The Effect of Local Government Debt on Firm Leverage：Empirical Evidence from the City-level of China

Since 2008, the Global Financial Crisis has had a huge impact on China’s export-oriented economy. The State Council in 2008 launched an economic stimulus plan known as Four-Trillion Investment” （70.50% of the total package, i.e. 2.82 trillion RMB, was financed by local governments）. Since then, the scale of local government debt has increased significantly, which has produced some unexpected economic consequences for the allocation of credit resources and even economic development.　　The revenue and cost of government borrowing are the core concerns of many countries. The impact of government borrowing on the investment and financing of firms has been studied in the existing literature. Due to the great differences in the development of legal system and financial market, the micro consequences of government borrowing are also inconsistent, i.e. there is a dispute between the crowding-out effect” and the crowding-in effect” in the economic theory. Therefore, does local government debt affect the debt of local firms? If so, how does the affection occur? These are real problems worth studying.　　Based on the data of 266 cities in China, this paper tests the impact of the local government debt scale on local firms’ debt level and debt cost in 2008−2017. The results show that: First, the scale of local government debt decreases firm leverage. Specifically, the scale of local government debt decreases firm leverage by reducing the short-term debt and operating debt scale. Compared with state-owned, non-infrastructure and public welfare industries, and profitable companies, the scale of local government debt has a stronger negative effect on the firm leverage of non-state-owned, infrastructure and public welfare industries, and loss-making companies. Second, the scale of local government debt increases the debt cost of non-state-owned companies. The results show that the expansion of the local government debt scale has a crowding-out effect on firm leverage through the demand competition mechanism, and increases firms’ debt cost through the price mechanism.　　This paper contributes to the literature as follows: First, it not only tests the effect of local government debt on firm leverage, but also analyzes the way of local government debt affecting firm leverage. The results are helpful to enrich the literature of the impact of local government fiscal policies on micro enterprises. Second, different from the measurement of using federal or central government general debt, we measure the scale of local government debt based on city-level data, which is not only helpful to analyze the effect of government debt on firm behavior under the same institutional background, but also helpful to reduce the dependence on the time series model, make the data structure more matching, and make the research conclusion more robust. Third, we test the effect of government debt on firm leverage and debt cost from the perspective of the demand competition mechanism and price mechanism, which helps to reveal the causes of difficult and costly in financing” reflected by firms, and provide some decision reference for the central government in controlling the scale of local government debt, optimizing the allocation of credit capital, improving the financing ability of firms, and promoting economic development.