Capital Structure in Transition: Financial Strategy in China's Emerging Economy

Abstract

During economic transition, firms must dramatically reduce their financial dependence on the state and begin to borrow from non-state capital sources. This paper draws on organizational theory to examine this fundamental transformation of firm capital structure during China's transition. I propose that managers borrowed from external sources even when internal funds were available because retained earnings were considered state assets. Firms used retained earnings to signal financial health but borrowed externally to reduce dependence on the state. Uncertainty during transformation also produced interfirm imitation of borrowing strategies, particularly imitation of local and high status others. Finally, I argue that levels of market development and changes in development over time affected firm borrowing strategies and that these strategies are best viewed as trajectories over time. Analysis of survey data on the capital structure of formerly state-owned firms from 1980 through 1989 provides support for these arguments and highlights the importance of institutional context in understanding corporate borrowing and strategic decision making.