The Importance of Agency Costs in Influencing the Relationship between Capital Structure and Firm Performance

This study investigates the relationship between capital structure and financial performance at Cimerwa Plc over the period 2019-2023. The research addresses the gap in understanding how capital structure decisions specifically the mix of debt and equity affect the financial outcomes of manufacturing firms in Rwanda. This issue is particularly significant for Cimerwa Plc, a leading cement manufacturer, which relies on an optimal capital structure for financial stability and sustainable growth. The study aims to analyze Cimerwa’s capital structure, assess its financial performance, and examine the nature of the relationship between capital structure and performance. The study is grounded in three theoretical frameworks: The Trade-Off Theory, which highlights the balance between debt-related benefits and financial distress costs; the Pecking Order Theory, which emphasizes a preference for internal financing over external sources; and the Agency Theory, which addresses conflicts of interest between managers and shareholders that may influence capital structure decisions. A quantitative research design was employed, utilizing 40 observations derived from the company’s annual reports and insights from expert interviews. Data were analyzed using multiple linear regression to examine the impact of capital structure variables debt ratio, equity ratio, and financial leverage on financial performance indicators, including Return on Assets (ROA), Return on Equity (ROE), and Earnings Per Share (EPS). The findings reveal a significant positive relationship between capital structure and financial performance. The regression model yielded an R-value of 0.791, indicating a strong correlation between the independent variables and Cimerwa’s financial outcomes. The R² value of 0.625 shows that the model explains 62.5% of the variance in financial performance, while the Adjusted R² of 0.603 confirms the robustness of the predictors. The model’s F Change statistic (178.171, Sig. = 0.000) further demonstrates the statistical significance of the relationship. Based on these results, the study recommends that Cimerwa Plc adopt a structured financing strategy that maintains an optimal balance between debt and equity, coupled with continuous monitoring of financial performance, strategic debt management, and enhanced liquidity management to support long-term growth and financial stability.