Corr uption, Financial Development and Capital

Structure: Evidence from China

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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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because of the restraints of our research method. Fourth, we cross out 4 listed companies in Tibet
because the Tibetan legal environment index contains many omissions. Based on the above
selections, the final number of companies is 1,803 and the firm-year number is 14,403.
Company financial data, total stock market value and circulating shares market value comes
from the CSMAR database, and the actual controller data comes from CCER (SinoFin) database.
Otherwise, the gross domestic product of each province, municipality and autonomous
administrative region, the growth rate of gross domestic product, the consumer purchasing index,
the total investment in fixed assets and the investment in state-owned enterprises come from the
China Statistical Yearbook. The deposit balance for banking in each province, municipality and
autonomous administrative region and the RMB deposit balance of residents in urban and rural
areas at the end of the year are derived from the Almanac of China's Finance and Banking. The
legal environment index for each province, municipality and autonomous administrative region
are derived from the growth index and legal environment index of market intermediary
organizations (data from 2010 to 2013 comes from Lagrange multipliers) of China’s Marketization
Index, published by Fan et al. (2011).
3.2 Empirical Model and Variables Definition
We use the following basic dynamic panel model to check the influence of corruption and
financial development both on firms’ capital structure and on term structure.
(1)
Meanwhile, we also focus on the influence of the interaction between corruption and
financial development both on firms’ capital structure and on term structure. Thus:
(2)
Based on Alvesa and Ferreirab (2011) and Fungavova et al. (2015), we delay all of the
independent variables for one term to reduce the reverse causality that occurs simultaneously.
i, j and t represent companies, the provinces, municipalities or autonomous administrative
regions in which the company locates and time (similarly hereinafter), respectively;  represents
a firm’s fixed effects;
firm’s capital structure decisions. Because total debts includes a portion of non-interest debts, a
firm’s effective gearing might be magnified. Thus, the total debts variable could not represent
firm’s risk of breaching contracts effectively (Rajan and Zingales, 1995). To avoid the dilution
effect of non-interest debt on lever adjustment and taking this paper’s purpose into consideration,
the paper takes the interest-bonded debt ratio as the main index of the lever. Whether to choose
book-leverage or market-lever is a problem worth considering. This paper learns from the method
of Tiitman and Wessel (1988) and Berger et al. (1997), considering not only a firm’s book debt
ratio (Lev1) but also its market debt ratio (Lev2 and Lev3). More specifically, Lev1 equals
(short-term loans of the year-end + long-term debts that will due in one year of the year-end +
long-term loans of the year-end) / total assets of the year-end; Lev2 equals (short-term loans of the
year-end + long-term debts that will due in one year of the year-end + long-term loans of the
year-end) / (total debt of the year-end + equity of the year-end (circulating shares market values));
Lev3 equals (short-term loans of the year-end + long-term debts that will due in one year of the
year-end + long-term loans of the year-end) / (total debt of the year-end + equity of the year-end
( total market value)). Simultaneously, we have considered the maturity structure of firm’s bank
credit (MR), which equals long-term loans of the year-end / (short-term loans of the year-end +
long-term debts that will due in one year of the year-end + long-term loans of the year-end).
In addition, when all other affecting factors remain stable, the capital structure decision is a
continuous and dynamic adjustment progress, possessing some certain inertia characteristics and
path dependency. Previous capital structure decisions affect current decision making. Moreover,
one outstanding advantage of dynamic panel data model is that by controlling the fixed effect we
can simultaneously overcome the problem of omitted variables and the reverse causality problem
(Arellano and Bond, 1991). Thus, we include the lags of the dependent variable in our model by
learning from Huang and Ritter (2009) and Elsas and Florysiak (2008).
Fin represents the financial development level of each province, municipality and
autonomous administrative region. Because this paper focuses on the capital supply effect on
firms’ capital structure decisions, we measure regional financial development by the ratio of
deposit balance in financial institutions in each province, municipality and autonomous
administrative region to regional GDP, following the method adopted by Fan et al. (2012). FinD
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represents the dummy of financial development.
Corru represents corruption level in each province, municipality and autonomous
administrative region. Building on Goel and Rich (1989), Fishman and Gatti (2002), Glaeser and
Saks (2006), Nie and Jia (2011), Dong and Torgler (2013), we measure corruption level by the
ratio of embezzlement and bribery and misappropriation of public funds cases reported in the
Procuratorial Yearbook of China in each province, municipality and autonomous administrative
region to the sum of public officers. CorruD represents the dummy of Corru.
X presents control variables; the selection of control variables refers to the firm’s internal
characteristics (Li et al., 2009; Yu et al., 2011; Fan et al., 2012; Jõeveer, 2013) and the influence of
the macro-economic environment. The definition and measurement of a firm’s internal
characteristic factors are as follows: Profitability = earnings before interest and tax / total assets
(Profit); MBR =(total debts + market capitalization)/ total assets = (circulating stock market +
book debt value)/ total assets (MBR); Tangible asset = net fixed asset/ total asset (Tang); Size =
natural logarithm of total assets (Size); Non-debt Tax Shield = depreciation of fixed assets/ total
assets (Dep); age is measured by the duration of Initial Public Offerings (Age); Industry Dummy
Variable. The macroeconomic environment variables include regional GDP growth rate (Ggdp),
regional legal environment (Law) and regional non-state-owned economy proportion (Nsoe).
3.3 Methodology
In models (1) and (2), the lags of dependent variables function as explanatory variables,
making the explanatory variables introversive. Thus, if we apply the random or fixed effect of
panel data to estimate the model, we obtain a biased and non-confirming estimated result. To solve
the introversion problem, Anderson and Hsiao (1981) propose to eliminate individual effects by
means of first-difference. Next, we can use the differences of two-period-lagged dependent
variables or two-period-lagged dependent variables as the instrumental variables of
one-period-lagged dependent variables to eliminate heterogeneity. However, according to Ahn and
Schmidt (1995), although these types of instrumental variables are consistent, they might not be
efficient estimators because they have not used all of the moment conditions or all of the
difference structures of residual disturbance items. Based on Anderson and Hsiao’s theory (1981),
Arellano and Bond (1991) propose the estimation method for difference GMM by using lagged
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instruments of explanatory variables and predefined variables along with the difference of strict
external variables because with instrumental variables, we can obtain an efficient estimation.
However, further studies by Blundell and Bond (1998) and Bond et al. (2001) find that this type of
GMM estimation is easily affected by weak instrumental variables and causes finite sample errors.
To overcome this problem, Arellano and Bover (1995) and Blundell and Bond (1998) propose the
system GMM estimator, which combines a difference equation and a level equation and uses
additional difference variables as the tool of relevant variables of the level equation. In general,
system GMM estimators possess a better finite sample property. In terms of the choice of
structural tools for a weighted matrix, GMM estimation can be divided into one-step estimation
and two-step estimation. Although one-step GMM is a consistent estimation, it depends on the
hypothesis of the homoskedasticity of the disturbance term. Two-step GMM skips the presetting of
the concrete form of weighted matrix, instead using the consistent estimators obtained in the first
step by IV estimation as the weighted matrix in the second step IV estimation. Thus, efficient
estimators under conditions of homoscedasticity and sequence are obtained. Theoretically
speaking, it is more rational to choose the two-step GMM method. Nevertheless, Bond at al. (2001)
believed that under the condition of finite samples, the standard of a two-step GMM estimator
would result in a significant downward bias, influencing statistical inferences. To obtain a
non-biased estimator within standard errors, we adopt the method proposed by Windmeijer (2005)
to revise the estimators of standard errors. In general, we use the STATA process (xtabond2
command) developed by Roodman (2006) to implement the two-step GMM estimation.
4 Empirical Results Analysis
Table 1 presents the results of general bank credit decisions for companies according to
models 1 and 2. The table shows that the previous year debt ratio positively affects the current
debt ratio regardless of whether financial leverage is calculated by market value or book value. In
other words, companies adjust their debt ratio according to their realities. Simultaneously, however,
we find that adjustment speed is higher when financial leverage is calculated using market value.
In addition, we find that corruption has a significant positive influence on a firm’s debt ratio, in
other words, the higher the corruption level, the more bank loans a company can obtain,
corresponding with Fan et al. (2012) but not with Zhu and Chen (2007). The reason for this result
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might be that the corruption index applied by Zhu and Chen (2007) is the firm’s per-million loan
cost, whereas the corruption index applied here is the regional corruption index, which is similar
to the corruption index of Fan et al. (2012). In terms of the financial development index, when we
calculate financial leverage by book value and ignore corruption level, financial development has
a significant positive influence on the firm’s debt ratio; when we consider corruption level,
financial development has an insignificant positive influence on the firm’s debt ratio. When we
calculate financial leverage using market value, the financial development index has a significant
positive influence on the firm’s debt ratio regardless of whether we consider the corruption level.
Generally, with the advance in financial development, companies will have more access to bank
credit, which corresponds with De Carvalho (2009), Agostino et al. (2009) and Fan et al. (2012).
Considering the interaction terms of financial development and corruption level (CorruD*Fin,
FinD*Corru), we found that in regions with a higher corruption level, financial development still
has a negative influence on a firm’s debt ratio. This means that in regions with a higher corruption
level, investors can find it difficult to obtain the return of their capital and interests if the debtor
breaches the contract. Meanwhile, when applying for credit, debtors can increase their chances of
obtaining bank credit only by bribing bank officers. Consequently, an increased credit supply will
not lead to an increased firm debt ratio. However, in regions with higher financial development,
corruption level has a significant negative influence on the firm’s debt ratio, which means that in
regions with a higher credit supply, companies can easily obtain bank credit without bribing bank
officers or seeking judicial corruption; moreover, control of corruption contributes to firms’ ability
to obtain credit.
For the control variables, legal variables have a positive influence on a firm’s debt ratio, but
return a different performance in the book value financial leverage and market value financial
leverage models. The influence is insignificant in the book value financial leverage model,
whereas in the market value model, we see that a better legal environment is accompanied by
more bank credit at a 1% level of significance. This result corresponds with the majority of studies
(see LLSV, 1998). GDP growth rate and Size have significant positive influence on a firm’s debt
ratio, which means that a higher GDP growth rate is accompanied by more bank credit and that a
larger company size is accompanied by more bank credit, corresponding to Rajian and Zingales
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(1995) and Shenoy and Koch (1996). The reason for these results might be that large companies
are more resistant to bankruptcy (Shumway, 2001) and have better reputations (Diamond, 1989).
Age has a significant negative influence on a firm’s debt ratio, which contradicts most other
studies. The reason for this finding is probably that the longer a company has been public, the
more easily it can replace debt funding with equity funding, which is the preference of China’s
listed companies (Huang and Zhang, 2001). Profitability, tangible asset and the proportion of the
non-state-owned economy have a negative influence on a firm’s debt ratio. However, this
influence becomes significant only when we calculate financial leverage by market value. All of
these conclusions prove that the higher the earnings before interests and tax and the greater the
ability to obtain internal funding, the less a company needs to obtain external funding (Rajan and
Zingales, 1995; Booth et al., 2001; De Jong et al., 2008; Yu et al., 2011; Fan et al., 2012). With
stronger collateral ability to obtain tangible assets comes less credit, corresponding with the results
of Li et al. (2009) and Zhao and Zhu (2006). The reason for this finding is probably that in China,
where finance is underdeveloped and the legal environment is incomplete (Allen et al., 2005), the
amount of credit that a company can obtain is not dependent on its tangible assets. Judicial
enforcement procedures perform the function of bankruptcy regimes in China, where the state’s
control and monopoly on bankruptcy makes it difficult and costly to access bankruptcy regimes.
Therefore, there are many cases of Chinese judicial enforcement procedures in which the debtors
have no available property (Tang, 2008). In regions that have a higher non-state-owned proportion
of the economy, the reason that companies obtain less bank credit might be that there are more
non-state-owned corporations in the region, there is discrimination against non-state-owned
companies’ ownership (Jiang and Li, 2006; Yu and Pang, 2008) and internal funding leads to less
bank credit for non-state-owned companies (Gou et al., 2014). Growth opportunity has a positive
influence on a firm’s debt ratio and is significant only when financial leverage is calculated by
market values, which means that with more growth opportunity, companies need more external
funds and therefore their debt ratio increases (Rajan and Zingales, 1995). Non-debt tax shields
have an insignificant negative influence on a firm’s debt ratio.
Table 2 shows the result of firms’ debt maturities in model 1 and model 2. The table shows
that a company’s previous-year long-term debt ratio has a significant positive influence on current
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debt ratio regardless of whether we control the region’s corruption level and financial development
level. In other words, a company will adjust its long-term debt ratio according to reality. Financial
development and the legal environment have an insignificant negative influence on a firm’s
long-term debt ratio. The result proves that although the Chinese banking system has experienced
years of marketization reforms, banks remain cautious about granting long-term credit and choose
to grant more short-term credit to companies. The reason for this might be that a bank’s short-term
credit contributes to reducing the incentives to substitute assets by substantial shareholders (Myers,
1977) or that contribute to displaying a financial agency’s comparative advantages in supervising
and controlling a substantial shareholder’s asset substitution (Jiang and Li, 2006). Corruption has
an insignificant positive influence on a firm’s long-term debt ratio, which means that there is
serious corruption in the Chinese bank-credit system (Xie and Lu, 2005). Similarly, considering
the interaction of financial development and corruption level (CorruD*Fin, FinD*Corru), we find
that in regions with a higher level of corruption, financial development has a positive influence on
a firm’s debt ratio, which means that in regions with a higher level of corruption, growth in credit
supply will lead to an increase in firms’ long-term debt ratio; conversely, in regions with a higher
level of development, corruption has a significant negative influence on firms’ debt ratio, which
means in regions with more credit supply, companies can easily obtain credit without bribing bank
officers or seeking judicial corruption.
For the control variables, age has a significant positive influence on firms’ debt ratio, which
means that although age cannot increase a company’s total bank loans (see Table 1), it can
increase a company’s long-term bank loans. The proportion of the non-state-owned economy has a
positive influence on firms’ long-term debt ratio, which shows that in regions of with a larger
proportion of the non-state-owned economy, although less total bank credit is obtained, with the
chronicity and persistence of fixed investments and the constant growth of regional GDP, regional
governments have an incentive to intervene in banks’ credit maturity. Other indexes show an
insignificant influence on firms’ long-term debt ratio.
5 Robustness Test and Discussions
To test the robustness of the above results, we conducted sensitive tests as follows:
5.1 The Influence of the Stock Market Development
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Demirgüc-Kunt and Maksimovic (1996) find a negative correlation between long-term debts
and short-term debts and the scale of the capital market when analyzing the influence of
stock-market development as a source of firm funding. Would the development of the stock
market, a source of external financing for companies, affect this paper’s conclusions? We also
added stock market development as a control variable and referred to the method of Zheng and
Deng (2010). Therefore, in view of the special case in which an equity division of tradable stock
and non-tradable shares existed in China during the sample time, we used several data to reflect
the (supply) scale of regional stock market: we used two indexes to reflect the supply scale of the
regional stock market. First, we examine the actual supply of the regional stock market: the
proportion of the regional total market value of shares in circulation (the average market value of
the initial regional total market value of shares in circulation and the final regional total market
value of shares in circulation during the year) in regional GDP (Lcgdp). Second, we examine the
total supply scale of the stock market: the proportion of regional total market capitalization (the
average market value of the initial regional total market capitalization and the final regional total
market capitalization during the year) in regional GDP (Tcgdp). Given the lack of a difference
between the two results, this paper shows only the results of the total market value of shares in
circulation in Table 3, which shows that there are no changes in the significance and symbols of
the main variables: corruption, financial development and their interaction.
5.2 Influences of the Actual Controller of State-Owned and Non-State-Owned
Enterprises
The financing decisions of state-owned and non-state-owned enterprises in China—that is,
the ownership discrimination in the context of bank loans, have always been an area of scholarly
focus (Allen et al., 2005; Fang, 2007 and 2010; Yu et al., 2011). Most studies show that
state-owned enterprises enjoy advantages over private enterprises in obtaining bank loans (Martin,
2012; Yu and Pan, 2008; Ba et al. 2005; Jiang and Li, 2006). Does ownership influence the
relationship between corruption and financial development and a firm’s capital structure? We
divided samples into actual controllers of state-owned enterprises and controllers of
non-state-owned enterprises according to the identity information of the controllers; then we
conducted regression tests using the same model in Table 3, with the results shown in Tables 4 and
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5. Similarly, there are no changes in the significance and symbols of the main
variables—corruption, financial development and their interaction—based on the results shown in
Tables 4 and 5.
5.3 The Influences of Interest-Bearing Debts
According to Welch (2011), most scholars only consider interest-bearing debts, but consider
total debts in the denominator position, which eventually affects the related research results.
Therefore, this paper, adopting the measure method of Welch (2011), conducted the following
calculations: Lev1 equals company’s (the short-term loans of the year-end + long-term liabilities
due within one year of the year-end +long-term loans of the year-end) / (short-term loans of the
year-end + long-term liabilities due within one year of the year-end + long-term loans of the
year-end + book value of the year-end); Lev2 equals (short-term loans of the year-end + long-term
liabilities due within one year of the year-end + long-term loans of the year-end) / (short-term
loans of the year-end + long-term debts due within one year of the year-end + market value of
tradable shares of the year-end); Lev3 equals (short-term loan of the year-end + long-term
liabilities due within one year of the year-end + long-term loans of the year-end) / (short-term loan
of the year-end + long-term liabilities due within one year of the year-end + long-term loans of the
year-end + total market value of the year-end), whose results are shown in Table 6. Similarly, we
found no differences in the significance and symbols of our main variables: corruption, financial
development and their interactions.
In addition, we replaced the registration number of corruption and bribery and embezzlement
cases in Chinese provinces, municipalities and autonomous regions/ the total number of public
officers in the corresponding provinces with the registration number of corruption and bribery and
embezzlement cases in Chinese provinces, municipalities and autonomous regions/ the total
population of the corresponding provinces; replace the regional deposits/ GDP with regional
savings/GDP; (market value of tradable share+ liabilities book value)/ total assets with (total
market value+ liabilities book value)/ total assets to compute the book-to-market ratio. We found
no differences in the significance and symbols of our main variables: corruption, financial
development and the interaction between the two (limited for reasons of length; although related
results are not listed, all of the results can be searched if necessary).
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6 Conclusions
This paper takes listed companies listed on the Shanghai and Shenzhen stock markets from
1998-2013 as a research sample to define the roles of corruption and financial development and
their interaction, as a certain factor, in the capital structure of companies under the special
circumstances of special laws in China. The special legal environment in China, internal factors in
companies, industry factors and endogenous problems being equal, our research results show that
both corruption and financial development have significant positive effects on firms’ bank loans.
However, after the interaction of corruption and financial development is added, the relationship
between corruption and financial development transforms into competition effect rather than
complementary effect—that is, the worse the corruption in an area, the fewer bank loans are
obtained by companies created by financial development. However, corruption and financial
development have an insignificant negative influence on firms’ long-term loans. Namely, in
regions with a higher level of corruption, growth in credit supply will lead to an increase in firms’
long-term debt ratio; conversely, in regions with more credit supply, corruption has a significant
negative influence on firms’ debt ratio. In addition, these conclusions hold even though different
methods are used to check the stability of research. Apparently, to improve the financing
circumstances of company credit, the institutional circumstances in the region should be optimized,
which would reduce companies’ external financing costs. Although corruption can produce
significant positive effects on obtaining of loans from banks, companies must pay rent-seeking
costs and then suffer from the loss of social welfare to win or increase the chances of obtaining
credit. Therefore, the next point of reform should be to improve their procedures for administrative
examination and approval of bank creditors and strengthen the punishment and prevention of
credit and judicial corruption to weaken the negative effects of corruption on firms’ capital
structure decisions. Moreover, it is important to substantially increase the level of regional
financial development, and raise the credit supply of bank, which can also reduce (to some extent)
the influence of corruption on corporations’ debt-funding decisions.