Is a deleveraging policy effective? Evidence from China

Leveraging the quasi-natural experiment of a nationwide deleveraging campaign (the Campaign) by the Central Economic Work Conference in December 2015 in China, we examine the impact of deleveraging adoption on the financial leverage, cost of debt, corporate investment, cash holdings, research & development (R&D) investment, and performance of firms. We find that: 1) The Campaign lowers financial leverage in all firms, 2) state-owned firms (SOEs) lower their long-term financial leverage more than those of non-SOEs, 3) both SOEs and non-SOEs make less corporate investments, hold more cash, make more R&D investment, and exhibit poorer operating performance, and 4) Relative to non-SOEs, SOEs exhibit lower cost of debt, more corporate investments, holding more cash, making less R&D investments, and exhibit better operating performance post-Campaign. While the Campaign drives firms to lower their leverage, it brings unintended consequence for firms in terms of cost of debt, corporate investments, cash, and R&D, which ultimately adversely affects firms’ operating performance.