A Re-Examination of the Capital Structure Theory: Evidence from Chinese Listed Companies

Abstract

In this study, we examine whether and to what extent the main stream capital structure theories developed in Western countries apply to Chinese listed companies during its most recent transition period after year 2000. Specifically, we examine a variety of trade-off and pecking order models and compare their performance by nesting these two different models in the same regression. Using market-based leverage data from 1057 non-financial Chinese listed firms during the period from 2000 to 2011, we present empirical evidence indicating that: firstly, equity tracks the financing deficit better than debt in Chinese firms, which is not consistent with the pecking order theory. Secondly, Chinese firms seem to be more sensitive in expanding debt for meeting their financing needs than in using surplus for retiring debt. Thirdly, Chinese firms have an optimal market-based leverage ratio. Both the partial adjustment and error correction models suggest that Chinese firms adjust towards target leverage slowly before 2006. However, after 2006, they accelerate their leverage adjustments at a speed as fast as that documented in the developed markets. The increasing adjustment speeds are attributed to the shrinking transaction costs and agency costs caused by recent currency and share-split structure reforms. Overall the trade-off theory works better than the pecking order theory in explaining Chinese firms' capital structure. Chinese companies' financing behaviors are becoming more akin to those in the developed market with increasing integration and financial liberalization.

Reassessing theories of capital structure: Empirical insights from companies listed in Vietnam

“…11 The Hausman test is employed to examine the difference between the fixed-effects approach and the random-effects approach, and the test indicates the fixed-effects approaches are more suitable. 12 Dynamic panel GMM regression models have become a popular choice in recent years for empirical research in various fields, such as in the studies by Dai et al (2020) and Guo et al (2018) in social and business. 13 The rejection of AR2 test will signify the presence of series autocorrelation.…”

The Capital Structure Through the Trade-Off Theory: Evidence from Chinese Firm

“…Therefore, the need to understanding firm's capital structure is key in the long run. According to Guo [12], using the data from 1994 to 2003 with a sample of 1200 Chinese listed companies, the results indicate that firms size and its assets are negatively related to profitability, managerial shareholding, and growth opportunities in the company.…”

“…In the study of firm's capital structure, the key approach is based on the firm's static approach. There are also other models whose main focus is on the dynamic approach as presented by Guo, Liang, et al [16]. This seems to introduce a complementary approach towards determining the model on capital structure of the firm.…”

Macroeconomic risks and capital structure adjustment speed: The Chinese evidence

“…Existing literature on capital structure of Chinese firms ranges from the test of pecking order theory and trade‐off theory of capital structure to capital structure adjustment speed. Guo, Lien, and Dai (2016) and Guo, Yu, Dai, and Zhang (2018) report that trade‐off theory dominates pecking order theory in explaining Chinese firms' capital structure. Zhang, Gao, and Yang (2016) examine the impact of split share structure reform (SSSR) on capital structures using the interest‐bearing debt ratios of Chinese firms and find the debt ratios increased due to market expansion and improved corporate governance after the SSSR.…”

“…Reversion to target leverage involves using cash to pay off debt by over‐levered firms or adding debt by under‐levered firms. Guo et al (2018) report that Chinese firms seem to be more sensitive in expanding debt to meet their financing needs than using surplus to retire debt. Consistent with the trade‐off theory, our findings show that the firms that are closer‐to‐target leverage ratio adjust faster than their counterparts during high economic growth state, possibly due to the ease of financing smaller magnitude of deviation from target leverage.…”