What determines the leverage decisions of Chinese firms?

Abstract

We study the leverage decisions of listed Chinese manufacturing firms over the period 1995–2004. We show that some firm characteristics, such as profitability and size, affect the leverage decisions of these firms, while other characteristics such as collateral and growth opportunities do not. Additionally, we find no important differences in the financing of listed firms across eastern (coastal), central and western regions. We also find evidence that contrary to other firms, the leverage of firms located in high FDI recipient provinces and firms who receive more subsidies from the state is not influenced by their profitability. Finally, we consider whether WTO accession affects the leverage of firms but find no strong evidence to support this claim.

Keywords:

• leverage
• profitability
• regional variation

JEL Classifications:

• G30
• G32

Acknowledgements

I would like to thank Dr A. Guariglia and all the participants at the various workshops at the School of Economics, University of Nottingham for their comments on this paper. My thanks to all the participants at the 18th Chinese Economic Association (UK) Annual Conference held at the University of Nottingham in April 2007 and the China Centre for Economic Studies and Chinese Economic Association (UK) Joint Conference held in Shanghai in September 2007 for their very helpful comments.

Notes

∗∗∗ indicates significance at the 5% level

∗ indicates significance at the 10% level

∗∗indicates significance at the 5% level

∗∗∗indicates significance at the 1% level. Also see notes to Table 1 and Table 2.

∗indicates significance at the 10% level

∗∗indicates significance at the 5% level

∗∗∗indicates significance at the 1% level.

1. The G7 countries are United States, Germany, Canada, Italy, France, Japan and the United Kingdom. The sample of developing countries comprises India, Pakistan, Thailand, Malaysia, Turkey, Zimbabwe, Mexico, Brazil, Jordan and Korea.

2. China has one of the highest growth rates in the world and most of this growth is believed to be coming from the manufacturing sector. The manufacturing sector now ranks fourth in the world after the US, Japan and Germany. China has a 50% share of the worldwide camera market, a 30% share for air conditioners, a 25 percnt; share for washing machines and a 20% share for refrigerators.

3. Although the legal framework in China is quite developed, enforcement mechanisms are poor, which makes the legal system inefficient.

4. Interest payments are usually tax deductible, and therefore taking debt enables firms to benefit from an interest tax shield.

5. Firms that operate in the protected sectors include petrochemicals and energy and raw materials.

6. Eastern region: Beijing, Tianjin, Hebei, Liaoning, Shanghai, Jiangsu, Zhejiang, Fujian, Shandong, Guangdong, Hainan; Central region: Shanxi, Jilin, Heilongjiang, Anhui, Jiangxi, Henan, Hubei, Hunan; Western region: Inner Mongolia, Guangxi, Sichuan, Chongqing, Guizhou, Yunnan, Shaanxi, Gansu, Qinghai, Ningxia, Xinjiang, Tibet.

7. China applies a series of measures that allow for refunds, reductions, or exemptions from taxes and other payments owed to the government. These appear designed to subsidize exports of manufactured goods or to support the purchase of domestic over imported equipment and certain other manufacturing inputs. The subsidies data is over the 1994–2004 period.

8. We try to include a tax variable in our specification as used by Booth et al. (2003); however, the coefficient is insignificant in most cases so we drop this variable.

9. If the p-values for the Sargan and the m2 test are both greater than 0.05, then the instruments are acceptable.

10. Note that we cannot include industry dummies in the Fixed Effects and GMM estimations.

11. To check for the robustness of our results, we use another measure of profitability; that is, distributable profit. Distributable profit is profit left after all taxes and payments have been made and what is actually left to distribute to shareholders. The results (not reported), are mostly similar to the results obtained above.

12. On the other hand, the preference for short-term debt might simply be the ‘way of doing business’ in China, where both lenders and borrowers prefer to lend and borrow short term.

13. The F-statistic obtained when we test for the equality of the coefficients is 13.23 for lagged debt and 5.20 for the profitability variable, suggesting that these variables when interacted with region dummies are statistically different from each other.

14. When the state first listed the firms, the best performing ones from each province were selected to be quoted so it is not surprising that the leverage of firms does not differ much across regions.

15. Unfortunately we do not have firm level FDI so we cannot examine this issue further.

16. This could also be because WTO accession would only impact export-oriented firms. However, we do not have information about whether our sample of firms exports or not.