The Effect of Chinese Interest Rate Liberalization on Corporate Debt Maturity Structure

Debt maturity model is constructed under constant interest rate in this paper, combined with the reformation characteristic of financial system in China. The analysis suggests that under fixed interest rate caused by financial repression, none but enterprises with high quality could choose optimal debt maturity structure to maximize their own utility; most of firms with average quality or poor quality could not choose optimal debt maturity structure on their own initiative, while they would only be distribute debt of different maturity structure by bank who estimate the risk of loan with debt repay index. So the lower of corporate debt paying ability, the less of long-term debt banks would distribute, which result in overmuch proportion of shortterm debt in debt maturity structure in Chinese firms. With the deepening of interest rate market reformation, the control of float rate would be reduced step by step. As a result, the structural shortage of long-term debt in corporate debt maturity structure will be settled effectively. Banks relieve risk of debt repayment by adjust level of interest rate, and all the firms could achieve optimal debt maturity structure to maximize own utility. On the other hand, with the liberalization of interest rates, the signaling function of debt maturity structure would be resumed so that we can distinguish private information of corporate quality by its debt maturity structure. KeywordsDebt maturity structure; Fixed interest rate; Interest rate liberalization I. RESEARCH BACKGROUND Debt maturity choice is one of most important aspects in corporate financing, which determines the right and obligation of creditor and debtor. With longer term of debt, there is higher uncertainty and risk for firms in the future (Myers, 1977)[1]. Previous finance theory in west discusses optimal choice of debt maturity structure for firms under situation of incomplete market. Flannery (1986)[2] brings forward the hypothesis of information asymmetry, which indicates with serious information asymmetry, good firms would choose short-term debt because the cost of information dissymmetry caused by issuing long-term debt is much larger than additional transaction cost for short-term debt; while bad firms choose to issue long-term debt for the opposite reason. Barcly & Smith (1995)[3] take empirical study on debt maturity choice, sampling American industrial firms with the years 1974 through 1992. The result of their research supports Flannery’s point of view. However, this conclusion does not come into existence in China. Comparing debt maturity structure of Chinese firms with that of French, Germanic and British firms (Tab.1), we see that: the mean of short-term debt’s proportion in Chinese firms is 87%, which is much higher than that of French firm (41%), Germanic firm (47%) and British firm (54%), and the median of short-term debt’s proportion in Chinese firms (94%) is also significant higher than that of French firm (39%), Germanic firm (43%) and British firm (53%). It reflects difficulty of long-term financing and serious unbalance of debt maturity structure for Chinese listed companies. The reason of that, we consider, is mainly about the different market environment of domestic and international. TABLE I. COMPARISON OF DEBT MATURITY STRUCTURE BETWEEN CHINESE AND OVERSEAS FIRMS Country China France Germany U.K. Mean of long debt’s proportion 0.13 0.5883 0.5328 0.4571 Median of long debt’s proportion 0.0579 0.6067 0.5705 0.4727 Mean of short debt’s proportion 0.87 0.4117 0.4672 0.5429 Median of short debt’s proportion 0.9421 0.3933 0.4295 0.5273 Data source: Antonios, Yilmaz [4] Relative to domestic market, Debt market overseas develops much more completely. With the interest rate liberalization, firms are able to finance by issuing every maturity of debt optionally in the debt market. But in China, development of corporate bond market lags behind domestic stock market and international bond market. At first, there is strict restriction for firms issuing bond in the market. Most of firms especially middle and small firms could not be admitted in corporate bond market. Secondly, the cycle of review and approval for the issuance of corporate bonds is so long time and it lead to dislocation of capital supply and demand in the firm. The third, “Regulations on Administration of Corporate Bond” in China prescribes the return rate of corporate bond issuing is no higher than 40% of bank savings rate in the same term, which influence the attraction to investment. Accordingly, most of Chinese firms finance by bank loan or national finance. In fact, the bank interest rates for savings deposits and loans in China are fixed interest rate with lower real rate for a long time. 1 Chinese corporate Law regulates the condition of issuing corporate bond: (1)The net assets of company limited by shares is not lower than RMB 30 million yuan, and that of company with limited liability is not lower than RMB 60 million yuan; (2) total of bond balance does not exceed to 40% of corporate net assets. 978-1-4244-4639-1/09/$25.00 ©2009 IEEE Although after reform and adjustment, the system of floating interest rates which takes central bank's lending rates as benchmark are established in China, and interest rates begin to bring the economic lever function into play, the interest rate is still at a lower level (the coefficient of interest rate division is less than 29.5%) yet, term structure of interest rates is irrationality, management of interest is rigidified, the level of interest rate for corporate loan is mainly determined by central bank. So under the financial repression and interest rate restriction, how does firm in China choose their debt maturity structure? Along with the reformation of the financial system develops to interest rates liberalization, how does corporate choice for debt maturity structure change? This paper tries to discuss these two questions. II. DEBT MATURITY CHOICE UNDER FIXED INTEREST RATE Under the financial repression and interest rate restriction, the bank interest rates for savings deposits and loans in China are fixed interest rate with lower real rate for a long time. In order to analyze the effect of fixed interest rate on corporate debt maturity choice, we construct a two-period model (Fig.1) [5] for discussing. Figure 1. Debt term and debt maturity Suppose there are two periods and two participators (firm and bank). At time zero, the firm needs 1 unit investment for its project, and it can only be financed by debt. The corporate quality “q” distributed with ƒ(q) distribution. The success probability for project of firm with quality “q” is “Pq”, which is ordered by the first-order stochastic dominance; viz. the better firm has higher success probability. At t=1 and t=2, the project’s fortunes over the preceding period become public information, although the corporate quality “q” remains private information known only to the entrepreneur. During each time period, there is a probability, Pq, that the project will success, and a probability (1-Pq) that it will lost. The success probability at t=1 and t=2 is independent with each other. We define r0 as risk-free interest rate for short-term debt, rL as lending rate for long term debt. At time zero, the firm chooses debt maturity structure θ, which represents the proportion of short-term debt to total debt LTD STD STD