OPPapers.com

Determinants Of Capital Structure In China

Introduction
Since the economic reform in 1970’s, China is now in a process of transforming a command economy to a market economy, and has achieved a great success in economic development. The world is now paying more attention on Chinese economy. Capital structure is one of the issues that are worthy of consideration. However, most previous studies on capital structure and its determinants arisen from the practical experience of western developed countries such as UK and US. There have been few studies concerning the particular situation of China, where state still plays an essential role in all economic activities. Therefore, this paper will discuss the key determinants of the capital structure of Chinese firms, comparing to UK firms. Other than those demand side factors that have been frequently discussed, the paper focuses both firm-specific and non firm-specific issues, which are also apparently important in China. It will briefly go through the general theories involved at the beginning, and then analyze 5 major firm-specific factors influencing leverage level with comparison to firms in UK. Finally, two non firm-specific effects will be examined as the unique characteristics of Chinese firms.

Theories involved
There are two influential theories on capital structure determinants that will be focused mainly in the paper. One of them is the static trade-off theory developed in 1980s, which states that each firm should reach an optimal capital structure through balancing the tax field benefits and the financial stress brought by debts. (Brounen and Eichholtz 2001). The other one concerned is the pecking order theory claiming that firms make their finance choices based on how conveniently and easily they can access to the capital. As a result, internal capitals such as retained profit are preferred to external ones, while equity financing is considered to be the last resort. (Frank and Goyal 2002).

Firm specific factors
Most previous capital structure...