Trade Liberalization and Corporate Financing Decisions

This paper provides robust empirical evidence that trade liberalization significantly impact corporate financing decisions. Trade liberalization results in changes in tariff schedules in both domestic and foreign markets, which are most likely exogenous to individual firms. Our empirical strategy exploits this exogenous shock to identify the effect of trade liberalization on corporate financial structure. Examining a panel of firms in 37 developed and developing markets over 1996-2008, we find that both outward tariffs and inward tariffs are significantly and em positively associated with firm leverage, suggesting that firms tend to use more equity and less debt when international trade barriers are reduced. Using China's entry to the World Trade Organization (WTO) as a natural experiment, we find consistent empirical evidence: the Chinese listed firms significantly reduce their leverage ratios in the post-WTO period. Further analysis shows that the effect of trade liberalization on capital structure is more pronounced for firms whose technologies are distant to the technological frontiers, firms that are more sensitive to exports, and firms facing a higher level of external financing constraint. Our findings shed light on the economic consequences of trade liberalization and highlight the importance of international trade to corporate financing decisions.