Financial Leverage and Financial Performance in Emerging Tourism Economies: Empirical Evidence from Sri Lanka’s Listed Hotel Sector

Financial leverage plays a critical role in shaping a company’s performance, particularly as businesses strive to reduce their overall cost of capital. Thus, this study investigates the relationship between financial leverage and financial performance among high market-capitalized hotels listed on the Colombo Stock Exchange (CSE) over the period of 2015–2024. Drawing on trade-off, pecking order, and agency theories, this study investigates the effect of two key financial leverage indicators, debt ratio and debt-to-equity ratio, on financial performance using measures such as return on assets (ROA) and return on equity (ROE) while using firm size as the control variable. Using panel data, the study covers 18 listed hotels and 180 firm-year observations and employs regression analysis. The findings reveal that the debt ratio has a significant positive effect on ROA, supporting the trade-off theory's notion that moderate debt enhances asset utilization and operational efficiency. Conversely, debt-to-equity ratio shows no significant impact on ROA. Regarding ROE, the debt-to-equity ratio and debt ratio demonstrate a significant positive effect, suggesting that higher leverage can improve shareholder returns under prudent management. The study enriches the limited empirical literature on capital structure within Sri Lanka’s tourism sector and offers practical insights for hotel managers, investors, and policymakers seeking to optimize capital structures in volatile, tourism-dependent emerging economies. Limitations include the study’s sectoral focus and reliance on secondary data. Future research could extend the scope to other sectors listed in the CSE, apply alternative non-financial performance measures, or conduct cross-country analyses to deepen the understanding of leverage dynamics in emerging markets.