Corporate Governance and the Capital Structure of Listed Firms: Evidence from China

Abstract

The relationship between the capital structure and profitability of listed firms in China is investigated in this paper, in that the leverage, profitability and a firm's ownership structure are studied in detail. It is an exploratory study based on all firms listed on the Shanghai and Shenzhen stock exchanges from 1999 to 2005. The results of the empirical analysis are reported. The most significant finding is that pecking order theory does not appear to hold in China. The order for profitable firms at least is retained earnings, equity finance, and then debt. The first aspect of pecking order theory holds as more profitable firms are able to utilize internal financing, which in consonance with the principle of least resistance, is the preferred channel of financing. The more profitably the firm, the less reliance the firm has on debt. On the other hand, tax shields do not provide an incentive to rely on debt as the pecking order theory would support and infers that debt is the least likely financing source utilised by listed firms in China. Of further economic impact is the finding that the higher the proportion of leverage, the less profitable is the firm. Also of interest is the finding that state has a negative relationship with leverage and that legal person, public and foreign holdings are found to have a positive relationship with the leverage of listed firms in China. This shows that there is a greater reliance on debt financing when there is a move away from state ownership. Both foreign and LP owners are large institutional shareholders in the main and apply leverage monitoring agent. In addition foreign holders are likely to experience information asymmetry problems and thus seek monitoring management decisions though debt.