Capital structure and firm value in China: A panel threshold regression analysis

Since the study of Modigliani and Miller (1958), a large number of studies have contributed to the discussion about the optimal capital structure, which is a fundamental topic of corporate finance. In this study, we investigate whether there is an optimal leverage at which point firm is able to maximize its value. An advanced panel threshold regression model is applied to test the panel threshold effect of debt ratio on firm value among 650 A-shares of Chinese listed firms from 2001 to 2006. The results confirm that a triple-threshold effect does exist and show an inverted-U correlation between leverage and firm value. This study shows that it is possible to identify the definitive level beyond which a further increase in debt financing does not improve proportional firm value. Some important policy implications emerge from the findings.