Mean reverting leverage policy in China: theory and evidence from industrial and sectorial level unit root analysis

Abstract

Purpose

This study aims to apply unit root test to investigate the behavior of Chinese firms toward their leverage policy. The study is based on two influential and competing theories of capital structure.

Design/methodology/approach

This study applies unit root test to investigate the behavior of Chinese firms toward their leverage policy. The study is based on two influential and competing theories of capital structure. Trade off theory advocates that firms have a target level of leverage ratio and that firms try to achieve that optimal leverage ratio, whereas pecking order theory argues that firms have no target level of leverage and that they follow a specific pattern of leverage. For this purpose, this study applies a Fisher type unit root test to 12,808 firm level observations. The data are unbalanced and cover a period from 1991 to 2014.

Findings

The results reveal the presence of a stationary behavior across short-term, long-term and total leverage policies. For short-term leverage policy, 21 per cent firms show stationary behavior, while for long-term, 20 per cent show a targeting behavior; for the total leverage policy 17 per cent of firms are found to follow a tradeoff model. To make the findings more interesting sample was further classified into profit and loss making firms. The study finds that loss making firms do not follow a target level of leverage in China. Furthermore, unit root is applied to all firms before and after crises-2008. It is revealed that stationary behavior is more prevalent before crises-2008.

Originality/value

This study is highly important from the point of view that it quantifies firms into distinct categories of following specific model of capital structure. To the best of the author’s knowledge, the findings of this study add to current research knowledge about Chinese firms with respect to adjustment behavior toward a target capital structure.

Citation

Rehman, A.u. (2018), "Mean reverting leverage policy in China: theory and evidence from industrial and sectorial level unit root analysis", Journal of Asia Business Studies, Vol. 12 No. 3, pp. 290-306. https://doi.org/10.1108/JABS-10-2016-0138