The Effects of China's Split-Share Reform on Firms’ Capital Structure Choice

44 Pages Posted: 23 Oct 2015 Last revised: 6 Nov 2016

See all articles by Liang Guo

Liang Guo

California State University, East Bay

Donald D. Lien

University of Texas at San Antonio - College of Business - Department of Economics

Ya Dai

Analytic Focus LLC

Date Written: October 22, 2015

Abstract

The Split share Structure Reform in year 2005-2006 raises the curtain for China's secondary privatization. It mitigates the agency conflicts between controlling shareholders and minority shareholders and, thus, brings substantial changes to China’s financing behaviors. This paper aims to examine its impact on firms’ capital structure decisions by applying a variety of trade-off and pecking order models. Using data from 1,176 non-financial Chinese listed firms during the period from 2000 to 2012, 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. This phenomenon is more prominent after year 2006 as the shares reform increases the trading activities in the secondary stock market and thus alleviates the asymmetric information problems. Secondly, the partial adjustment model suggests that Chinese firms have an optimal leverage ratio and they adjust below-target leverage ratios faster than above-target leverage ratios after the implement of the shares structure reform although they make a symmetric adjustment towards the target leverage ratio before year 2007. The implication is that the share-split structure reform reduces the agency costs and costs of upward leverage adjustment, leading to a faster target reversion for firms with below-target leverage ratio but not for those with above-target leverage ratio. Thirdly, the error correction model reveals that before the reform Chinese firms make dynamic adjustment towards target leverage at an asymmetric rate, with stronger and faster response to the changes in target leverage than to past divergence from long-run target leverage ratio. In the post-reform period, however, Chinese firms have made a symmetric adjustment towards the desired leverage as they correct the divergence of their actual leverage ratios from the long-run target level at a faster speed while they do not significantly speed up their response to the short-run target leverage changes. All these results further support the applicability of dynamic target adjustment models.

Keywords: Split-share reform, Capital structure, Trade-off theory, Pecking order theory, Dynamic target adjustment models

JEL Classification: G32

Suggested Citation

Guo, Liang and Lien, Donald and Dai, Ya, The Effects of China's Split-Share Reform on Firms’ Capital Structure Choice (October 22, 2015). Applied Economics, Volume 48, 2016 - Issue 27. Available at SSRN: https://ssrn.com/abstract=2678190 or http://dx.doi.org/10.2139/ssrn.2678190

Liang Guo (Contact Author)

California State University, East Bay ( email )

Donald Lien

University of Texas at San Antonio - College of Business - Department of Economics ( email )

6900 North Loop 1604 West
San Antonio, TX 78249
United States
210-458-4313 (Phone)
210-458-4308 (Fax)

Ya Dai

Analytic Focus LLC ( email )

San Antonio, TX
United States

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