Capital Structure and Financial Distress Risk: Evidence from China

Abstract

Some of Chinese companies exhibit the risk of financial distress due to high leverage, leading to a series of social problems. This study seeks to investigate the effect of capital structure on the risk of financial distress. This study took a modified Z-score model as the measurement of the financial distress, while the independent variable capital structure included, debt to total assets ratio, debt to equity ratio, long-term debt to total assets ratio. The sample includes 18,630 firm-years from China's Shanghai and Shenzhen A-share listed companies between 2012 and 2021. To test the hypothesis of multivariate regression analysis using panel data. The pooled ordinary least squares (POLS), fixed effect (FE), random effect (RE) methods of regression were employed in carrying out this analysis. The results show a positive effect of capital structure on financial distress risk among Chinese listed firms supported by trade-off theory. Thus, policy makers should pay attention to leverage to prevent the risk of financial distress caused by over-leverage.