Abstract

This study investigated the determinants of financing decisions of firms from the Middle East and North Africa (MENA) region, particularly the effect of public corruption on financing decisions and the effect of disorder following the Arab Spring on public corruption-financing structure relationship. The study encompasses a total of 800 business entities from 14 different countries, spanning the time frame of 2005–2018. Data is analyzed through the application of static fixed effects and dynamic GMM-System models. Results indicate that large, tangible companies prefer debt, whereas profitable companies with more room for growth choose equity. Less corruption is associated with increased corporate debt. The use of debt decreased because of the Arab Spring, and corruption’s effect on leverage became weaker. The speed of adjustment to the target leverage is comparatively slow for book leverage, while it is significantly greater for market leverage. These outcomes are consistent with the pecking order behavior resulted from increasing information asymmetry, but the tradeoff theory has some support as well. The implications of this study entail the need for enhancing investor protection, strengthening control measures, increasing transparency, and fostering the overall growth of the financial system to facilitate enterprises’ use of debt financing, particularly in the post-Arab Spring era. This paper provides fresh empirical evidence demonstrating the effect of the Arab Spring on capital structure and on the relationship between country corruption and capital structure in the MENA region. The paper also expands the body of research on capital structure and corruption across countries by providing empirical findings from a region that has been relatively overlooked in previous scholarly works.

Introduction

Lack of a perfect capital market necessitates the need for capital structure (CS) policy [1, 2, 3, 4, 5]. The choice of debt and equity is important not only for stable corporate financial health but also for the role it plays in economic growth [6,7]. Since Modigliani and Miller’s [8] slice-of-the-cake argument, the literature has identified many firm-specific CS determinants [6,9] as well as macroeconomic factors [7,10, 11, 12]. Country corruption facets, such as weak regulations and inconsistent policies at the macro level, may affect financing decisions as they influence agency conflicts of interest, the risk of financial fraud, and resource waste at the business level [10,13]. Such consequences are exacerbated if accompanied by weak disclosure policies that enhance the information asymmetry problem and increase the cost of capital [14]. Consequently, financial market activity reduces as a result of investors’ low confidence.

Public corruption is a potential determinant of CS that is largely ignored. A common link is through asymmetric information as a result of ineffective management transparency, monitoring, and law enforcement [15]. This information gap is also caused by manager-shareholder agency conflicts [16]. Because of poor ruling systems and regulations, emerging countries are deemed more corrupt than developed countries [17]. Non-financial enterprises are less regulated compared with financial firms, and thus they are more exposed to corruption [18].

Conclusions

This study investigates the CS practices of non-financial companies operating in the MENA region. Country-level corruption and the Arab Spring’s effect on CS is analyzed through the application of static and dynamic models. Country corruption has an effect on CS because of the significant agency problems and information asymmetry that are associated with corrupt practices. The developing countries in the MENA region are more susceptible to corruption because of inadequate governance systems and regulations, which make them a suitable choice for this study.

Our contribution to the literature on capital structure is threefold. The study expands the research on CS across countries in a geographic area that has been relatively overlooked in previous scholarly works. Our second contribution is emphasizing the significance of enhancing institutional environments in developing countries to facilitate firms’ access to external finance, particularly when the level of corruption in a country is found to have a significant effect on the decisions that corporations make about their CS. Finally, addressing the effect of the Arab Spring, a period of political instability, on the CS decisions is the first instance in which such an analysis has been conducted. The findings of this research are likely to be significant to other developing countries and regions and carry major implications for emerging economies that share similar attributes.

Abstract

Existing literature shows that female-led companies exhibit lower leverage compared to their male-led counterparts, a trend frequently attributed to the traditional view of higher risk aversion among women. We explore firms with female CFOs at or close to their optimal leverage and find that their capital structure is no different than that of firms with male CFOs. We argue that female CFOs reveal their true preferences and risk appetite during significant capital structure adjustments and find that their tolerance for risk aligns closely with that of their male counterparts. Our study challenges the conventional narrative by demonstrating that the financing decisions of top executives are likely not influenced by gender-based psychological differences.

Introduction

Extensive literature builds upon upper echelons theory ( Hambrick and Mason, 1984 ) and relates various executive traits, such as gender, ethnicity, age, R&D background, and legal and financial expertise, to corporate policies and outcomes ( Custódio and Metzger, 2014 ; Serfling, 2014 ; Cline and Yore, 2016 ; Doan and Iskandar-Datta, 2021 ; Li and Xiang, 2022 ; Huang et al., 2023 ; Liao, Ouyang, and Tang, 2023 ; among others). The evidence suggests that the identity of the people at the helm of the company plays a role in shaping firm strategies, including the choice of capital structure. 1 One factor that has been advanced as contributing to the link between executive identity and leverage is the varying degrees of risk aversion that firm leaders might have.

Numerous studies in business and psychology show that gender is related to risk preferences, with females exhibiting higher levels of risk aversion, and lower overconfidence and competitiveness than males ( Barber and Odean, 2001 ; Croson and Gneezy, 2009 ; Bertrand, 2011 ; Charness and Gneezy, 2012 ; Chen, Leung, Song, and Goergen, 2019 ; Wang and Fung, 2022 ; Perrin, Bertrand, and Klein, 2023 ). Within the corporate finance field, extant literature finds evidence that the gender of the members of the top management team affects the capital structure of the firm. Female CEOs and CFOs are associated with lower leverage and less debt issuance ( Huang and Kisgen, 2013 ; Faccio, Marchica and Mura, 2016 ; Schopohl, Urquhart, and Zhang, 2021 ), shorter debt maturity ( Datta, Doan, and Toscano, 2021 ), higher cash holdings and lower cash flow volatility ( Elsaid and Ursel, 2011 ).

Conclusion

Our investigation into the capital structure decisions of firms led by female CFOs during leverage rebalancing events presents compelling evidence that challenges the conventional narrative linking gender to risk aversion in corporate finance. Our analysis reveals no significant gender-based differences in the optimal leverage ratios set by CFOs. This finding calls for a reevaluation of the impact of executive gender on corporate financial strategies, suggesting that factors beyond gender stereotypes are at play in shaping these decisions.

Like most studies in empirical corporate finance, we acknowledge that we can never fully address endogeneity concerns in the absence of a natural experiment despite employing several empirical strategies designed to address omitted variable bias and reverse causality. We do point out, however, that if there is an omitted factor that simultaneously influences the likelihood of having female CFOs and the level of leverage, then for this factor to account for our findings, it should have a differential effect across the year immediately before and the year of rebalancing.

Abstract

     An essential issue of listed firms is adjusting their capital structure as stock market volatility increases. Our study examines this concern by using panel data of the Shanghai Stock Exchange for the period 2008–2018. We find that stock market volatility has immediate positive effects on both total market leverage and short-term market leverage but a negative influence on the long-term market leverage of Chinese listed firms. In this scenario, Chinese listed firms adjust their debt structure by using high bank debts and cutting trade credit due to lower debt costs. Further analyses confirm that the proportion of bank debts to total debts visibly increases while that of trade credit to total debts distinctly decreases. Furthermore, we implement robust tests regarding potential issues, such as sample selection, model selection, endogenous factors, and quantile regression to strengthen the robustness of the main findings. This study provides the first framework for investigating a link between the stock market volatility and capital structure decisions in a typical emerging market.

Introduction

     To date, determinants of capital structure have remained an incomprehensible subject in corporate finance. When firms are allowed to issue stocks on the equity market, equity issuance plays a vital role in the surging corporate capital. In terms of volatility, Welch (2004) documents that a critical matter of corporate finance is the volatility of stock price as a driver of notable changes in the behaviors and financial decisions of corporate managers. Figlewski and Wang (2000) demonstrate that the increase of the volatilities of stock market returns and individual stock returns leads to the decline in market values at the firm level. Following market timing theory, listed companies tend to issue equity when their market values are comparatively high relative to their book and past market values, and then repurchase their issued equity when their market values are low, which exerts a persistent effect on corporate capital structure (Baker & Wurgler, 2002). Chen et al. (2014) and Ahmed and Hla (2019) show that the volatility of individual stock returns significantly influences the capital structure of listed firms in the United States (US) and Pakistan markets, respectively. Most of their findings support the prediction of Tradeoff Theory (TOT) that companies diminish debts to balance and deal with the increasing prospect of default owing to high volatility risk; still, the practical results of Ahmed and Hla (2019) from the Pakistan market are pretty complicated. Similar to Pakistan, China is known as a developing equity market that is unstable, sensitive, and enormously volatile with unexpected shocks from the global market. In addition, the unique capital structure and debt structure of Chinese enterprises are inherently an exciting topic and thus widely explored in research (Fan et al., 2021; Zhang et al., 2015). To our best knowledge, the nexus between stock market volatility and corporate capital structure has not been explored. Surviving literature and evidence have powerfully prompted us to investigate the effect of stock market volatility on the capital structure choices of listed firms in the concrete context of the China stock market rather than imitating previous studies which focus on the volatility effect of individual stock returns on the corporate leverage.

Conclusion

     Choosing the capital structure as the increased stock market volatility is a vital concern of listed firms. This matter becomes more critical for listed firms activating in emerging markets, especially in China’s equity market, due to the following problems. First, emerging equity markets are immature and volatile. Simultaneously, listed firms in developing markets are quite sensitive to the equity market’s volatility. Second, thus far, corporate financing in China market essentially proceeds from internal funding and bank debts. In addition, Chinese firms universally have a high proportion of mature debts. Third, trade credit is an unofficial debt channel popularly used by Chinese firms when facing strict procedures from banks and credit institutions.

     Our study examines how the Chinese stock market volatility immediately affects the capital structure choices of Chinese listed firms from 2008 to 2018. The unique point of this research is the approach based on the capital use routines of Chinese firms instead of using two traditional capital structure theories to explain Chinese corporate capital structure, as in excellent previous literature (Chen, 2004; Huang & Song, 2006; Ni & Yu, 2008; Tong & Green, 2005; Zou & Xiao, 2006). We find that Chinese listed firms use the total market leverage and short-term market leverage at high levels, but long-term market leverage is used at low levels when the China stock market volatility increases and the lending interest simultaneously decreases. Empirical results point out that the positive correlation between corporate market leverage and stock market volatility is derived from the decline in the listed firm’s market value and the increase in bank debts. Trade credit significantly decreases while the bank debts tend to strongly increase in the debt structure of Chinese listed firms as the China stock market increases in volatility. Furthermore, we detect that short-term debts and bank debts are preferred in the capital structure of Chinese listed firms in response to the growing uncertainty of the China stock market and the change in lending interest rate.

Abstract

Introduction

Literature review and hypotheses development

Methodology and data

Empirical results

Conclusion

Research implications

Availability of data and materials

References

Acknowledgements

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Abstract

This study utilizes mediation analysis and bootstrapping to analyze the mediating effect of capital structure on the association between managerial ability and firm performance. The dataset consists of 6384 firm-year observations from the Taiwanese electronics industry during 2005–2018. Our results indicate that (1) low (high) levels of debt are likely observed in firms with CEOs with high (low) ability, (2) managerial ability positively affects firm performance, and (3) capital structure mediates the positive relationship between managerial ability and firm performance. Overall, the findings may have limited generalizability due to the specific sample characteristics and provide convincing support for the importance of capital structure as a mediator in the managerial ability-firm performance nexus. Specifically, this study highlights the need for examining the effect of managerial ability on firm performance through a mediator.

Introduction

In today’s fast-changing business climate, only focusing on the direct effect of managerial ability on firm performance may not fully reflect a manager’s ability to sustain competitive advantage. The current gap in the literature that links managerial ability to capital structure or firm performance, does so inadequately. Notably, although the literature shows that managerial ability has only unobservable effects on capital structure (Matemilola et al. 2013), there is less empirical evidence to show how it affects firm performance except for Ford and Shonkwiler (1994) and Wang et al. (2021). As a result, the association between managerial ability and firm performance may be considered spurious in the absence of a mediator. Thus, a study on the effect of managerial ability on firm performance via the role of a mediator is needed.

Additionally, literature has extensively examined the factors of corporate decision-making, including capital structure (Chen 2004; Chen et al. 2019; Huang et al. 2018; Klasa et al. 2018; Matemilola et al. 2019; Vo 2017) and firm performance (Hansen and Wernerfelt 1989; Hui et al. 2019; Huselid et al. 1997; Kafouros and Aliyev 2016; Liljeblom et al. 2019). A firm’s capital structure evidences managers’ abilities and affects profitability. According to the pecking order theory (Myers and Majluf 1984), if a company is profitable, it has retained earnings or cash for financing. Similarly, capital structure is a key factor in firm performance (Saeedi and Mahmoodi 2011). This is confirmed by agency theory (Jensen and Meckling 1976). Moreover, while managerial ability may explain a company’s debt level, Hackbarth (2008) suggests an association between managerial traits and capital structure decisions. Managers might have the ability, but their impact on firm performance may be indirect and operating through other variables such as capital structure. This mediating effect has not been investigated in the literature; hence, our study fills a much-needed gap.

Abstract

Keywords

JEL Classifications

1. Introduction

2. Literature and hypotheses development

3. Research methods

4. Empirical analysis

5. Conclusions

Declaration of competing interest

References

Abstract

This study examines the role of earnings management in the relationship between firm performance and capital structure, dividing earnings management into discretionary and nondiscretionary accruals to test established theories on the capital structure. Using data on 802 companies in the member countries of the Asia-Pacific Trade Agreement (APTA), our findings reveal that, in the absence of earnings management, the relationship between the capital structure and firm performance follows the trade-off theory or the pecking-order theory. Our results are consistent with agency theory only through managers’ intervention via earnings management. In India, substantial opportunistic behavior in discretionary accruals is observed, and management seems to focus on manipulating capital structure performance in opportunistic ways. Furthermore, discretionary earnings are focused more on hiding asset inefficiency that arises from forced increases in firm size, reducing earnings risk. These practices reduce the impact of the capital structure on firm performance. This study has vital implications for debt managers and performance analysts in APTA member countries. Rather than testing the applicability in a traditional way, this study recommends dividing earnings management into discretionary and nondiscretionary accruals to test capital structure theories. Because nondiscretionary accruals play a dominant role in earnings management, firm behavior is consistent with trade-off or pecking-order theory, as seen in patterns in the relationship between the capital structure and firm performance, whereas agency theory holds only after external intervention by managers in terms of earnings management.

1. Introduction

Earnings management has been one of the most crucial and specialized areas of research in finance for many years. The concept of earnings management1 and its measurement have been extensively studied. Studies have identified accruals as the most suitable measure of earnings management (DeAngelo, 1986, pp. 400–420; Dechow, Sloan, & Sweeney, 1995, pp. 193–225; Healy, 1985; Healy & Wahlen, 1999; Jones, 1991). Scholars understand that earnings management practices are used to fabricate firm performance, which might misguide owners or investors (Balsam, Bartov, & Marquardt, 2002; Burgstahler & Dichev, 1997a, 1997b; Chung, Firth, & Kim, 2005; Schipper, 1989; Scott, 2000; Siregar & Utama, 2008).

With the development of earnings management concepts, numerous studies have been conducted to explain its relationship with other aspects of business (Balsam et al., 2002; Chaney & Lewis, 1995; Dechow et al., 1995, pp. 193–225). However, the literature is scarce concerning the manipulation of capital structure efficiency through earnings management. The variation in the impact of the capital structure on firm performance between managed performance and unmanaged performance is still unaddressed.

Highlights

Abstract

Keywords

1. Introduction

2. Methodology

3. Barriers and strategies for NBS finance in different ecological domains

4. General barriers and strategies for financing urban NBS

5. Barrier 1: coordination across public and private financiers for urban NBS

6. Barrier 2: valuation and accounting for the multiple benefits of urban NBS

7. Conclusion: a framework for enabling urban NBS finance

8. Limitations and avenues for future research

Declaration of competing interest

Acknowledgements

Appendix A. Supplementary data

References

Abstract

Obtaining public and/or private finance for upscaling urban nature-based solutions (NBS) is a key barrier for reaching urban sustainability goals, including climate mitigation and adaptation. We carry out a systematic review of the academic literature to understand the key barriers and corresponding strategies for financing urban NBS. First, we report on specific financing challenges and strategies found for NBS uptake in four urban ecological domains: buildings, facades and roofs; urban green space (parks, trees); allotment gardens (including urban agriculture); and green-blue infrastructure. Across domains, we identify two overarching barriers of NBS finance: (1) coordination between private and public financiers and (2) integration of NBS benefits into valuation and accounting methods. We discuss strategies found in the literature that address these barriers; here, two things stand out. One, there is a large variety of valuation strategies that does not yet allow for an integrated accounting and valuation framework for NBS. Two, strategies aimed at coordinating public/private finance generally look for ways to encourage specific actors (real estate developers, residents) that benefit privately from an NBS to provide co-financing. We visualize our findings into a framework for enabling (public and/or private) finance for upscaling urban NBS.

1. Introduction

Nature-based solutions (NBS) are a form of eco-innovation that specifically promote nature as a means for providing solutions to climate change (mitigation and adaptation), bad air quality, loss of biodiversity, vulnerable coastlines and other threatened ecosystems, food insecurity and health, social and economic deterioration/injustice (Kabisch et al., 2016, p. 2; Nesshöver et al., 2017, p. 1216–1217). The European Commission additionally emphasizes NBS as a way to realise socially inclusive green growth (European Commission 2015). In general, NBS are recognized for their ability to simultaneously deliver multiple benefits (‘solutions’) to urban sustainability goals, such as biodiversity, climate change mitigation and adaptation, as well as social wellbeing (Kabisch et al., 2016).

NBS are realised in different urban ecological domains such as green buildings, facades and roofs, green space connected to grey infrastructure (playgrounds, street trees), parks and urban forests, allotments and community gardens as well as of different types of green-blue spaces such as lakes, urban drainage systems, permeable surfaces and wetlands. Derelict and former industrial areas and brownfield sites can potentially be re-developed as urban NBS. This diversity of NBS illustrates that NBS are adapted to place-based conditions (Dorst et al., 2019); each ecological domain or context can provide a unique set of services, benefits and values for different urban stakeholders, ranging from ecological services such as climate mitigation and water management to social and economic benefits, such as social cohesion and economic development. Urban NBS often represent local public goods (Besley and Coate 2003)—benefitting primarily those citizens in the area where they are located.

Firms in China with higher corporate social responsibility (CSR) performance may not substantially reduce their cost of equity capital versus firms in developed countries. To compare the different capital structures between developing and developed countries, this study examines whether CSR affects a firm’s cost of equity and debt capital in China. Our results show that Chinese firms with higher CSR performance can rapidly reduce their cost of debt capital. When we use capital structure (CS) as a moderator to evaluate the relationship between CSR and the cost of capital, the findings present that CS does not play a moderating role. The CSR value curve indicates that CSR investment by Chinese firms is still at legal and compliant levels, incurring more information asymmetry and less market efficiency in the country’s financial sector.

Introduction

The dramatic growth in international financial markets has caused corporate social responsibility (CSR) to become increasingly important. A firm now has to focus its attention on both increasing its revenue and being a good corporate citizen. Such a major transformation requires national and global companies to approach their business from the perspective of sustainable development and support CSR activity in order to benefit from any positive financial impact. CSR can be regarded as a manner in which companies consider environmental, social, and governance factors in their business decisions and processes, along with the strength of their relationships with various corporate stakeholders (Oikonomou, Brooks, & Pavelin, 2014). In developed markets such as the United States, firms prefer to raise their funds through the equity market, but in China, a uniquely fast developing country, firms tend to raise funds from the external debt market rather than the external equity market (Pessarossia & Weill, 2013). Fig. 1 demonstrates that U.S firms raise at least 70% of their corporate funds from the equity market, while less than 60% of Chinese corporate funds come from the equity market. There indeed is a huge gap in capital structure (CS) between China and developed markets such as the U.S (see Fig. 1).

1- Introduction

2- Data and research design

3- Main analyses

4- Extensions and robustness checks

5- Conclusion

References

Abstract

We find that both firm leverage and short-term debt ratios are negatively associated with social capital (i.e., the altruistic tendency and mutual trust among people within a community). This relation is more pronounced in cases where information asymmetry problems are more severe and is robust to using alternative measures of key variables, addressing endogeneity issues, employing alternative model specifications, and simultaneously estimating leverage and short-term debt. An analysis on debt structure (bank loans vs. public debt) shows consistent results. Our findings are in line with the idea that social capital lowers the need for corporate borrowing mechanisms as a means to alleviate agency problems for firms.

Introduction

The capital and debt structures of a firm can affect its value in many ways. One particular channel is through how they alter managerial incentives and impact investment decisions (Jensen and Meckling, 1976). In this regard, finding the optimal levels of leverage and debt maturity involves trading off the benefits and costs associated with them. For instance, using more leverage and shortening debt maturity can both alleviate problems that arise from management entrenchment (Harris and Raviv, 1990; Jensen, 1986), but at the same time introduce shareholder-creditor conflicts and liquidity risk, respectively, in addition to financial distress (e.g., Johnson, 2003; Myers, 1977). 1 Thus, an economic variable that bears the function of substituting the benefits of leverage and short-term debt, thereby lowering the associated potential costs and allowing the reallocation of resources, can be valuable to the firm. In this paper, we hypothesize that social capital fits such a role. Following Guiso et al. (2004), we define social capital as the degree of altruistic tendency and the level of mutual trust among people within a community. Plainly speaking, high social capital regions comprise of individuals that are more trustworthy, more cooperative, and less self-centered (see, for instance, Hasan et al., 2017b; Jha and Chen, 2015; Jha and Cox, 2015). We propose that managers in these areas are less likely to misbehave or take actions that may harm investors. This can be due to their society reflecting who they are, shaping who they become, or forcing them to be more concerned about reputation losses before taking value-destroying actions (Mead, 1934, p. 178). Through each of these channels, the managers are more likely to be perceived by investors as trustworthy.

To determine how carbon emissions reduction affects supply chain operations and financing decisions, this paper examines a green supply chain, which consists of one manufacturer (playing the leading role) and one capital-constrained retailer; in this supply chain, bank financing and trade credit financing are viable. This research explores the retailer’s optimal order quantity, the manufacturer’s optimal wholesale price, the optimal level of carbon emissions (for both bank financing and trade credit financing), and the design of the contract to coordinate the supply chain. We find that the supply chain achieves a win-win outcome in terms of production quantity and emissions reduction when the manufacturer invests in emissions reduction. In addition, we find that a supply chain with a contract outperforms a non-contract supply chain in production quantity and emissions reduction. Furthermore, the effect is more remarkable when trade credit financing is viable.

Introduction

The costly effects of global warming are continuously increasing and impacting economies all over the world. One of the main causes of global warming is the greenhouse effect, which is triggered by the increase of carbon dioxide emissions into the atmosphere (Gleick et al., 2010). To solve this problem, almost 200 countries committed to participating in the Paris Agreement in 2015. This agreement aimed to control and mitigate the negative effects of climate change (such as the world’s rising average temperature and greenhouse gas emissions). Due to an increasing recognition of the importance of environmental protection, there is currently a trend of attempts to address the issue of pollution caused by industrial development within the supply chain management process. Recent research has discussed this trend under the term “green supply chain management” and has introduced the concepts of sustainability and environmental thinking to green supply chain management (Sheu et al., 2005). Green supply chain management incentivizes manufacturers and retailers to take emission reduction into consideration when making business decisions. Researchers have found that green supply chain management is a win-win strategy for both retailers and manufacturers. Zhao et al. (2012) discovered that economic profits can be enhanced by improving a company’s environmental performance (from production to sales). Ma and Gao (2013) suggested that, by determining the wholesale price together, the supply chain can make more returns by reducing carbon emissions.

Prior research suggests that as a firm grows older many of its features change, and collectively these influence a number of aspects of its behavior. In terms of a firm’s capital structure decisions, there are several studies that document how aging firms have more assets-inplace than growth options, and so justifies their taking on more debt (e.g., Hovakimian, Opler and Titman (2001), Sundaresan, Wang and Yang (2015), etc.).1 In a different vein, other research suggests that after going public, the appropriateness of different corporate governance features for aging firms also changes. Filatotchev, Toms and Wright (2006) argue that as firms age (and particularly after their IPO), their governance (board composition) needs to change to reflect its different needs. 2 More recently, Johnson, Karpoff and Yi (2016) argue that the costs and benefits of takeover defenses change as the firm ages. They report evidence that after a firm’s IPO, the costs tend to outweigh the benefits as the firm ages and is reflected in their valuation, especially in firms that employ the most stringent defenses. Both of these studies suggest that the effect of these features on a firm’s capital structure decisions may change as the firm ages as a publicly traded firm. Given the above points, we are the first study to examine how the age of a firm since its initial public offering mediates the effects of its governance on the firm’s capital structure choices. However, to examine this issue we must confront several issues that are poorly addressed in prior research.

Emerging economies provide interesting scenarios for examining how institutional context influences the financing behavior of firms. In this study, we examine the capital structure of Chinese listed firms following the SplitShare Structure Reform of 2005. This reform allowed a reduction of government ownership by making government shares tradable. We find that the impact of government ownership on leverage is dependent on whether the government is the largest shareholder in a firm and whether the government ownership is through a parent state-owned enterprise. In addition, we document that the largest non-government shareholder positively influences leverage. Overall, our results reveal that the largest controlling shareholder, either government or non-government, has a significant impact on the capital structure of Chinese firms.
2018 Sun Yat-sen University. Production and hosting by Elsevier B.V. This is an open access article under the CC BY-NC-ND license (http://creativecommons.org/licenses/by-nc-nd/4.0/).

Introduction

Capital structure decisions are influenced by firm-specific, industry-specific and institutional factors. Rajan and Zingales’s (1995) seminal analysis of seven developed countries shows the importance of these three types of factors. Although the variables that influence financing decisions in developed countries are also influential in emerging economies, Booth et al. (2001) show that distinctive institutional features in emerging countries also play important roles. Emerging countries therefore provide interesting scenarios for studying a variety of institutional characteristics. Throughout the last decade, academics have become increasingly interested in studying the distinctive institutional context of China—the world’s largest emerging economy. Studies of the financing behavior of Chinese firms (Chen, 2004; Allen et al., 2005; Zou and Xiao, 2006; Huang and Song, 2006; Bhabra et al., 2008) report that these firms rely on informal financing channels, prefer short-term finance and use substantially lower amounts of long-term debt than similar firms in developed markets. Ayyagari et al. (2010) document that Chinese firms obtain 20% of their funds from banks and 80% from channels such as retained earnings, informal sources, loans from family and friends, trade credits, investment funds and equity. Chen (2004) and Zou and Xiao (2006) find that the well-documented firm-specific determinants of leverage such as firm size, profitability, growth opportunity and asset tangibility are also relevant in China. Yet, the low explanatory power of these determinants calls for more research into the impact of institutional features on capital structure in China. A notable institutional context in China is that the ownership of publicly traded firms is highly concentrated, and the government is a major player in corporate financing (Sun and Tong, 2003). Government ownership can induce firms to borrow more through preferential loan policies and loan guarantees and an intention to maintain state control. Alternately, it can lead to less borrowing due to opportunistic managerial behavior and the higher likelihood of approval of equity issues.1 Among a handful of studies of the effect of government ownership on capital structure, Huang and Song (2006) and Zou and Xiao (2006) observe no impact of government ownership on the leverage of Chinese firms, whereas Bhabra et al. (2008) and Li et al. (2009) document a positive impact on long-term debt. Pessarossi and Weill (2013) show that government ownership facilitates the issuance of corporate bonds.

Introduction

The focus of the empirical capital structure literature is almost exclusively on publicly traded firms without shedding much light on the financial decisions of private firms. The scarce research on the capital structure of private firms is unfortunate since these firms represent most of the economy.1 Given that private firms are fundamentally different from public firms, we cannot draw reliable conclusions about private firms’ debt financing choices based on public firms’ financing choices. Towards this end, in this paper we answer the following questions: First, does a firm’s private/public status affect its choice of debt versus equity financing? Second, do private firms rely more on short-term debt? Third, do economic conditions influence differently debt financing choices of private and public firms? One notable difference between private and public firms is the level of information asymmetry between managers (insiders) and investors (outsiders). Due to the cost of asymmetric information, a firm follows a pecking-order rule regarding its financing sources: retained earnings to debt, short-term debt to long-term debt, and debt over equity.2 Because private firms are more opaque than public firms (the assessment of a firm’s risk profile is more difficult), the value of outside equity in private firms is more sensitive to information asymmetry than in public firms. As a result, private firms are likely to rely more (less) on debt (equity) financing than public firms. Similarly, private firms are expected to use more short-term debt than long-term debt, holding all else equal. Previous studies on corporate policies of private firms consider only the very large private firms, omitting the majority of small and medium size firms (e.g., Brav 2009; Saunders and Steffen 2011; Gao et al. 2013). Knowing that the cost of information asymmetry is more pronounced in smaller and medium-size private firms, the exclusion of these firms potentially renders an incomplete picture of the role of asymmetric information in debt financing of private firms. Using the entire population of Canadian firms allows us to circumvent potential sample selection biases typical for subsamples of firms. After controlling for standard capital structure determinants, our results show that the leverage of private firms is 12% higher than for public firms. In addition, based on the within-firm estimator, private firms’ leverage is 3% higher compared to public firms’ leverage, suggesting that unobserved firm heterogeneity drives a substantial portion of leverage choices, and hence the need to use firm fixed effects. Asymmetric information plays a role not only in financing choices (i.e., debt vs. equity) but in debt maturity as well. Private firms are expected to rely more on shortterm than on long-term debt because private firms would likely reap higher benefits of short-term debt by revisiting their creditors more frequently in order to gain from monitoring and consequently lower information asymmetry costs. Similarly, private firms with high information asymmetry are expected to issue short-term debt to avoid locking in their cost of financing with long-term debt if they expect to borrow at more favorable terms in the future (e.g., Diamond 1991; Barclay and Smith 1995). Our results show that after controlling for firm time-varying factors and unobserved firm heterogeneity, private firms rely more on short-term debt than public firms.