Institutions and capital structure : the case of Chinese property companies

Abstract

Different institutional features have been found to affect capital structure decisions, but their connections to corporate finance theories are not always clear. One thing that obscures the connections is the complexity of institutions, and hence the difficulties in achieving the ceteris paribus condition in empirical studies. The connection this study is interested in is the predictive power of the agency theory and the pecking order theory under different information environments. The key challenge is to find cases with distinct information environments while keeping other institutional features constant. The strategy of this study is to compare two similar groups of property companies listed on the Mainland China stock exchanges and the Hong Kong Stock Exchange, respectively. Both groups of companies operate in the Mainland property market and are subject to the same tax code, macroeconomic market conditions and property market policies, but the degrees of transparency and integrity of the stock markets are weaker for the Mainland-listed companies. After constructing the two groups of samples for comparison, two tests are developed for assessing the predictive power of capital structure theories – a test of the agency theory using such corporate governance factors as managerial shareholding and shareholding concentration, and a test of the pecking order theory using an error correction model. The relative sizes of the coefficients estimated from the Mainland and Hong Kong-listed samples show that factors related to agency conflicts and information asymmetries exert a stronger influence on the capital structure decisions of Mainland-listed companies than on those of the Hong Kong-listed companies. Further tests on the R-squared statistics of the regression models show that variables derived from the two capital structure theories can explain more variations of the capital structures of Mainland-listed companies than those of Hong Kong-listed ones. The findings are robust after controlling for SOE effects, the value discount of untradeable shares, and potential self-selection bias. Using this well-controlled comparison to achieve the ceteris paribus condition, the tests reveal an indirect effect of institutions on capital structure decisions of listed companies. Institutional factors affect capital structures by influencing the roles of other determinants derived from the agency and pecking order theories. This study builds up and tests the connection between institutions and corporate finance theories, and concludes that the information environment affects the predictive power of corporate finance theories through influencing the strengths of their underlying assumptions.