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1 Introduction
Ever since MM theory was been introduced by Modigliani and Miller (1958), the company’s
capital structure decision has been the most controversial topic in academic and business circles
(Rajan and Zingales, 1995). When investigating imperfections in the financial markets, scholars of
company finance have loosened not only the premise of MM theory but also the factors that
influence the company’s identity, industry and institution and the environment of the company’s
capital structure decision (Demirgüç-Kunt and Maksimovic, 1999; Booth et al., 2001; Bancel and
Mittoo, 2004; Joeveer, 2006; Kirch and Terra, 2012). Recently, one study has found that county
characteristics not only directly affect a company’s capital structure decision but also indirectly
affect the company’s capital structure decision through factors such as company identity (De Jong
et al., 2008; Venanzi et al., 2014). Thus, some academics take a single country as their research
sample, exploring the effect of financial development and the legal environment in various areas
of a country on company’s financial decisions (Demirguc-Kunt and Maksimovic, 1998; Rajan and
Zingales, 2003; De Carvalho, 2009; Agostino et al., 2009).
It is well-known that corruption and credit access are two important problems experienced by
Chinese companies. According to Doing Business 2015, which is published by the World Bank,
the convenience level of China’s business environment in 2014 ranked 90
and the convenience level of credit access in China ranked economies with a score of 36 points in Transparency
International’s 2014 global Corruption
Perception Index (CPI). This raises the question of whether the corruption experienced by Chinese
companies affects their access to credit. Demirguc-Kunt and Maksimovic (1999), Booth et al.
(2001) and Fan et al. (2012) find that the more protected a country’s legal system, legal execution
and property rights, the more debt funding and long-term debt funding are available to the
companies in that country. In that event, with the advancement of financial development in China,
it is unclear whether financial development has curbed the influence of corruption on firms’ capital
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structure decisions. In other words, have the interactions between corruption and financial
development affected firms’ capital structure decisions?
This paper takes lists companies in the Shanghai and Shenzhen stock markets from 1998 to
2013 as research samples, empirically investigating the influence of corruption and financial
development—and the interactions between the two—on Chinese companies’ capital structure
decisions. The empirical results show that after controlling for China’s legal environment,
companies’ internal factors, and industry factors, and considering endogeneity problems,
corruption and financial development have significantly positive effects on companies’ bank loans.
However, after investigating the interactions between corruption and financial development, we
find that the relationship between the two involves competition instead of completion. More
specifically, financial development does add to a company’s bank loans in areas with a higher
level of corruption. However, corruption and financial development have insignificant negative
effects on a company’s long-term bank loans. In addition, all of these results hold when
controlling the development level of the stock market and the nature of a company’s property, and
considering merely bank debt and changing the correlation variables.
Following are this paper’s primary contributions. First, unlike most studies, which use
cross-country data as their research samples, this paper uses only Chinese listed companies.
Although China has a unified legal system and credit policy, there is a huge divergence among
various provinces, municipalities and autonomous regions in terms of their financial development,
legal environment and corruption (Allen et al., 2005; Wang and You, 2012). Therefore, taking
China as the research sample not only eliminates the specific influencing factors from the state
level, improving the influence of the institutional environment (Svensson, 2005; De Carvalho,
2009) but also overcomes some problems that occur in cross-country studies such as inconsistent
accounting standards and a lack of comparability among statistical caliber, social rules, manners
and customs, and concepts of value. In this way, we have arrived at more dependable results.
Second, many studies have adopted the Law and Finance perspective of La Porta et al. (1988),
analyzing the influence of the legal system, judicial efficiency and financial development on a
company’s financing decisions, few studies have considered the influence of corruption on a
company’s financing decisions. However, most of those studies considered the corruption which
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creditors obtain the collateral or maintain the creditor rights after a debtor’s defalut and the the
effect of corrruption on creditor grant loans(Qian and Strahan, 2007; Haselmann et al., 2010). This
paper focuses on company loans in which credit corruption or juridical corruption may occur
following a debtor’s breach of contracts in the context of the legal environment in various parts of
China. More specifically, the focus is the influence of a corrupt environment on companies’ capital
structure decisions. Finally, although some studies have focused on the influence of corruption and
financial development on a company’s capital structure decisions (De Carvalho, 2009; Fan et al.,
2012), none have considered the influence of the interaction of corruption and financial
development on a company’s capital structure decisions
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①
. In China, a developing country, we must
promote financial-industry reform, accelerate the speed of financial development, increase the
scale of company loans, and decrease companies’ financial costs on the one hand, and achieve
strict control over corruption to provide a sound external funding environment for banks to grant
credit and for companies to obtain credit on the other hand. This paper will provide empirical
evidence for China to develop its financial industry and curb corruption.
We organize the remainder of this paper as follows: Section 2 presents a literature review
and develops our hypotheses. Section 3 describes sample data, variables and methodology.
Section 4 presents the empirical findings. Section 5 discusses issues of robustness and describes
numerous additional tests. Section 6 concludes with a brief summary.
2 Literature Review, Hypotheses Development
2.1 Corruption and Capital Structure
Corruption has been considered a crucial factor in constructing a state’s legal system,
resource distribution and company behavior (Fan et al., 2012). Corruption affects a company’s
capital structure decision in two ways. On the one hand, when investors intend to invest in a
company, they expect to regain their capital based on criteria specified in the contract (Bolton and
Dewatripont, 2005; Leland and Pyle, 1977). Thus, if the contract cannot be performed, however
complete it is, the creditor receives its capital and interest back with little right of recourse.
Ahlin and Pang (2008) examine empirical evidence of the effect of corruption-curbing and financial
development on economic growth. Fishman and Svensson (2007) investigate the effect of corruption and tax
revenue on company growth. Chan (2009) examines the influence of corruption and financial restraint on company
growth.
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Judicial corruption is one factor that affects contract performance and creditors’ carry-out of right
of recourse. Shleifer and Vishny (1993) have announced that in seriously corrupt countries,
investors suffer a higher risk that they will not get their capital back. These higher risks and
potential implementation costs make banks reluctant to offer credits or increase the credit standard
in a manner that will increase the cost of securing external funding. In this situation, corruption
can lead to a decrease in bank credit (La Porta et al., 1997). Weill (2011a) takes advantage of data
from banks and regional corruption indexes, finding that Russia’s corruption resulted in blocked
bank credit. Zhu and Chen (2007) and De Carvalho (2009) analyze corporate data on China and
Brazil and find that corruption prevents corporations from obtaining bank credit.
Moreover, in addition to judicial corruption, there is credit corruption that appears when
companies apply for bank credit. Stiglitz and Weiss (1981) find that adverse selection caused by
asymmetric prior information between bank and debtors can lead to credit rationing. The existence
of credit rationing suggests that some debtors choose to pay an interest rate far in excess of the
official rate. Consequently, they are motivated to bribe bank officers to obtain credit. If debtors
actively bribe bank officers to increase their chances of receiving credit, then corruption increases
the company’s bank credit. Weill (2011b) analyzes cross-country bank data, finding that although
corruption blocks bank credit in general, this block decreases when the degree of a bank’s risk
aversion increases, which reduces credit barriers for companies. Chen et al. (2013) draw on Cai et
al. (2011), measuring corporation corruption through entertainment expenses reported in the
Chinese Corporate Financial Index and finding that corruption contributes to companies’ receipt of
bank credit. Fan et al. (2012) analyze cross-country data from 39 countries and Fungacova et al.
(2015) analyze data from 14 transition countries. Their common finding is that there is a positive
correlation between corruption level and a company’s receipt of bank credit and a negative
correlation between corruption level and long-term bank credit.
In recent years, despite the fact that the rapid development of China’s capital market has
offered more options for corporate funding, our capital market remains relatively underdeveloped
(Gong et al., 2014), our funding tool is not adequate enough (Zhao et al., 2008) and banks remain
the major capital provider for corporations and occupy a monopolistic position in the credit market.
Although the Central Bank decreases the banks’ monopoly profit by controlling interest rates,
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bank officers have various methods of evading those controls and taking rent from corporations by
virtue of their monopolistic position, obtaining illegal profits in the process. To increase the
likelihood of receiving credit, corporations are willing to bribe such bank officers (Xie and Lu,
2005). In the meantime, regulators are strict about banks’ control of their non-performing loan rate,
which means that banks must control the risk of not regaining their capital. Short-term credits are
favorable for banks to obtain timely and constant information about debtors, thus placing
corporations under the banks’ close supervision and control (Diamond, 1991; Rajan, 1992; Jiang
and Li, 2006; Yu and Pang, 2008). Thus, banks would prefer to grant more short-term credit,
especially in regions in which corruption is very serious. Therefore, this paper proposes hypothesis
1:
Hypothesis 1: Corruption has a positive effect on a company’s debt ratio, whereas there is a
negative effect on a company’s long-term debt ratio.
2.2 Financial Development and Capital Structure
Capital structure focuses on the source of firm capital and its component percentage. Classic
capital structure theory assumes implicitly that the elasticity of capital supply is ideal and that
firms need only to make funding decisions that maximize firm value depending on their financing
status; it ignores the restriction of capital supply. Faulkender and Petersen (2006) suggest that
capital structure is the result of both capital demand and capital supply. Cross-country studies of
capital structure suggest that the financial market environment and the development level are
primary factors that affect firms’ capital structure decisions (Rajan and Zingales, 1995; Booth et
al., 2001).
There are two strands of literature that address how financial development affects firms’
capital structure decisions. The first strand examines the direct influence of financial development
on a firm’s capital structure decisions. Jiang and Li (2006) take Chinese listed companies as a
sample, finding that larger a regional bank’s loan balances or the fiercer the competition between
banks, the higher a firm’s short-term credit. De Carvalho (2009) takes companies in Brazil as a
sample, finding that in an environment with a higher level of financial development, firms have
greater access to bank credit. Agostino et al. (2009) takes small and medium-sized companies in
Italy as a sample, finding that the more branch institutions owned by a regional bank, the higher
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the debt ratios of small and medium-sized companies. Sett and Sarkhel (2010) take non-financial
private companies in India as a sample, finding a positive correlation between a firm’s financial
leverage and the development of the market for bank credit, but a negative correlation between a
firm’s financial leverage and the development of the stock market. Based on dynamic panel data
from 359 non-financial companies, Kirch and Terra (2012) examine the effect of the financial
development of five South American countries on the expiring date of firm credit. Their result is
that financial development has a positive effect on a firm’s long-term credit. Fan et al. (2012) find
that in countries with more cash in the banks or higher savings rates, companies have a higher debt
ratio and more short-term debt.
The second strand examines the indirect effect of financial development on firms’ capital
structure decisions, in other words, how credit policy or credit shocks affect both financial
development and firms’ capital structure decisions. Kashvap et al. (1993) find that contractionary
monetary policy changes a firm’s external funding in that the bank credit available to the firm
substantially decreases. Sufi (2007) finds that with the introduction of bank credit rationing,
companies with worse credit are granted access to bank credit, resulting in an increased debt ratio.
Leary (2009) finds that the debt ratio of small companies with a high degree of dependence on
bank loans and low credit ratings changes more significantly than large companies with a low
degree of dependence on bank loans and high credit ratings. Voutsinas and Werner (2011) analyze
the fluctuation of the influence of credit supply on firms’ capital structure from 1980 to 2007,
finding that credit-supply fluctuation affects companies that are the most dependent on bank credit.
Su and Zeng (2009) find a negative correlation between the risk of failing to repay credit and the
capital structure of listed companies in China, whereas there is nearly no correlation between
credit rationing, stock market performance and capital structure. Zeng and Su (2010) analyze the
influence of China’s 1998 credit expansion and 2004 credit contradiction on firms’ capital
structure, finding that after the 1988 credit expansion, small companies with a high degree of
privatization and weak ability to secure their debt received more bank capital and experienced a
remarkable increase in their debt levels. Conversely, after the 2004 credit contradiction, these
types of companies’ debt ratio significantly decreased. Wu et al. (2013) take 848 Chinese listed
companies from 2001 to 2010 as samples, finding both that credit policy significantly affects a
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firm’s capital structure as a macro-level factor in terms of financial supply and that credit supply’s
influence on circulating debt is greater than its influence on long-term debt. Shen et al. (2015)
check the influence of the impact of bank loans and the credit cycle on Chinese firms’ capital
structure using empirical evidence of quarterly data, finding that the influence of credit supply on
the debt ratio of differently scaled companies varies. More specifically, with the increase in the
credit supply, large state-owned enterprises increased their debt ratio.
By reducing the cost of external funding (Rajan and Zingales, 1998), financial development
both provides a relatively sound method of debt funding for firms and prompts a constant increase
in the debt funding levels of firms (Claessens et al., 2003). In an emerging market economy whose
institutions remain relatively backward and whose capital markets have not matured, companies
attempt to accumulate capital primarily through debt funding. Financial development is the
primary external factor that affects a firm’s capital structure (Schmukler et al., 2006). According to
Fan et al. (2012), the crucial factor that affects a firm’s capital structure might be the asymmetry in
the information and contracting costs of the company and the potential external fund provider. The
existence of asymmetric information might enable companies to benefit from higher levels of debt
(Diamond, 1993; Flannery, 1986) because banks has the advantage of the economy of scale in
terms of information-obtaining and banks have stronger incentives than do other small investors to
use collected information to supervise the debtor. In financially developed regions, banks can
effectively obtain and deliver information about debtors (Yu and Pang, 2008). In addition, market
efficiency contributes to avoiding opportunistic behaviors by company managers (Diamond, 1991).
Therefore, banks are willing to grant loans to firms at a satisfying price. Conversely, in financially
underdeveloped regions, the problem of asymmetric information is more serious, and banks
control their default risk by establishing a somewhat higher contracting cost. Moreover, in a
financially underdeveloped region, financial agents are willing to offer more long-term debt
funding given their ability to collect information about debtors’ economy of scale and their ability
to supervise the debtors (Barclay and Smith, 1995; Demirguc-Kunt and Maksimovic, 1999). Thus,
a developed financial system not only makes it convenient for companies to access external debt
funding but also offers cheaper credit to valuable firms (Guiso et al., 2004). On these grounds, this
paper proposes hypothesis 2:
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Hypothesis 2: Financial development has a positive effect on firm debt ratio and long-term
debt ratio.
2.3 The Interaction between Corruption and Financial Development and Capital
Structure
Since the 1990s, the status of China’s market economy has been gradually established and
with the deepening of market-oriented reforms, our country’s financial system reform has been in
a state of constant advancement. The market is playing a greater role in resource distribution.
Financial reforms have increased the independence of bank credit and credit decisions have
become more market-oriented. The issue of credit will become more dependent on hard factors
such as a firm’s business performance and debt ratio (Lin and Li, 2005). We found that China’s
marketing progress varies largely by region (Fan et al., 2011). China exhibits many divergences in
terms of the legal system and the market’s progress. Consequently, firms from different regions are
confronted by various legal systems and levels of financial development (Zheng and Deng, 2010;
Xie and Huang, 2014).
In regions that have a poor legal environment, especially where corruption is serious, taking
advantage of the right to issue loans, bank executives either obtain direct rebates by issuing loans
or obtain invisible benefits through other methods under the banner of marketization (Guo, 2014).
The established practices of bank officers require firms to sign invisible contracts that divide the
rents if they want to obtain credit and more credit funding (Joel and Howitt, 1980). Thus, in
regions with serious corruption, even if regional financial development improves, that
improvement will result in little change in the influence of corruption on firms’ capital structure
decisions because of the effect of firms’ expectations on corruption. Wang and You (2012) find
that to some extent, corruption substitutes for financial development. Kirch and Terra (2012) find
that institutional quality comes before financial development when analyzing the influence of
financial development and institutional quality on the expiration date of firms’ debt in five South
American countries.
Similarly, in financially developed regions, competition in the financial market is fierce and
laws provide better protections for creditors’ rights. By studying the relation between the
protection of creditors based on legal provisions and the quality of law enforcement and banks’
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credit market, LLSV (1998) finds that the better creditors’ rights are secured, the more developed
the credit market, the larger the scale of credit (Haselmann et al., 2010), and the more credit a firm
can obtain, the longer the time to maturity (Qian and Strahan, 2007; Hall and Jorgensen, 2008).
However, the relation between the protection of creditors and bank credit is affected by the quality
of judicial enforcement. Marcella et al. (2001) find that the quality of judicial enforcement in
Argentina is poor, creditors have little credit available and banks have many non-performing loans.
Laeven and Majnoni (2005) find that after controlling several influences from a state’s
characteristics, judicial efficiency is the primary driver (second to inflation) of an increased
interest margin. Safavian and Sharma (2007) find that the better the right of creditors is secured,
the more loans firms can obtain. However, in countries with a poor law-enforcement system, firms
receive fewer benefits from improvements to creditors’ rights. Thus, in financially developed
regions, corruption has a negative influence on firms’ ability to obtain bank credit.
Hypothesis 3: The effect of corruption and financial development on a firm’s capital structure
decision is a competition effect. In other words, in regions with a higher level of corruption, there
is a negative correlation between financial development and a firm’s debt ratio; In regions with a
higher level of financial development, there is a negative correlation between corruption, a firm’s
debt ratio and a firm’s long-term debt ratio.
3 Sample Data, Variables and Methodology
3.1 Sample Data
We use annual report data on China’s listed companies from 1998 to 2013 to check the
influence of corruption and financial development on firms’ capital structure, choosing 1998 as the
beginning year to ensure the comparability of the corruption data because the revised edition of
the Criminal Law of the People’s Republic of China was passed during the 5
National People’s Congress on March 14
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session of 8
, 1997. Chapter 8 of that law includes—for the first
time—prohibitions on embezzlement and bribery. Moreover, based on earlier documents
researching firms’ capital structure and taking China’s realities into consideration, we have made
the following selections. First, we cross out listed financial companies from our research samples
because of their specific governing policies. Second, we cross out ST and PT companies because
their specific financial data. Third, we cross out listed companies without 3 years of financial data
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