Master Thesis:
The Determinants of Chinese Public Companies’ Capital Structure
and How are They Affected by China’s New Accounting Standards
Student Name: Song Jing
Student Number: 10839488
Date: 28 September, 2015
Supervisor: Dr. Stefan Arping
Master thesis Master in International Finance
Abstract
China issued New Accounting Standards in 2006 to standardize its accounting system and reduce its difference with international standards. In this paper, we use the data of Chinese public companies from year 2001 to year 2005 and from 2006 to 2010, and conduct an empirical study to figure out explore the relationship between relevant factors and capital structure of public firms and how is it affected by the New Accounting Standards. The results showed that new accounting standards have effect on how scale of company affect capital structure, market timing activities exist in Chinese market, Chinese public firms have a preference of equity financing and whether the public firm is controlled by government or not has no significant influence on its capital structure.
This document is written by Song Jing, who declares to take full responsibility for the contents of this document. I declare that the text and the work presented in this document is original and that no sources other than those mentioned in the text and its references have been used in creating it.
The Faculty of Economics and Business is responsible solely for the supervision of completion of the work, not for the contents.
Acknowledgements
Firstly, I wish to express my sincere gratitude to my supervisor Dr. Stefan Arping for providing me with all the necessary help for the research and for his constant patience and guidance.
Secondly, I want to say thanks to my friends Yahui Ge, Dan Yi, Juan Li, Linghuan Zhang, Ningbo Li, Miao Zhang, Jingjing Luo, Gigi Jia, Han Jiang. Without your help and company, I wouldn’t have had such a brilliant year for my Master program.
Lastly, I would like to thank all members of the MIF office for all works you have done during past year.
1. Introduction...1
2. Literature review ...3
2.1 Market timing theory...3
2.2 Pecking order theory...6
2.3 Trade off theory...9
3. Data...10 3.1 Variable Description...10 3.2 Sample selection...13 3.3 Data Resource ...15 4. Hypothesis ...15 5. Empirical study...17 5.1 Empirical Model...20 5.2 Regression Result...22 5.3 Further analysis...27 6. Conclusion...28 Reference...30
1. Introduction
Since became a member of WTO in 2001, China has faced the problem of anti-dumping investigation from several countries. However, as there are giant gaps between China’s accounting standards and International accounting standards, it couldn’t be of much help in the respondent. Because of this issue, China’s economy is not admitted as market-oriented economy, so during the process of anti-dumping investigation, America and European Union normally use data of subrogate countries, which are Japan, Singapore, India, America and so forth. However, as most of the selected subrogate countries have much higher labor cost, it is unfair for China in the investigation. As a result, China’s New Accounting Standards was issued in 2006.
The main changes are listed as follows. Firstly, according to China’s New Accounting Standards, investment estate are separated from self-used estate and estate inventory, which can reflect the constitute of real estate owned by the enterprise more clearly.
Secondly, China’s New Accounting Standards requires that the scale of impairment of assets should be expanded, rather than limited to the former eight items. It also requires that company should have impairment test for its asset on the date of balance sheet and long-term asset impairment reserves cannot be reversed. The new accounting standards have more strict rules in asset impairment, and the amount of asset and before tax profit will be reduced dramatically after applying to the new standards.
At last, China’s New Accounting Standards introduced the definition of financial assets, which include the cash, short-term investment, some portion of long-term investment, long-term bond and accounts receivable.
In this paper, we will focus on the effects of this accounting system reform has on the capital structure of Chinese public companies.
Capital structure refers to the way a corporation finances its assets and the composition of its capital, especially the ratio of equity and debt. In China, with the development of capital market, public companies play a more and more important role in the society and the overall economics, for that they involve a huge amount of investors and their operation condition have large impact on their stake holders. Capital structure is one of the key factors of public companies’ financial management. It involves the market value, operation efficiency and financial risk of the companies.
Modern corporate finance theory is one among the fundamentals of modern finance theory, while capital structure plays an important role in corporate finance theory. Capital structure theory aims at realizing the possible maximum enterprise value and maximizing stockholders’ wealth. It does not only affect the firm’s capital cost and performance, but also the enterprise’s management system (the relationship between stakeholders and the firm itself). In addition, capital will have effect on the behavior of management layer of the corporation.
Scholars from other countries have made a lot of theoretical and empirical studies on capital structure since it became a hot topic in security market in 1958. Compared to it, although Chinese scholars also get some improvement in capital structure theory research, there haven’t been a capital theory system which really adapts to China’s capital market practice.
In the past decades, there were a lot of scholars studying on capital structure of public companies. The issue that what are the factors influencing the capital structure of public
companies and how they have impact on it has been controversial for years. Up to now, there are three widely accepted theories that could explain the insight of capital structure in the world, which we will explain in detail in literature review.
2. Literature review
2.1 Market timing theory
Market timing hypotheses was first proposed by Stein in 1996. It said that when the market value of one stock was overvalued due to the irrationality of investors, the managers of the company may take advantage of the over-passion of investors and finance by issuing shares.
In the past nearly twenty years, there were a large amount of thesis probing into market timing theory and practically testing based upon historical data in Chinese or overseas’ stock markets.
Baker and Wurgler(2002), through analyses of actual financing decisions, long run returns following equity issues and repurchases and realized and forecast earnings around equity issues, found that equity market timing is the dominant aspect of real financial policy. In other words, firms rarely care whether financing with equity or debt, they just chose the alternative with, at that point, the most market value. They used the market-to-book ratio to measure the market timing opportunities perceived by managers and found that firms with low-leverage trended to raise funds when their market value was high. Conversely high-leverage firms trended to finance when their market valuation was low. These effects on capital structure persisted for at least a decade. At last they also suggested that in market
timing theory, there was no optimal capital structure but just accumulate financing decisions over time into the capital structure outcomes. The market timing theory of capital structure would have substantial explanatory power.
On the other hand, in the research conducted by Hovakimian 2006, he empirically probe into the relationship between leverage and market-to-book ratio (EWAMB), weighted average market-to-book ratio (EFWAMB) and other independent variables such as profitability (PRE), size, asset tangibility (TNG) and so on. He found no evidence of significant equity market timing for debt issues and debt reduction but results coinciding with market timing of equity issues. However, the effects on capital structure are small and transitory, which means it is not significantly long-lasting effects of market-to-book on leverage. He also put forward an alternative hypothesis that external finance weighted-average market-to-book is related to target leverage because it contains information about future growth opportunities. Specifically, current financing and investment decisions are determined by EFWAMB and market-to-book ratios averaged over time reflect slowly changing growth opportunities. In all, his research didn’t support the hypothesis that the significant long-lasting effects of market-to-book ratios on capital structure reflect past equity market timing. He suggested an alternative hypothesis that external finance weighted-average market-to-book contains information about the firms’ growth opportunities not captured by current market-to-book.
Alti, in 2006, attempted to capture market timing and its impact on capital structure by focusing on a single financing event that is the initial public offering (IPO). He measured the market timing directly by whether the IPO takes place in a hot issue, characterized by high
IPO volume in terms of the number of issuers, or a cold issue market. In this research, he found that market timers, identified as firms that go public when the market is hot, issue substantially more equity than cold market do. Further tests regarding issuers’ starting leverage, investment and dividend policies, and cash balances are all consistent with the idea that the hot market effect on equity issues is indeed driven by market timing. Market timing effect on firms’ capital structure is negative, which is also a short term effect. Hot market firms experienced a greater decline in their leverage ratios in the IPO year. After their IPOs, hot market firms started to issue significantly more debt and less equity than cold market firms did. As a result of this active, the leverage ratios of hot market firms increase significantly in the 2 years following IPO and reverse the negative impact of hot market effect. He also claimed that market timing is an important determinant of financing activities in short run, but in long run, its effects are not significant.
In the recent years, China’s scholars did a lot of researches about the market timing theory as well. In the research conducted by Guozhong Li in 2006, which intended to probe into the market timing hypothesis in Chinese market, he did an empirical study base on the data of Chinese public companies during previous 10 years and he found that firms with high market-to-book tended to issue equity rather than debt. In short run, market-to-book ratio had significant effects on firms’ capital structure. However, in long run, average weighted market-to-book ratio (M/Befwa) which representing the historical market-to-book ratio of a firm had nearly no explanatory power to capital structure. He also found that Chinese public firms adjust their present capital structure based on the market-to-book ratio in the last period.
That means market timing only had short run effects in Chinese market and accumulative historical market-to-book ratio had insignificant effect on firms’ capital structure and their financing decisions.
Song Ma (2013) through empirical study on data during 1999 to 2009 of Chinese public companies tested the effectiveness of market timing theory in Chinese market. He found that in short run (1-2 years) market timing had significant effects on firms’ capital structure, however in long run (5-6 years), those effects would no longer lasting. He claimed that the Chinese market had only been developing for several decades and the market system had not been mature. And the regulations had not been completed yet. It was hard for public firms to seize the very market timing.
Bin Lu and Binyue Gao, in 2012, used the Tobit model and data in Shanghai and Shenzhen stock exchanges during 1998 and 2009 to testify the effect of market timing on Chinese public firms’ capital structure. The result showed that market timing indeed had effect on firms’ capital structure, however the effect was declining and until the fourth year after IPO, the effect became insignificant. They also found that the profitability of firms had positive relation with capital structure during the period 3 to 4 years after IPO. After that, the relation would reverse to negative.
2.2 Pecking order theory
Pecking order theory was first suggested by Donaldson in 1961 and it was modified by Stewart C. Myers and Nicolas Majluf in 1984. It stated that companies would like to first
finance (from internal financing to equity) with internal funds and considering issuing equity as a financing means of last resort, for the lower information cost of financing.
Murray and Vidhan (2003) tested the pecking order theory of corporate leverage on broad cross-section of publicly traded American firms for 1971 to 1998. They found, contrast to what the theory suggested, internal financing is not sufficient to cover investment spending on average and external financing is heavily used. Debt financing did not dominate equity financing in magnitude. However, when narrower samples of firms were considered the greatest support for the pecking order was found among larger firms in earlier years. Over time, support for the pecking order declines for two reasons. Comparing to larger firms, small firms were less able to follow the pecking order theory. With more and more small firms trading publicly, the overall average moves further from the pecking order. In addition, equity became more important. At last, they claimed that this didn’t mean that the information contained in the financing deficit is completely irrelevant. The components of the financing deficit appeared factored in to some degree, particularly by large firms when they adjusted their leverage.
Jean and Nellie (1996) tested the pecking order theory by examining the financing of firms that went public in 1983. They estimated a logit to predict external financing, and a multinomial logit to predict the type of financing using data on the IPO firms’ security offering during 1984-1992. Their result provided little support for the pecking order theory. Firms did not appear to reach the capital market because of shortfall in internal funds, the size of the deficit, which had no predictive power for the decision to obtain external funds. There
was no significant evidence showing the relationship between deficit and the tendency to borrow or issue equity. However, the theory was supported by the finding that firms with surplus funds avoid the capital markets. They interpreted their result as evidence against the pecking order theory and consistent with the optimal capital structure model in which firms raise external financing in the absence of a deficit to reach a target capital structure. Their results did not indicate that firms strongly avoid external financing, as pecking order theory predicts. Furthermore, equity was not the least desirable source of financing, since it appeared to dominate bank loans.
In Chinese market, Shaoan Huang and Gang Zhang (2001) conducted a research upon public firms during 1990 to 2000. They had a close look at the capital structure of those firms and found that Chinese firms significantly prefer to financing with equity. The primary reasons of such preference are the low cost of equity and immature financial market condition. The equity financing preference had very bad effects on the efficiency of capital, prospects of firms and the overall macro financial market. Further, they proposed some suggestion to weaken the equity preference. First is to complete the share-issuing and accounting regime, using the policy to guide and constrain the public firms. Second is to improve the systems of public firms, ensuring every decision benefit to the company. The last is to promoting marketization, let the market chose the ones with ability, passion and supervision to be stock holder, and ones without those to be the creditor.
Haixia Tian, Xinlan Wang (2010) claimed that public firms in China mainly financed with external source and rarely took use of internal funds. On the other hand, there was an
increasing trend of using debt financing. The strict restrictions in debt market and loose regulation in stock market is the first reason for such present condition, which made financing with equity bare lower cost and risk. In addition, Chinese stock market was under development, information management, trading system and regulation were needed to be improved. At last, the management structure of public firms was undesirable. The information asymmetry between managers and stockholders pulled down the capital efficiency of firms heavily.
2.3 Trade-off theory
Lakshmi and Stewart (1999) tested the traditional tradeoff theory, representing by a target adjustment model, against the pecking order model of corporate financing. They found both model independently perform well and had explanatory power to corporate financing behavior. When the two models were tested jointly, the coefficients and significance of pecking order models changed hardly; the performance of the target adjustment model degraded, though the coefficients still appeared significant. The strong performance of the pecking order did not occur because firms would like to meet the unanticipated cash needs by debt in the short run. The results suggested that firms planned to finance anticipated deficit with debt. The overall results suggested greater confidence in the pecking order than in the target adjustment model.
Weiqiu Yuan (2004) tested trade off theory against pecking order theory in Chinese market by using the financial data during 1995 to 2002. The result showed that pecking order theory had little explanatory power for the capital structure of Chinese public firms, while trade off
theory was significantly coincident with the overall financing condition in Chinese market. The author suggested that the preference of financing methods of domestic firms did not mean that the financing behaviors of domestic public firms were irrational. On the contrary, taking advantage of low cost was a rational decision. Furthermore, financing behavior coincident with trade off theory meant the existence of the optimal capital structure of public firms. Managers of public firms drove the whole firm to the optimal point, which also meant that their financing behaviors were outcomes of rational decisions.
3. Data
3.1 Variable Description
Table 1. Variable Description
Variable Definition Asset Liab Profit M/B Inv/Fin Gov ShortL
The total asset of the firm at the end of the year The total Liability of the firm at the end of the year The net profit of the firm at the end of the year The ratio of total market value/ book value
The ratio of cash flow from investing/ cash flow from financing Whether the percentage of government ownership is more than 50% The total short-term liability of the firm at the end of the year
Market Timing
According to market timing theory, firms tend to issue equity when they believe
their stocks are overvalued, and repurchase share and finance with loans when their stocks are undervalued. We can identify the market timing of firms by look at the total market value of their shares. Here we use Market Value/Book Value (M/B) to represent the market timing for firms.
Market Value/Book Value (M/B) = Market Value/ Total Stockholder’s equity
A high MB ratio means the stocks of the firm are overvalued, on the other hand, a low MB ratio means the stocks of the firm are undervalued.
Market Index
The market index here denotes both Shanghai stock exchange market index and Shenzhen stock exchange market index. We use market index to illustrate the overall market condition, and it is another way to measure market timing.
Capital Structure
The capital structure shows how a firm finances its asset through equity or liability. Here we study firms’ capital structure through the Liability/Asset Ratio which means the composition of liability in firms’ total financing. The liability is the total liability of the firms including both long term and short term. Liability/Asset Ratio (D/A) = Total Liability/ Total Asset
Scale
We believe the scale of firms would have effect on firms’ capital structure. When making financing decisions, firms with large scales would consider differently with firms with small scales, for that they have more capital, reputation and social resources. Since the scale of a firm is hard to measure directly and would accumulate and grow through time, we use the
Total Asset (Asset) to illustrate the firms’ scale.
Short Term Liability (ShortL)
The short-term liability of the firms denotes liabilities should be paid in one year.
When firms have to finance with external sources, we believe liabilities due in short term would be a necessarily factor managers must consider.
Net profit (Profit)
Net profit denotes the revenue deducted by any cost generated through operation during the whole year. We believe the net profit is one of the key factors when making financing decisions. First of all, high level of net profit means larger amount of internal sources. Secondly, profit means the confidence to deal with liabilities. Higher profit makes the firms stronger to bear more liability. In addition, high level of profit would stimulate managers to invest more to persuade even more profits.
The ratio of Funds financed with debt to the total asset (FL)
The funds firms financed by debt and equity through the whole year are key factors that have direct effect on the capital structure of the firms.
FL=Funds financed by debt/ Total Asset FE=Funds financed by equity/ Total Asset
Government Owenership(Gov)
It is a dummy variable to illustrate whether the government is in control of the firms. If Chinese government owns more than fifty percent of the firm’s stock shares, we say that the firms are under control of the government and value of the dummy variable equals to 1. Otherwise the firms are not under control of the government and the value of the dummy value should equal to 0.
3.2 Sample selection
We collected the data of Chinese public firms in both Shanghai stock exchange and Shenzhen stock exchange from 2001 to 2005 and from 2006 to 2010.
The reasons are followed:
(1) Chinese public firms started to report cash flow since 1998. (2) The reformation of accounting system took place in 2006.
(3) We mainly focus and study on the capital structure of firms in short term. All the data are screened base on the rule followed:
(1) Type A shares are issued and subscripted by RMB, so we remove all other types except Type A shares.
(2) Type ST public firms are removed, since their unhealthy finance situations may bring noisy to the empirical result.
large difference in capital structure. All the firms in those two industries are removed. (3) Firms with key variable data missing are removed.
(4) Firms with abnormal data are removed. (e.g.: extremely high MB ration, MB>=15)
Table 2. Statistical Description of Samples (2001-2005)
Year Number Maximum D/A Minimum D/A Average D/A Median D/A
2001 1249 13.583 0.012 0.502 0.439 2002 1310 10.375 0.013 0.522 0.457 2003 1372 23.799 0.011 0.557 0.487 2004 1463 34.786 0.008 0.604 0.509 2005 1460 43.075 0.013 0.658 0.535 Average 1371 25.124 0.011 0.569 0.485
Table 3. Statistical Description of Samples (2006-2010)
Year Number Maximum D/A Minimum D/A Average D/A Median D/A
2006 1520 877.256 0.021 1.265 0.545 2007 1620 124.022 0.009 0.782 0.521 2008 1372 142.718 0.018 0.767 0.516 2009 1684 138.378 0.002 0.707 0.511 2010 2122 29.493 0.011 0.535 0.464 Average 1664 262.373 0.061 0.811 0.511
3.3 Data Resource
Sample data are collected through China Stock Market Accounting Research
(CSMAR). Financial data are collected by the end of year. Data are processed by STATA12.0.
4. Hypothesis
Assuming the market timing activities of firms make sense, when the overall market condition is good, the managers of firms would prefer to issuing shares rather than debt.
Hypothesis 1: The amount of Initial Public Offering (IPO) and seasoned issue is correlated
with the market index.
When the market index goes up, the number of IPO and seasoned issue increases. On the contrary, when the market index goes down, the number of IPO and seasoned issue decreases.
As the market timing theory goes when the stock price of a firm is overvalued, the firm trends to issue equity to finance. On the other hand, when its stock price is undervalued, the firm trends to finance with debt.
Hypothesis 2: The firms’ capital structure, which is the Liability/Asset Ratio (D/A), is
significantly negative related to the Market Value/Book Value (M/B).
Firms with large scale have more accumulated capital, better social resources and steadier operation condition than small-scale firms. We believe, comparing with small scale, firms with large scale have stronger ability to bear debt and would like to have a financial preference of debt.
Hypothesis 3: The ratio of funds financed with debt to the total asset (FL) is significantly
positive related to the natural logarithm of total asset (LnAsset) of the firm.
The net profit is a kind of measurement of the profitability, internal sources and ability of bearing debt. In addition, we believe firms with stable and high level of net profit would prefer to adjusting their capital structure to a higher level of liability, for that the tax shield of debt could be maximized.
Hypothesis 4: The ratio of funds financed with debt to the total asset (FL) is significantly
positive related to the ratio of net profit to total asset (RProfit).
According to the trade of theory, firms have its expected debt to assets ratio. At this debt to asset level, firms would have the maximized market value and gain the most benefits from tax shield deducted by bankruptcy cost. Managers would adjust the capital structure of firms to follow the optimal ratio all the time. When parts of liabilities are going to expire, managers would like to bring in new loans to keep the ratio.
Hypothesis 5: The firms’ capital structure, which is the Liability/Asset Ratio (D/A), is
positively related to the government ownership.
That is to say, if the government owns more percentage stock shares of one firm, the firm is more likely to take more debt. In this case, we use one dummy variable to distinguish firms that are controlled by the government, which means the government owns more than 50% of the firm’s total equity. In our thoughts, in general, the government-controlled firms tend to
bear more liabilities. In theory, they are able to take more risk which are arisen by the large amount of liabilities and are more easier to finance more money by debt because they are supported by the government which means their ability to pay back funds are higher and risk for lenders are much lower when compare with other public companies.
Hypothesis 6: The firms’ capital structure, which is the Liability/Asset Ratio (D/A), is
negatively related to the natural logarithm of Cash Flow from Investing Activities/Cash
Flow from Financing Activities Ratio(LnInv/Fin).
Hypothesis 7: After the New Accounting Standards, the scale of company has different effect
on capital structure when compared with the period before it.
According to the main changes mentioned above, the new standards require that the scale of impairment of assets should be expanded, rather than limited to the former eight items. It also requires that company should have impairment test for its asset on the date of balance sheet and long-term asset impairment reserves cannot be reversed. The amount of asset will be reduced by large amount and thus big companies would be more likely to use debt to finance to reduce the impairment loss than small companies.
5. Empirical study
Based on the studies on capital structure already done by scholars overseas and in China, our empirical study mainly consist of two parts: (1) testing existence of the market timing effect
in Chinese market and, if existing, its short term influence; (2) testing the impact on capital structure of other factors.
According to the hypothesis 1, we take the IPO and seasoned issue firms during January, 2001 to December, 2010 as our samples. We view the index of Shanghai and Shenzhen stock exchange as the measurement of overall stock market condition. Then we construct the line charts.
Chart 1. The relationship between Shanghai Stock Exchange Index and IPO and Seasoned Issue Firms
Chart 2. The relationship between Shenzheng Stock Exchange Index and IPO and Seasoned Issue Firms
As shown in the chart above, we found that there are some difference between the index line and IPO and Seasoned Issue line, however both of them are following the same trend in general. When the index line goes up, the number of IPO and seasoned issue firms line goes up too, between which there are a little time lag. When the index line goes down, the number of IPO and seasoned issue firms also goes down significantly. There is also a little time lag.
Set the time period August 2006 to August 2008 as an example, there are five times of rise in the index line in both stock exchanges. Correspondingly, there are five times of rise in the number of IPO and seasoned issue firms. In the same period, there are five times of tiny drops in the index line in both stock exchanges. Corresponding to each drop, the number of IPO and seasoned issue firms dropped obviously.
Based on the charts and analysis above, we could claim that the phenomena of market timing exist in Chinese capital market. When the overall condition of the stock market is good, firms would like to finance with equity, and when the overall condition of the stock market is not satisfying, fewer firms would choose to finance by issuing shares.
5.1 Empirical Model
According to the hypothesis and expectation of variables, at first we construct the following theoretical model:
D/A=α+βShortL+c Asset + d M/B+ e Profit+ f Gov+ gInv/Fin+µ
D/A: The ratio of total liabilities/ total assets at the end of the year
ShortL: The total short-term liabilities of the firm at the end of the year
Asset: The total asset of the firm at the end of the year
M/B: The ratio of market value/ book value at the end of the year
Profit: The net profit of the firm at the end of the year
Gov: Whether the Chinese government owns more than 50% of the firm’s stock shares
Inv/Fin: The ratio of cash flow from investing activities/ cash flow from financing activities
However, after we run the data in STATA software, we found out that R-square for this model is even smaller than 0.01, which indicates that this model evidently isn’t suitable for these data. So, we need to modify the model to adapt to these variables.
After consideration, we choose to use the natural logarithm of some variables instead using them directly. There are several reasons for using the natural logarithm form. First and foremost, using natural logarithm form of these variables can provide us with better goodness of fitting for the model. After changing the model to the natural logarithm form, the model can explain the relationship between the variables in a higher degree. Secondly, similarly vital, as the data we use are in the form of panel data, we should be aware of the appearance of non-stationary. However, the usage of natural logarithm model can help to prevent this problem, otherwise, we might have to use difference to solve this problem. Last but not least, using natural logarithm model could contribute to lowering the probability of multi-collinearity and heteroscedasticity. Using natural logarithm form model, it is less likely to have these two problems in the model.
Thus, the new model after adjustment is like following:
LnD/A=α+βLnShortL+c LnAsset + d LnM/B+ e LnProfit+ f Gov+ gLnInv/Fin+μ D/A: The ratio of total liabilities/ total assets at the end of the year
ShortL: The total short-term liabilities of the firm at the end of the year Asset: The total asset of the firm at the end of the year
Profit: The net profit of the firm at the end of the year
Gov: Whether the Chinese government owns more than 50% of the firm’s stock shares
Inv/Fin: The ratio of cash flow from investing activities/ cash flow from financing activities
α is the interception, μis the error term andβetc. are the coefficients of these variables to LnD/A.
5.2 Regression Result
We use the financial data during 2001 to 2005 to run the regression. The results are followed.
Table 4. Result of regression (2001-2005)
LnD/A Coefficient Standard Error t value P>|t|
LnSshortL LnAsset LnM/B LnProfit Gov LnInv/Fin Constant 0.6920 -0.4935 0.4120 -0.1195 0.1566 -0.0050 -4.2203 0.0074 0.0127 0.0046 0.0022 0.1151 0.0018 0.1763 93.87 -39.00 8.87 -5.46 1.36 -2.74 -23.94 0.000 0.000 0.000 0.000 0.174 0.006 0.000
Table 5. Result of regression (2006-2010)
LnD/A Coefficient Standard Error t value P>|t|
LnShortL LnAsset LnMB LnProfit Gov LnInv/Fin Constant 0.1440 0.05536 0.0330 -0.0506 0.1365 4.6955 -4.2203 0.0057 0.0123 0.0070 0.0054 0.2213 0.0046 0.2265 25.27 4.50 4.70 -9.36 0.62 3.14 20.73 0.000 0.000 0.000 0.000 0.537 0.002 0.000
As the result shown above, we can see that, for both periods, the absolute values of t values for all variables except Gov are all bigger than 1.96, which indicates that all these variables except Gov have significant impact on the capital structure of the firms at 95% significance level. And for f test, we can find that P value is 0.0000 which is lower than 0.05. So we can say that these variables have joint significant influence on the capital structure ratio.
To be more specific, the market to book ratio (M/B) has significant negative relationship with the capital structure (D/A) of public firms, which proves the correction of hypothesis two. It also illustrate that the market timing effect has short-term impact on public firms in Chinese market.
As for hypothesis five, we mentioned above that from the result we can tell that Gov doesn’t have significant impact on the firms’ capital structure, which means the firms will not be affected by their ownership structure when they choose their capital structure. So, we made a mistake about hypothesis five and we have to draw our conclusion that whether public firms are controlled by Chinese government or not doesn’t cause significant difference in their choice of capital structure. In our opinion, the reason for this phenomenon is that although the firms are controlled by the government, normally, the government will not actually get involved in making the decisions. Most time, the internal board of directors will make the decisions and the government will only play the role of supervision and directing.
When it comes to hypothesis six, we can see that the Inv/Fin ratio has significant influence on the liabilities/asset ratio. In addition, as the coefficient is negative, these two ratios are negatively related to each other. So, hypothesis six is correct according to the regression result.
For hypothesis seven, we notice that for first period, LnAsset, which is the measure of the companies’ scale, has negative relation with LnD/A. However, for the period after the new standards, the relation becomes positive. So, we can say that hypothesis seven is correct according to regression result.
To probe into the factors impacting on firms’ capital structure, we construct another theoretical model to testing the rest hypothesis.
FL: The ratio of funds financed by debt/total asset at the end of the year Asset: The total asset of the firm at the end of the year
ShortL: The total short-term liabilities of the firm at the end of the year
RProfit: The ratio net profit of the firm at the end of the year/total asset at the end of the year
M/B: The ratio of market value at the end of the year / book value at the end of the year Gov: Whether the Chinese government owns more than 50% of the firm’s stock shares
α is the interception, µis the error term andβ etc. are the coefficients of these variables to FL.
The result of the regression is followed.
Table 6. Result of regression 2 (2001-2005)
FL Coefficient Standard Error t value P>|t|
LnAsset LnShortL RProfit M/B Gov Constant -1.7177 0.9880 -0.4654 -0.0002 0.1919 16.9385 0.0554 0.0365 0.0325 0.0013 0.6468 0.7654 -31.02 27.04 -14.30 -0.13 0.30 22.13 0.000 0.000 0.000 0.894 0.767 0.000
Table 7. Result of regression 2 (2006-2010)
FL Coefficient Standard Error t value P>|t|
LnAsset LnShortL RProfit M/B Gov Constant 38.1534 350.5796 -0.1394 0.0535 381.2300 -2915.2250 31.0185 16.2114 0.00750 0.0059 684.2911 631.6568 1.23 21.63 -18.49 9.12 0.56 -4.62 0.219 0.000 0.000 0.000 0.577 0.000
As the result shown above, we can see that, for the data from 2001 to 2005, the absolute values of t values for all variables except M/B and Gov are all bigger than 1.96, which indicates that all these variables except M/B and Gov have significant impact on the ratio of funds financed with debt/ total asset of the firms at 95% significance level. However, for the result of data from 2006 to 2010, we find that the result has changed in some aspects. We can see that although Gov still doesn’t have significant impact on FL, M/B has significant impact on the ratio of funds financed with debt/ total asset of the firms at 95% significance level this time. While LnAsset has no significant impact on FL at 95% significance level.
As shown in the first chart above, the scale of firms (Asset) is significant negative related with the ratio of funds financed with debt to the total asset (FL). It means during the period from 2001 to 205, firms with large scale prefer to finance with less debt. However in the five years after the accounting system reform, the scale of firms (Asset) has no significant impact
on the ratio of funds financed with debt to the total asset (FL). Although the results are different, but both of them indicate that the hypothesis three does not conform to the reality as well.
In both periods, the net profit of the firms has significant positive impact on the ratio of funds financed with debt to the total asset. It means firms with high level of net profit and profitability would prefer to finance with debt, which proves the correction of hypothesis four.
5.3 Further Analysis
In the result showed above, in first period, the scale (Asset) of firms has significant negative impact on the funds financed with debt. One possible reason is that Chinese public firms have strong preference on equity because of the immature capital market, incomplete regulation system and inefficient management system of firms.
Theoretically, the cost of equity financing should be higher than debt financing. However, in Chinese market, the cost of issuing debt is impressively low. According to the financial data in 2000, the Price per Share ratio (P/E ratio) of new-issuing shares is nearly 27, which means if the firms issuing the shares pay all their profit as dividend, the cost of the equity financing is about 2.7%, lower than the cost of after tax bank loan at the same time (5.58%*(1-15%) =4.74%). In addition, by financing with equity, firms do not need to pay back the premium and transfer the risk to stockholder. And in Chinese stock market, public firms hardly pay or pay dividends at a very low level, which lower the cost of equity financing even further.
Due to the incomplete regulation system, information asymmetry happens all the time. In order to pursue high improper benefits, some public firms report their financial situation incompletely, unpunctually and dishonestly.
On the other hand, as for public firms, their management construction is inefficient. Behaviors of public firms are the reflection of their managers rather than their shareholders, which makes the agency problem. The managers, in order to maximize their personal benefits, have a strong preference of equity financing. The debt financing would make the make the managers bear the risk of bankruptcy, increase the bankruptcy cost and reduce their controlling interest. In addition, if bearing debt, the firms have to pay the interest and premium, which would occupy a part of cash flow of firms.
In all, under the situations above, public firms in China generally have a preference of equity financing. And before the issue of China’s New Accounting Standards, firms with large scale have stronger preference than small scale firms.
6. Conclusion
In this study on Chinese public firms’ capital structure, we use the sample of public firms in Shanghai and Shenzhen stock exchange from 2001 to 2005 and 2006 to 1010 to analyze the effect of the accounting system reform and the relationship between capital structure and relevant factors. Through the process above, we can draw the following conclusions.
(1) Market timing theory makes sense in Chinese market. When the overall condition of economy is good, firms would trend to finance with equity. When the overall economy condition is bad, the number of firms that use equity financing would decrease sharply.
(2) When the stock price of firms is overvalued, the firms would prefer to issue share to finance funds. When the stock price is undervalued, firms would decrease the equity financing and turn to debt financing.
(3) Public firms in Chinese market have a preference of equity financing for the reason of low cost of issuing share, incomplete regulation in market and inefficient management construction of firms. And firms with large scale have stronger preference than small scaled firms.
(4) Whether the public firm is controlled by government or not has no significant influence on its capital structure.
(5) Firms with larger scale are less likely to use debt financing rather than firms with small scale.
(6) In Chinese market, firms with high level of short-term liabilities would more like to use debt financing.
(7) After the issue of China’s New Accounting Standards, large companies becomes more favorable of using debt financing comparing with small companies.
Reference
Alti A., "How Persistent Is the Impact of Market Timing on Capital Structure", Journal of Finance, 2006.
Baker and Wurgler, "Market Timing and Capital Structure", Journal of Finance, 2002.
Baruch Lev, "Remarks on the Measurement, Valuation, and Reporting of Intangible Assets", Economic Policy Review, 2003.
Bin Lu, Binyue Gao, " Impact on Capital structure of Public Firms of Market timing and expected capital structure——Empirical Study based on Chinese Public Firms ", South China Journal of Economics, 2012.
Guozhong Li, "Capital Structure and Market Timing: Evidence from Cross-section Data of Chinese Listed Companies", Journal of Central University of Finance and Economics, 2006.
Haixia Tian, Xinlan Wang, "Study on Capital structure and Financing Preference of Public Firms ", Study and Explore, 2010.
Hovakimian A., "Are Observed Capital Structures Determined By Equity Market Timing". Joumal of Financial and Quantitative Analyses, 2006.
Jean Helwege, Nellie Liang, "Is There a Pecking Order? Evidence from a Panel of IPO Firms", Journal of Financial Economics, 1996.
Lakshmi Shyam-Sunder, Stewart C. Myers, "Testing Static Tradeoff against Pecking Order Models of Capital Structure", Journal of Financial Economics, 1999.
Masulis, Ronald W., "The Effect of Capital Structure Change of Security: a study of exchange offers", Journal of Financial Economics, 1980.
Modigliani F. and Miller M.H., "Corporate Income Taxes and the Cost of Capital: A Correction", American Economic Review, 1977.
Mokhova Natalia, "The cost of capital in the present-day condition: The impact of the Global Financial Crises", Economics and Management, 2011.
Murray Z. Frank, Vidhan K. Goyal, "Testing the Pecking Order Theory of Capital Structure", Journal of Financial Economics, 2003.
Ross S., "The Determination of Financial Structures: An Incentive Signalling Approach", Bell Journal of Economics, 1977.
Shaoan Huang, Gang Zhang, "Study on Financing Preference of Chinese Public Firms", Economic Research Journal, 2001.
Song Ma, " Capital Structure and Market Timing——Empirical Study based on Chinese Public Firms during 1999-2009", Journal of Capital University of Economics and Business, 2012.
Stein Jeremy C., "Rational Capital Budgeting in an Irrational World", Journal of Business, 1996.
Weiqiu Yuan, "Study on Pecking Order and Trade off Theory", The Journal of Quantitative and Technical Economics, 2004.
