Presence of Foreign Firms and the Capital Structure of Domestic Firms: Evidence from China’s Manufacturing Sector?

Abstract

Using a simple theoretical model, where presence of foreign firms leads to a positive externality to domestic firms, this paper argues that an increase in foreign presence increases the debt of domestic firms and its impact on firm investment is also positive. As foreign presence increases both debt and investment, its impact on firm leverage cannot be unambiguously determined. We explore the link between foreign presence and firm leverage by using firm level panel data from China. The empirical estimation based on the Instrumental Variable Tobit regression reveals that, in overall terms, the impact of foreign presence on the leverage of domestic firms in China's manufacturing sector is negative. We find that the negative impact on the leverage of privately owned firms is relatively large. Furthermore, the impact of foreign presence on the leverage of domestic firms varies from industry to industry.

Keywords: capital structure, presence of foreign firms, panel data analysis, China

JEL Classification: F36, G31