Do cash flow imbalances facilitate leverage adjustments of Chinese listed firms? Evidence from a dynamic panel threshold model

Abstract

This paper investigates the asymmetric impact of cash flow on firms’ leverage adjustments. We use a dynamic panel threshold model and estimate it with a newly-developed first-difference GMM approach, which allows endogeneity in both threshold variable and regressors. Employing data of 1054 Chinese listed firms during 2004–2016, we show that Chinese listed firms have leverage targets, towards which they adjust at an average speed of 25.9%. Moreover, firms with larger absolute cash flow adjust towards their leverage targets significantly faster than those with smaller absolute cash flow. This finding is robust to a post-financial crisis sample period, alternative measures of leverage and cash flow, and the incorporation of an additional control variable. We find evidence that cash flow imbalances facilitate leverage adjustments by reducing adjustment costs, and Chinese listed firms rely more on debt issues. These findings provide new insights on firms’ leverage adjustment and cash flow management.