FDI and Import Competition and Domestic Firm's Capital Structure : Evidence from China

This study examines how foreign competition affects the capital structure of domestic firms, using Chinese firm-level data. We find that imports and inward foreign direct investment (FDI) have varying effects on a firm's leverage, indicating heterogeneity in the impact of different types of foreign penetration. Specifically, domestic firms reduce their leverage ratio in response to high import competition, but increase it in response to FDI penetration. This asymmetry is more pronounced in high-tech industries, suggesting that while foreign competition can lower the profitability of domestic firms and exert downward pressure on their leverage, FDI penetration associated with positive productivity spillover can lead to a higher net present value of the expected future profitability and thus higher leverage. Our instrument variable approach using industry exchange rates and import tariffs supports these findings. Further analyses show that the positive effect of FDI on the leverage ratio of local firms is stronger when local firms possess stronger absorptive capacities and are exposed to more human capital transfers from foreign rivals