This paper empirically investigates the determinants of financing decisions in Chinese listed firms, using 3,196 firm-year observations from the Shanghai Stock Exchange during the period 2001–2005. Thereby, we investigate the effects of differences in institutions across Chinese provinces and municipalities, and compare the financing choices of state-controlled and private-controlled enterprises. We find that a better legal environment negatively affects the debt ratio and the proportion of debt that consists of bank loans in SOEs as well as private enterprises. Conversely, regional banking development positively influences these two variables. If anything, these effects of the rule of law and regional banking development on leverage are stronger for private-controlled firms. SOEs have lower debt ratios in regions with better stock market access, while private firms rely less on bank loans in regions with more government intervention in business. Finally, we document that SOE bank loans have a longer maturity, while their overall debt ratio and debt mix are comparable to those of private firms.

How corporate growth affects the choice between relationship-based debt and public debt remains an unsettled issue in the literature. For high-growth firms, the banking relationship mitigates asset-substitution and underinvestment problems due to debt financing. Close relationships, however, work against funding competition and facilitate holdup behavior by banks. This paper suggests an effective mechanism for high-growth firms, namely competition from equity, to curb banks’ rent extraction when public debt becomes more costly. According to the generalized Myers-Majluf view in the recent literature, new equity issues by high-growth firms actually reduce or even reverse the adverse-selection discount because asymmetric information about these firms’ valuations arise largely from growth rather than from assets-in-place. Our evidence from Japanese data for 1983 to 1997 shows that the relation between loan-to-debt ratio and growth, initially significantly negative, is indeed reversed toward the high end of growth spectrum and turns significantly positive. Consistent with our explanation, fast-growing high-flyers raise more new equity than do other firms. These results not only confirm the existence of both costs and benefits of monitored debt, but also explain why high-growth firms enjoy the benefits without fearing holdup behavior by banks.