The impact of the liability–asset ratio on profitability in China's industrial state-owned enterprises

Abstract

The liability–asset ratio of China's industrial state-owned enterprises (SOEs) has increased dramatically in the course of the economic reform period. Western observers point out the inherent dangers to enterprise solvency. Chinese policymakers view today's level as exceedingly detrimental to enterprise profitability and are introducing measures to reduce it. Yet the increase in the liability–asset ratio of industrial SOEs is the inevitable result of systemic changes; since the early 1990s, the liability–asset ratio has stabilized. The perceived negative impact of the current level of the liability–asset ratio on enterprise profitability does not hold up in regression analysis. It is true that low-profitability SOEs tend to have a high liability–asset ratio, perhaps due to government-ordained support through bank loans. However, once the endogeneity of the liability–asset ratio is controlled for, a high liability–asset ratio tends to imply a high level of profitability. This suggests that current industrial SOE reforms in China that focus on debt alleviation are misguided.