**1. Introduction**

Capital structure is one of the most perplexing puzzles in the financial literature that deals with solutions to optimal mix of debt and equity. The seminal work of Modigliani and Miller (1958) initiated this body of work, other researchers later developed theories along the MM, and empirical researchers validated the assumptions underlying the theoretical body of the literature by examining different dimensions such as firm characteristics, time or industry sector category. A mirror image of capital structure choice is essentially a decision to fund capital from the cheapest sources to maximize income after taxes (Yazdanfar 2012). The seminal work of Jensen and Meckling (1976) posits managerial behavior in the best interest of the shareholders which is to borrow at a level that will maximize shareholder value and firm profitability. Since the work of Jensen and Meckling (1976) several researchers have examined the relationship between leverage and profitability. The findings of these studies are contradictory and mixed, some suggesting a positive relationship (Ghosh et al. 2000; Hadlock and James 2002; Roden and Lewellen 1995; Taub 1975) and some suggesting a negative relationship (Fama and French 1998; Gleason et al. 2000) between leverage and profitability (El-Sayed Ebaid 2009). There are many studies on capital structure in the context of service sectors in Europe, USA, the Middle East and other parts of the world (Chakrabarti and Chakrabarti 2019; Choi et al. 2018; Park and Jang 2018; Sardo et al. 2020; Sermpinis et al. 2019; Szemán 2017). Compared to other sectors, service sector capital structure research is at a nascent stage. Further research needs to be done to enrich the understanding of the drivers of financial performance of this sector.

The key aim of this paper is to empirically examine the relationship between debt financing and firm performance of service sector companies listed in the Australian Stock Exchange. The service sector is chosen to reflect the changing configuration of the Australian economy from a resource-based economy to a service-based economy. Over the last one and a half decades, the Australian service sector contributed between 60–70% and is a major employer (Australian Bureau of Statistics 2019, 2020). This trend is expected to continue in the foreseeable future and it is important to ge<sup>t</sup> some

insights into the e ffect of capital structure on this sector firms. Four performance measures are used to capture firm performance: (a) return on asset, (b) return on equity, (c) return on capital employed and (d) operating margin. The paper finds: (a) portability (measured by return on equity, ROE) and leverage (measured by a ratio of short-term debt to total assets) is positively associated, (b) profitability (measured by return on assets) and leverage (measured by short-term debt) is positively associated and (c) no significant association between either ROE and ROA and long-term or total debt. The main contribution of this paper is that it has extended the current body of literature on capital structure by adding the Australian service industry context from very recent data. Australia's move from a resource-based economy to a service-based economy means the sector is growing, so the findings of this paper are expected to shed light on this emerging frontier of capital structure practices of service sector firms. The remainder of the paper is organized as follows. In Section 2, the literature is discussed. In the third section, the empirical literature is reviewed, followed by three sections on data, results and discussions. The final section concludes the paper with some possible directions for future research.
