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.