Financial Leverage and Financial Performance: The Mediating Role of Financial Distress: Evidence from Firms Listed in East African Community Exchange Markets

This study examined the mediating role of financial distress on the relationship between financial leverage and financial performance of firms listed on East African Community exchange markets. The study utilized explanatory and longitudinal research designs with the guidance of a positivist research philosophy. The study targeted 112 listed firms on the East African Community exchange markets. After applying inclusion and exclusion criteria, the study focused on 48 firms for a span of 10 years from 2015 to 2024, yielding 480 observations. Financial leverage was positively related to financial distress (b = 8.390, 95% CI [4.468, 11.214], p <.001) and negatively related to financial performance directly (b = -0.226, 95% CI [-0.293, -0.175], p <.001). Financial performance was positively related to financial distress (b = 0.011, 95% CI [0.008, 0.015], p < .001). The indirect effect was positive (0.093, 95% CI [0.044, 0.146], p <.001) and in the opposite direction of the direct effect, indicating competitive mediation. The total effect was negative on financial performance (-0.133, 95% CI [-0.211, -0.073], p < .001).These findings highlight that manager should weigh the cost of additional leverage against the returns it generates, especially where liabilities already approach total assets. The results also bring attention to management on redirecting their focus to financial leverage by maintaining adequate liquidity buffers, proactive covenant and refinancing management, and continuous internal monitoring of the firm's asset-to-debt ratio, which can cushion the mechanism through which excessive financial leverage adversely affects financial performance. Keywords: Financial Performance; Financial Leverage; Financial Distress; East African Community Exchange Markets