The deleveraging puzzle of investment opportunity shock: A quasi-natural experiments on drug marketing authorization holder

Abstract

Investment opportunity shocks may either force firms to reduce financial leverage to alleviate external debt constraints and maintain a flexible financial structure, or increase financial leverage due to the need to send positive signals to the market. We analyze this deleveraging puzzle using the reform of the Drug Marketing Authorization Holder (DMAH) in China as an exogenous shock. We find that DMAH has a deleveraging effect on drug firms, and that the agency cost and the market competition are the two key paths through which DMAH affects firms' financial leverage. Further tests show that the deleveraging effect mainly exists in non-SOEs, firms with higher financing constraints and stronger R&D willingness. Finally, drug firms have a better future performance by reducing their financial leverage. This paper provides insights for understanding corporate capital structure decisions under investment opportunity shocks.