How Does Financial Leverage Affect Financial Risk? An Empirical Study in Sri Lanka

Amity Journal of Finance, 2015

Posted: 20 Sep 2019

See all articles by Vijitha Gunarathna

Vijitha Gunarathna

Faculty of Management & Finance - University of Ruhuna

Date Written: September 26, 2015


Having debt or preferred stock capital is an important decision made by firms because the return on equity, in general, is expected to be higher with debt. Nevertheless, the costs associated with leverage tend to outweigh the benefits when the leverage increases beyond an optimal level. Thus, excessive leverage may create an uncertainty about a firm’s existence. However, straight forward guidelines on what constitutes the optimal level of leverage remain largely missing. Therefore, this study examines how financial leverage affects financial risk based on the data collected over ten years ranging from 2006 to 2015 regarding fifteen companies in Hotels and Travels, and Chemicals and Pharmaceuticals industries listed in the Colombo Stock Exchange. The findings revealed that financial leverage positively correlate with financial risk. However, firm size negatively affects the financial risk. Importantly, Hotels and Travels firms have a higher financial risk compared to Chemicals and Pharmaceuticals firms. Hence, financial leverage and firm size can be considered as determinants of financial risk. The findings imply that firms having a higher financial risk can avoid its risk by altering the capital structure when the market condition is favourable. Firms are, however, least able to do so during a decline in the industry.

Keywords: Debt Capital, Financial Leverage, Financial Risk, Firm size

JEL Classification: G31, G32

Suggested Citation

Gunarathna, Vijitha, How Does Financial Leverage Affect Financial Risk? An Empirical Study in Sri Lanka (September 26, 2015). Amity Journal of Finance, 2015, Available at SSRN:

Vijitha Gunarathna (Contact Author)

Faculty of Management & Finance - University of Ruhuna ( email )

Matara, Southern 80000
Sri Lanka

Do you have a job opening that you would like to promote on SSRN?

Paper statistics

Abstract Views
PlumX Metrics