current study hence sought to assess
determinants of financial performance of firms listed on the Rwanda Stock Exchange.

Many determinants influence the financial performance of firms listed on Rwanda Stock
Exchange. These include: capital structure, dividend policy, corporate governance, timely
rendition of information others are: function leverage, hedging, financial risk, risk tolerance,
risk evasion, financial literacy, liquidity, ability to invest, etc. However for the purpose of this
study, the study focused on the first determinants because it is assumed that in Rwanda they
seem to play high role in financial performance. The study hence established the effect of
capital structure, on financial performance of firms listed on the Rwanda Stock Exchange.

Study Objectives

The general objective of this study was to assess the effect of capital structure on financial
performance of firms listed on the Rwanda Stock Exchange

RESEARCH METHODOLOGY

The research design adopted for the study was descriptive survey design. The target
population for this study was the firms listed at Rwanda Stock Exchange (RSE) as at the year
2014. By the end of the year 2014, there were 6 firms listed at the Rwanda stock exchange. A
multi stage sampling approach was used where sampling was done at the unit of analysis
level and at the respondent’s level. The unit of analysis was the firms listed at the Rwanda

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stock Exchange. At this level, all the 6 firms were used in the study. This is a census
approach. Sampling was also done at the respondent’s level. The respondents were
management staff from the Operations, Finance and Accounts departments. The study
purposively sampled 4 staff members from each department totaling the sample size to 72
management staff from all the listed firms. The choice of the departments was because they
are departments mostly concerned with dividends and capital. The study used both primary
and secondary data. Primary data was obtained from questionnaires. The study obtained
primary data on dividend policy, capital structure, corporate governance and timely rendition
of information. Secondary data on capital structure (Leverage) ,ROA and ROE was collected
form annual reports and financial statements of the firms. A linear regression model was used
to link the independent variable to the dependent variable as follows:
Y=β0+β1X1+ e
Where:
Y= Financial performance
X1= Capital structure
β0 = constant
β1= are regression coefficients to be estimated
e= stochastic term

FINDINGS AND DISCUSSION

Response Rate

The number of questionnaires that were administered was 72. A total of 70 questionnaires
were properly filled and returned. The results for the response rate are as presented in Table
4.1.
Table 1: Response Rate
Response Frequency Percent
Returned 70 97.2%
Unreturned 2 2.8%
Total 72 100%

The results in Table 1 indicated an overall successful response rate of 97.2%. According to
Mugenda and Mugenda (2003) and also Kothari (2004) a response rate of above 50% is
adequate for a descriptive study. Babbie (2004) also asserted that return rates of above 50%
are acceptable to analyze and publish, 60% is good, 70% is very good while above 80% is
excellent. Based on these assertions from renowned scholars, 97.2% response rate is very
good for the study.

Demographic Characteristics

This section consists of information that describes basic characteristics of the respondents
such as gender of the respondent, age, level of education and work experience.

Gender of the respondents

The respondents were asked to indicate their gender. The results are presented in Figure 1.

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Figure 1: Gender

Results in Figure 1 indicate that majority of the respondents, 66%, indicated that they were
males while only 34% were females. This implies that male employees still dominate in these
firms listed under Rwanda stock exchange.

Age

Respondents were also asked to indicate their age brackets. The results are presented in
Figure 2.

Figure 2: Age Bracket

The results in Figure 2 reveals that majority, (66%), of the respondents were between the
ages 36-55years old while 34% were in the age bracket 26-35years.

Level of Education

Respondents were asked to indicate their level of education. The results are presented in
Figure 3.

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Figure 3: Level of education

The study findings indicate that majority, forty seven percent (47%) , of the respondents had
Bachelor’s Degree, 30% of the respondents had Master’s Degree. Another 10% had Diploma,
7% had PhD,6% had certificate.

Work Experience

The respondents were asked to indicate the duration they have worked in the firms. The
results are presented in Figure 4.

Figure 4: Work experience

The results in Figure 4 indicates that majority of the respondents who were 41% had worked
in these firms for duration 2 to 4years, 39% had worked for 5-10 years, 11%had worked for
duration of less than 2 years while only 9% had worked in these firms for more 10 years. This
implies that majority of the respondents had not worked in the organization for a long period.

Correlation Analysis

The study sought to establish the association among the study variables. The results are as
presented in Table 2.

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Table 2: Correlation Analysis

Capital structure ROA ROE
Capital structure Pearson Correlation 1 -.430** -.308*
Sig. (2-tailed) 0.002 0.033
N 48 48 48
ROA Pearson Correlation -.430** 1 .775**
Sig. (2-tailed) 0.002 0
N 48 48 48
ROE Pearson Correlation -.308* .775** 1
Sig. (2-tailed) 0.033 0
N 48 48 48

The results in Table 2 indicate that capital structure is negatively associated with ROA. The
results further indicate that the association between capital structures with ROA is significant
at 5% level of significance. The implication of the results is that an increase in capital
structure is associated with a decrease in ROA. Furthermore, the findings reveal that capital
structure is negatively associated with ROE. The results further indicate that the association
between capital structure and ROE is significant at 5% level of significance. The implication
of the results is that an increase in capital structure is associated with a decrease in ROE. The
findings are also consistent with the findings of a study by Mwangi, Muathe and Koimbei
(2014) which revealed that financial leverage had a statistically significant negative
association with performance as measured by return on assets (ROA) and return on equity
(ROE). However, the findings disagree with the findings by Velnampy & Vickneswaran,
(2014) which indicated that the correlation results confirmed that there is no significant
relationship between listed telecommunication firms’ capital structure, liquidity position and
profitability.

Descriptive statistics

The respondents were asked to rate various statements on dividend policy on a likert scale of
1 to 5. The statements were based on a likert scale ranging from strongly disagree rated as 1,
disagree rated as 2, neutral rated as 3, agree rated as 4 and strongly agree rated as 5. The
results are presented in Table 3.

Table 3: Attributes of Capital Structure

Mea Std
1 2 3 4 5 n Dev
The company relies on loan
in order to run 27.10% 11.40% 22.90% 21.40% 17.10% 2.90 1.46
The company has a huge
burden of current liabilities
as compared to current
assets 28.60% 24.30% 17.10% 17.10% 12.90% 2.61 1.40
The burden of cost of
equity is more than the
burden of cost of
debentures on Profit and
loss account 3.03 1.38
18.60% 18.60% 22.90% 21.40% 18.60%

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The company keeps its

leverage level under 1.12
control 3.83
7.10% 5.70% 11.40% 48.60% 27.10%
There are clear working
capital management
guidelines by the company
to avoid bankruptcy 4.30% 4.30% 7.10% 48.60% 35.70% 4.07 1.00

Average 3.29 1.27

The study sought to determine the effect of capital structure on firm’s performance. Twenty
eight point five percent (28.5% of the respondents disagreed to the statement that the
company relies on loan in order to run with another 38.5% agreeing. On the question of
whether the company has a huge burden of current liabilities as compared to current assets,
majority 52.9% agreed. On the statement whether the burden of cost of equity is more than
the burden of cost of debentures on Profit and loss account, 40% agreed to the statement.
Whether the company keeps its leverage level under control, majority 75.7% agreed with this
statement. Further when the respondents were asked whether there are clear working capital
management guidelines by the company to avoid bankruptcy, majority 84.3% agreed with the
statement. On a five point scale, the average mean of the responses was 3.29 which means
that majority of the respondents were agreeing to the statements in the questionnaire. The
standard deviation was 1.27 meaning that the responses were clustered around the mean
response.

Trend Analysis of Capital Structure

The study also sought to establish the trends of capital structure measured in terms of
liquidity ratio. The results are as presented in Figure 5.

Figure 5: Trend Analysis Capital structure

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The study findings on Figure 4.6 indicates that the liquidity ratio, which captured capital
structure, had unsteady trends between the first half of the study period to the end of the year
2014. The highest value of liquidity ratio was 0.733 while the lowest was 0.633 recorded in
the same year 2011.

Relationship between Capital structure and financial performance

The study sought to establish the relationship between capital structure and financial
performance of firms listed on the Rwanda Stock Exchange. The measures of financial
performance were ROA and ROE. The results for Model Summary are as presented in Table
4.

Table 4: Capital Structure and Financial Performance (Model Summary)

ROA ROE
R -.430a -.308a
R Square 0.185 0.095
Adjusted R Square 0.167 0.075
Std. Error of the Estimate 0.134548 0.435455

The results in Table 4 indicate that the association between capital structure and both ROA
and ROE was negative as indicated by and R of -0.430 and -0.308 respectively. This implies
that an increase in capital structure, measured as liquidity ratio, is associated with a decrease
in financial performance of the firms listed at the RSE.

Furthermore, the results indicate that 18.5% and 9.5% of the changes in ROA and ROE
respectively is explained by capital structure as indicated by R square of 0.185 and 0.095
respectively. The findings imply that capital structure explains a larger change in ROA than
in ROE. The fitness of the models was also established and the results are as presented in
Table 5.

Table 5: Capital Structure and Financial Performance (Model Fitness)

ROA ROE
F 4.813 10.446
Sig. .033b .002b
The study findings indicated in Table 5 reveal that the F statistic of both the regression model
of capital structure and ROA as well as ROE of 4.813 and 10.446 respectively was significant
at 5% level of significance which means that the two regression models fit well.
Furthermore, the study established the coefficients of the regression between capital structure
and financial performance. The results are as presented in Table 6.

Table 6: Capital structure and Financial Performance (Regression Coefficients)

B Std. Error Beta t Sig.
(Constant) 0.336 0.065 5.129 0.000
ROA Capital Structure -0.295 0.091 -0.43 -3.232 0.002
(Constant) 0.645 0.212 3.048 0.004
ROE Capital structure -0.647 0.295 -0.308 -2.194 0.033

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Models

ROA = 0.336 - 0.295 Capital Structure

ROE= 0.645 – 0.647 Capital Structure
The results in Table 6 indicate that the relationship between capital structure and both ROA
and ROE is negative as shown by a beta coefficient of –0.295 and -0.647 respectively.
Furthermore, the relationships are significant at 5% level of significance as indicated by
significance levels of 0.002 and 0.004 respectively. The study findings imply that a unit
increase in capital structure will lead to 0.295 and 0.647 units decrease in ROA and ROE
respectively. These study findings not consistent with the findings of
Velnampy&Vickneswaran, (2014) which revealed that there is no significant impact of
capital structure and liquidity position on the profitability.

Hypothesis Testing

The study sought to test the null hypothesis that capital structure does not affect financial
performance of firms listed on the Rwanda Stock Exchange. The hypothesis was tested based
on the results of an ordinary least square regression model of dividend policy and ROA. A
level of significance less than 0.05 leads to the null hypothesis being rejected while a
significance level above 0.05 leads to the null hypothesis not being rejected. The findings in
Table 4.11 indicates a level of significance of 0.002 which leads to the rejection of the null
hypothesis hence capital structure affects the financial performance of firms listed on the
Rwanda Stock Exchange.

CONCLUSION

Based on the study findings, the study concluded that the association between capital
structures and both ROA and ROE is negative and capital structure explains a larger change
in ROA than in ROE. Furthermore, the relationship between capital structure and both ROA
and ROE is negative and significant. Generally, the study concluded that capital structure is
negatively and significantly related to financial performance of firms listed at the RSE.

RECOMMENDATIONS

The study recommends that firms listed at the RSE should improve their capital structure and
implement strategies that lead to a reduction in liquidity ratio as it leads to improved financial
performance. The firms should keep its leverage level under control and have clear working
capital management guidelines to avoid bankruptcy

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