Powell, Philip
(2017)
The Determinants of Capital Structure of Chinese Microcaps.
[Dissertation (University of Nottingham only)]
Abstract
Research Question
The purpose of this study is to find out what the determinants of capital structure of listed Chinese microcaps are and how they help explaining the capital structure of these microcaps. Another goal is to find out if and which of the common theories in capital structure tested in this study, namely the Trade Off theory and the Pecking Order theory, as well as the business environment in China and, perhaps, other factors are relevant in explaining the capital structure of Chinese listed microcaps. This focus makes this thesis unique and a valuable addition to the contemporary research on capital structure of Chinese firms, microcaps and capital structure in general.
Multiple regression is used to assess the relationship between the dependable variable, which is leverage, and the independent variables, which were chosen as profitability, risk, non-debt tax shields, growth, liquidity and tangibility. In addition the independent variable “business age” is included in the final model of the microcap group. The companies contained in the samples are all listed in mainland China on the stock exchanges in Shanghai and Shenzhen. The benchmark group includes 1105 companies of different size, while the microcap group includes 175 firms of very small size. The companies contained in the samples were selected on the basis of data availability. Financial firms were not included due to their unique capital structure. The number of firms contained in the microcap group was set according to the definition of microcaps by Fama and French (2011).
Summary of the results and conclusions
The results showed that three variables of those tested in this study, namely liquidity, risk and profitability, are relevant in explaining the capital structure of the companies included in the sample of the benchmark group. For the microcap group, liquidity, profitability as well as business age, which was only tested for the microcap group, were found to be significant in explaining the capital structure. Liquidity and profitability showed a significant negative correlation with leverage, while business age showed a significant positive correlation. As there is a variable, namely risk, that was found to be significant in explaining the capital structure of the firms in the benchmark group, but not of the firms in the microcap sample, it seems evident that size, (microcap vs. non-microcap), makes a difference in terms of what variables determine capital structure.
It also seems evident that the Trade Off theory doesn’t play an important role in explaining the capital structure of Chinese listed firms, neither for the firms in the benchmark group nor for microcaps. The Pecking Order theory, however, was found to be of relevance for both samples tested.
It was concluded that of those determinants tested in this dissertation, especially profitability plays a major role in determining the capital structure of Chinese microcaps. The reason for this is probably that the financing environment is quite special in China, where SMEs have a lot of trouble obtaining outside funds. The comparison with research on capital structure of very small companies from other developing countries such as Thailand and Kenya showed that this is not only true in China. The fact that business age is also significant in explaining the capital structure of micro businesses in China strengthens the notion of the financing environment having a major impact on capital structure as mature firms likely have less difficulties obtaining loans. It was therefore concluded that the capital structure of microcaps, to a certain extent, is not decided upon by the business itself, but rather forced upon them by the present funding circumstances in China. This is probably, to a lesser extent, also true for non-microcap SMEs in China, since their choices in terms of capital structure are also quite limited.
It was also concluded that the determinants of capital structure of micro firms differ a lot from those found important in other studies, as many of the “traditional” determinants of capital structure, like risk, non-debt tax shields, growth and tangibility were all found to be insignificant in explaining the capital structure of Chinese listed microcaps.
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