Impact of financial leverage on profitability in lodging companies: An analysis on RevPAR

In 2009, the U.S. lodging industry suffered a double-digit drop, 16.7 percent, in revenue per available room (RevPAR). The occupancy rate and average daily rate (ADR) went down 8.7 and 8.8 percent respectively. In this situation, it is necessary for the management of lodging firms to find a way to improve profitability. However, before finding a way to improve profitability, understanding industry-specific characteristics of the lodging industry is necessary; of these characteristics, capital structure was the focus of this study. According to the prior research, RevPAR was considered as one of the determinants for profitability. However, there was little research to investigate the relationship between RevPAR and debt ratio. Therefore, the objectives of this study were to investigate (a) the determinants of the leverage, (b) the relationship between RevPAR and debt ratio, and (c) the relationship between profitability and debt ratio. In order to find the relationship among the factors financial data and RevPAR data for several the lodging companies were collected. The RevPAR and the other financial data for the lodging industry between 2001 and 2010 were retrieved from the COMPUSTAT database. After deleting observations with missing data and outliers 193 observations for the lodging firms remained for the analysis. The average return on asset during the period 2001 to 2010 was -0.58%. The negative value of the average ROA ratio from 2001 to 2010 showed that lodging companies recorded low profit during that period due to the global recession. From the results of this study, there was a positive relationship between debt ratio and PP&E ratio and RevPAR. The lodging firms with high long-term debt ratio and also with high PP&E ratio would have higher room rates, and this could result in higher RevPAR. However, from the results of this study, RevPAR and revenue had a significant negative relationship. In general, there is negative relationship between growth opportunities and debt ratio. The results of this study showed that there was no significant relationship between debt ratio and growth opportunities in this study. According to the results of this study, long-term debt ratio was negatively related to profitability (ROA). Most lodging firms showed a decrease in total revenue during the period. However, interest expense for long-term debt did not change because it was considered a fixed cost. Therefore, the firms with higher debt ratio may have low profitability because they had to serve their long-term debt. This study found an inverted U-shaped relationship between debt ratio and profitability. This inverted U-shaped relationship between debt ratio and profitability may indicate that there is an optimal debt ratio, and that firms which exceed the optimal level are not effective in increasing a firm’s value or profitability. The results of this study may indicate that when debt ratio exceeds the optimal ratio this may have an effect on profitability of the lodging industry firms.