Property rights protection, financial constraint, and capital structure choices: Evidence from a Chinese natural experiment

Abstract

We examine how changes in property rights security impact firm capital structure decisions by exploiting a quasi-natural experiment, specifically, the implementation of China's Property Rights Law in 2007 (the Law). Using a large dataset of non-listed firms and a difference-in-differences (DID) design, we examine the Law's cross-sectional heterogeneous effects on firm leverage. We find that financially constrained firms exhibit a significant increase in leverage relative to unconstrained firms after the Law's implementation. Our results are robust to three alternative measures of financial constraint: asset tangibility, ownership structure, and firm size. This finding is consistent with the financial constraint hypothesis that states that lenders are willing to extend more credit to constrained firms given that the Law strengthens creditor rights. Overall, we find that the Law has had a significant impact on firm leverage decisions and that it is particularly important to financially constrained unlisted firms.