Internal Control Quality and Leverage Manipulation: Evidence from Chinese State-Owned Listed Companies

Abstract

Promoting structural deleveraging is a key strategy for China to reduce high debt levels and mitigate systemic financial risks. In this context, the deleveraging of state-owned enterprises (SOEs) has become a national strategic priority. This study explores whether enhancing the quality of internal control as an internal governance mechanism can facilitate the deleveraging process of SOEs. Using a sample of A-share state-owned listed companies from the Shanghai and Shenzhen stock exchanges (2009–2023) and based on resource-based theory and signaling theory, we examine the impact and mechanisms through which internal control quality influences SOE leverage reduction. Our results demonstrate that higher internal control quality significantly promotes deleveraging in SOEs, and these findings remain robust after conducting endogeneity tests and employing alternative model specifications. Improved internal control mitigates resource misallocation and encourages firms to adopt two primary strategies: debt reduction (through short-term liability repayment and retained earnings) and equity expansion. However, the positive effect diminishes as Research and Development (R&D) intensity increases, reflecting the trade-off between innovation-driven growth and financial stability. Further heterogeneity analyses reveal that the deleveraging effect is more pronounced in local SOEs and over-indebted SOEs, as enhanced internal control helps eliminate non-performing liabilities. This study contributes to the literature on the economic consequences of internal control and provides empirical insights for policymakers seeking to optimize the capital structures of SOEs.