The Effect of Property Rights Protection on Capital Structure: Evidence from a Chinese Natural Experiment
We examine how changes in property rights security impact firm capital structure decisions by exploiting a natural experiment, the enactment of China's Property Rights Law in 2007 (the Law) Using a large dataset of non listed firms, we document a significant overall decrease in leverage after the Law's passage, consistent with the reinvestment hypothesis' prediction that business owners are willing to reinvest more of their profits as property rights protection strengthens, substituting for external debt. Financially constrained firms experience a relative increase in leverage following the Law's enactment, consistent with the financial constraint hypothesis' prediction that lenders are willing to extend more credits to financially constrained firms as creditor rights are strengthened. We also document a leverage decline in China's listed firms after the Law's enactment.