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

Abstract

For a long time, studying financial structure has been a crucial and essential issue in the finance industry. The major goal of this study is to use the Trade-Off Theory to identify the capital structure of Chinese firms. This paper analyzes the determinants of capital structure of Chinese Firms through the existence of dynamic and non existence which is an adjustment to target leverage ratio. This validation leads to test two complementary successive models, the first is a static, while the second is a dynamic model that incorporates transaction costs variable to see how we can talk about a speed adjustment allowing firms to get closer to the target ratio. The results of the first model show that the profitability and asset structure are the main explanatory variables of the level of leverage of Chinese firms. While for the dynamic model, the most remarkable result is manifested at the level of the adjustment costs that are relatively high which engendered a slow adjustment towards the optimal ratio. This paper assesses 20 Chinese top listed firms in the stock exchange data between 2010 to 2021. Panel data analysis was examined and auto-correlation using the reviews and model developed. Findings show the positive correlation between capital structure and debt financing with its variable. Low but positive correlation is in line with trade-off theory and leverage level. This research is significant to managers, and shareholders since it helps them in making viable investment decision and the right mix of capital for effective operations of the firm.