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Research Proposal

TITLE:

A RESEARCH INTO THE IMPACT OF CORPORATE FINANCIALIZATION ON CORPORATE PERFORMANCE AND THE MEDIATING ROLE OF LEVERAGE RATIO

1. Introduction

1.1. Background of Research   

The term financialization is being used to describe a wide range of economic and social phenomena, and it is becoming an increasingly prominent research topic. Financialization is defined as “a redistribution of corporate profit towards dividends and share buy-backs, and away from investment”, or “the share of paid-up capital held by institutional shareholders” (Gibbon et al., 2009, p.328). Meanwhile, financialization is viewed from a different perspective by Durand (2017) as a conglomeration of processes, which are interrelated and are spatial and historical manifestations of the capitalist production mode.  

To understand financialization, some researchers tried to clarify the definition of financialization based on a broad literature review. There were 17 different types of financialization that Lee et al (2009) found in their research. in 2009 (Lee et al., 2009). This broad definition, which builds on a prior definition by Epstein (2005), encompasses the various elements of financialization as “the increasing dominance of financial actors, markets, practices, measurements, and narratives, at various scales, resulting in a structural transformation of economies, firms (including financial institutions), states, and households” (Aalbers, 2019).

In the United States, financialization is observed to be a prominent trend among companies in the United States (Milberg, 2008). At the same time, a growing number of people are beginning to realize its importance after the worldwide financial crisis of 2007–2009, which can be viewed as a North Atlantic financial crisis (Klinge et al., 2021). In China, corporate financialization is also raising widespread attention among government bodies, the corporate sector, and researchers (Jin et al., 2022; Zhao and Su, 2022; Li et al., 2022). The focus of those studies is on the empirical, quantitative studies of the financialization of conventional non-financial corporate (NFCs) across countries and industries.

Meanwhile, some of the larger trends underpinning the process of corporate financialization include leverage ratio and corporate performance (Safieddine and Titman, 1999), crisis-ridden economic development in recent decades (Chesnais, 2017), globalization of production and finance (Durand, 2017), and the rise of institutional shareholders and the proliferation of the concept of shareholder value (Davis, 2009; Froud et al., 2000). Leverage ratio and corporate performance are focused in this research.

Scholars have begun to pay more attention to the corporate dimension of financialization since the global financial crisis and the ongoing Covid-19 pandemic (Baker et al., 2020). The bailouts, bubbles, and blown-up balance sheets of banks and non-financial corporations (NFCs) have spurred a slew of empirical research looking at corporate financialization from many angles and utilizing a variety of sources to answer a wide range of questions. When it was discovered that financialization had occurred, the inquiry into its effects on other socioeconomic phenomena had only begun. There is a focus on corporate investment behaviour, macroeconomic instability, and social inequality.

In terms of leverage ratio in the study of financialization, for one thing, financial assets held by companies have a dual effect on the leverage of companies. The strong liquidity of financial assets makes the allocation of financial assets an important financing method for companies, which inevitably replaces part of the debt financing of companies and directly leads to a decrease in corporate leverage. For another, managers’ preference for financial assets leads to a greater incentive for companies to take out bank credit, while the high returns from financial investments make it easier for companies to obtain credit support (Zhao and Su, 2022). The leverage ratio matters for corporate performance. An increase in leverage ratio will bring benefits such as tax shields and thus contribute to the improvement of corporate performance. However, high leverage ratio implies high debt. Debt can cause financial constraints and agency costs. When there is excessive debt, companies need to bear excessive financial costs due to the risk of debt default, and higher labor costs due to the rising risk of bankruptcy, which is detrimental to corporate performance (Safieddine and Titman, 1999).

In China, with the slowdown of economic development, the pressure of market competition and the overcapacity of traditional industries are driving to more consideration of boosting the real economy. Since the Global Financial Crisis in 2008, the Chinese Government has formulated a range of quantitative easy money policies with the main goal of releasing liquidity to the market to boost internal demand and the circulation of commodities through the introduction and implementation of these policies (Li et al., 2020). In this way, the government expects to help the production and operation of the real economy, ultimately promoting the optimization and upgrading of industrial structure and the rationalization of real industries (Zhao and Su, 2022).

In this context, the impact of corporate financialization on corporate performance is will be explored in this empirical exercise in the context of …. e forthcoming paper. The mediating role of leverage ratio in corporate financialization and its impact on corporate performance is will also be investigated.

1.2. Significance of Research

This research contributes to the existing understanding of how corporate financialization impacts corporate performance and the mediating role of leverage ratio in this process and this correlation for the period 2019 – 2022 in the specific context of the Chinese corporate sector. The period 2019 – 2021 is synchronized with the period when Covid-19 pandemic struck the world, including China. Before this period, there have already been studies that investigated how corporate financialization impacts corporate performance and how companies use leverage ratio to achieve profitability. However, similar studies on this topic during the period 2019 – 2021 are very limited. As far as the research knows, there lacks research using the latest corporate data to research this topic.

Meanwhile, this paper intends to choose companies (non-financial corporates/non-real estate corporates) listed in China’s A-shares stock market between 2019 and 2021 for the empirical research about the impact of corporate financialization on corporate performance. Those companies are also included in the research of the mediating role of leverage ratio. The data is to be collected from the CSMAR database. Companies fell in ST or *ST, companies with missing data, or financial corporates/real estate corporates will be excluded from the research.

This research will contribute to the existing study about the correlation between corporate financialization and corporate performance. In the existing study on this topic, most studies focused on exploring the development and the status quo of financialization from a macro-perspective. Just as the researchers Baker et al. summarised, the corporate dimension of financialization has just been highlighted since the past financial crises around the globe and the Covid-19 pandemic. For the micro-level studies on financialization, most studies explored the motivation of corporate financialization, the impact of corporate financialization on capital attraction, research and development investment, and production efficiency.

This research fills in the gap of the deficiency of studies on the impact of corporate financialization on corporate impact from the micro-level by enriching the current perspective of focusing on corporate risks or investment in R&D or innovation. In other words, this paper intends to explore into this research topic by integrating several dimensions about the effects of corporate financialization on corporate performance, especially risk control, profitability, efficiency and Chinese companies’ social contributions.  

This research will be of considerable practical significance. The findings of this research will help investors identify corporate risks and protect their interests. The financialization of Chinese companies not only affects their short-term and long-term development, but also is closely related to the actual income of investors. Therefore, the research findings of this paper can help investors clarify the internal logic and relationship between corporate financialization and corporate performance, thus more accurately monitoring and deciding corporate behaviours, promptly identify the tendency of excessive corporate financialization. Companies may also understand the role of leverage ratio in risk control and corporate performance during the process of corporate financialization.  

1.3. Research Aims/Objectives

The aims of this research are to analyze the impact of corporate financialization on corporate performance among non-financial / non-real estate companies listed in the A-shares stock market in China during the period between 2019 and 2021, and to evaluate the moderating role of leverage ratio in the process of corporate financialization.

The objectives of this research are listed as follows:

1. To analyze whether corporate financialization has effects on corporate performance of the non-financial / non-real estate companies listed in the A-shares stock market in China during the period between 2019 and 2021;

2. If there is statistically significant correlation between corporate financialization and corporate performance, this paper tries to identify whether it is a positive effect;

3. To evaluate the moderating role of leverage ratio in this process.

1.4. Research Hypothesis

Objective 1:

Null Hypothesis (H₀): corporate financialization has effects on corporate performance of the non-financial / non-real estate companies listed in the A-shares stock market in China during the period between 2019 and 2021.

Alternative Hypothesis (H₁): corporate financialization does not have effects on corporate performance of the non-financial / non-real estate companies listed in the A-shares stock market in China during the period between 2019 and 2021.

Objective 2:

Null Hypothesis (H₀): Corporate financialization has positive effects on corporate performance of the researched companies.

Alternative Hypothesis (H₁): Corporate financialization has negative effects on corporate performance of the researched companies.

Objective 3:

Null Hypothesis (H₀): leverage ratio has a moderating role in this process.

Alternative Hypothesis (H₁): leverage ratio does not have a moderating role in this process.

1.5. Structure of research

To achieve the aims and objectives of this research, the research will be designed to include five chapters. In Chapter one, the research introduction is presented. In Chapter two, the background literature on corporate financialization, corporate performance, leverage ratio, and the specific environment in China is presented. In Chapter Three, the research methodology and methods adopted by this research paper are introduced, including the data collection, sampling and analysis methods. In Chapter Four, the findings of the research are reported. In Chapter Five, the research findings are further discussed. The research is concluded after Chapter Five.

2. Review of Related Literature

2.1. Motivations for Corporate Financialization 

In the literature on the motivation of corporate financialization, declining profitability of firms is one of the main reasons for corporate financialization. Tobin (1984) argues that in the face of fierce international competition and declining profits of business operations, non-financial firms withdraw capital from production operations and invest it in financial markets. Stockhammer (2004) mentions in his study that, influenced by high financial returns and the financialization of firms has become increasingly prominent as managers use financial markets to allocate more financial assets in order to optimize management objectives and incentives due to high financial returns and changes in corporate governance. Demir (2009) shows that companies make financial investment decisions to earn high returns under the unstable and volatile macroeconomic development, and Pastor & Veronesi (2013) find that corporate financialization is more of a way to provide investment returns for companies through their study of financialization behavior of US listed companies.

Economic uncertainty, difficult and expensive financing are the key causal factors that cause firms to be in financial distress, and firms holding more liquid assets is an important strategy for firms to avoid financial crises. Bloom et al. (2007) states that when firms face a recession with high economic uncertainty and depressed demand, they are more willing to invest in highly liquid financial assets to help alleviate their own financing constraints, thus effectively weakening the financial risk of their operations. Stulz (1990) concludes that given the characteristics of financial products, financial assets will create a reservoir in firms with high financing burden when they are in financial distress effect.

2.2. Correlation between Corporate Financialization and Corporate Performance

The impact of financialization on corporate performance has been studied from the perspective of real investment by foreign scholars. Palley (2008) shows that additional financial assets will lead to limited investment in real business and seriously damage the operating income of the company. Stockhammer (2004) mentions that based on the macro perspective, financialized investment will inevitably divest the key resources of the main business operation and cause the aberrant development of the regional economy, which will have a negative impact on corporate performance. Greenwood (2004) finds that financial investment in firms does not improve innovation and efficiency, and financialization does not have a positive effect on firms. Seo et al. (2012) argue that the addition of financial assets to firms significantly crowds out real capital investment, which is not conducive to maintaining normal production and operations and leads to a decline in the operating profit of firms. Duchin et al (2017) find that the financial investment behaviour of firms crowds out industrial investment, significantly inhibits the improvement of firm productivity, and leads to a decline in the operating performance of real firms. Demir (2009) showed that when there is a capital gap in manufacturing firms, investment in financial assets can improve the financing constraint of firms, which in turn can improve the operating conditions and profitability of firms. Lu et al (2018) concluded that a significant increase in the proportion of financial investment is conducive to hedging the risk of declining corporate profits in the real economy, which in turn leads to improved corporate performance. Gehringer (2019) argued that moderate financialized investment can increase the sources of profitability and alleviate financing constraints.

2.3. Correlation between Leverage Ratio and Corporate Performance

When studying financialization and new investment funds (NIFs), Gospel et al. (2014) mentioned that various forms of NIFs, such as sovereign wealth funds, hedge funds and private equity, are interrelated with financialization, which are mutually promoting. Those NIFs are seen as “are a key driver of what can be called corporate financialization, that is the increasing importance of financial factors in the governance of the firm” (Gospel et al., 2014, p.312). In this complex correlation, leverage ratio also stands out as a key moderator in company performance. According to Safieddine and Titman (1999), when a target rejects a takeover bid, its leverage ratios increase by an average of 20%. In the five years following a failed takeover, companies that increase their debt ratios the most lower their capital expenditures, sell assets, reduce employment, sharpen their focus, and generate cash flows and share values that surpass their benchmarks'. Because of this, they believe targets with higher levels of leverage act in the best interests of shareholders when they reject takeover offers and that higher levels of leverage aid companies in maintaining their independence by encouraging managers to make improvements that would otherwise be required by potential raiders.

The study of financial decision-making is the focus of conventional corporate finance theory. An continuing topic in the corporate finance literature is the study of firms' capital structures and whether or not an optimal capital structure exists. Since Modigliani and Miller’s fundamental work (1958), a number of ideas have been developed that stray from the rigid assumptions of perfect capital market efficiency. Particularly important theories include the trade-off theory and the hierarchy of importance theory. The former is true when companies build an ideal debt ratio based on tax benefits of debt, while the latter is true when companies choose a sequential choice of funding sources and do not seek external money (borrowing or issuing shares) until own resources are depleted.

2.4. Empirical Studies on Corporate Financialization in China

Jin et al. (2022) examined the heterogeneous correlation between fixed investment rate and corporate financialization among non-financial companies listed in China over the period between 2007 and 2016. Their research revealed a moderating role of monetary policy in this relationship, as the monetary policy negatively impacts on their relationship. It is noted that the researchers found differences between non-state-owned companies and state-owned enterprises in this relationship and their responses to the moderating role of monetary policy. Similarly, Zhao and Su (2022) conducted an empirical research on corporate financialization in non-state-owned companies in China, and they found a U-shaped relationship between corporate financialization and the economic policy uncertainty. Non-state-owned companies appeared to have fewer financing constraints. Li et al. (2020) found that corporate financialization can affect companies’ social value or their performance regarding their social contribution. In this research, the researchers found that companies’ corporate environmental responsibility can moderate the negative impact of corporate financialization and profit maximization on companies’ social contribution.

3. Data and Methodology

3.1. Data

In this paper, the data will be randomly picked from Chinese non-state-owned companies listed in A-shares stock market, and those companies are non-financial or non-real estate companies. This data selection can reduce the impact of China’s monetary policies on companies’ responses and performance to corporation financialization (Jin et al., 2022; Zhao and Su, 2022). At the same time, companies’ data from 2019 to 2021 are selected, excluding companies falling into the ST and *ST categories. Companies with missing data relating finance and company features are also excluded from the data. Furthermore, the research will conduct Winsorization for all data (1%). The data can be accessed from CSMAR database, and the empirical analysis will be conducted with STATA 15.0.

3.2. Methodology

This research will adopt two kinds of research methods to test the above mentioned objectives.

1. Literature Research Method

The literature research method is to organize and analyze the existing studies related to this paper, and to summarize the current status and shortcomings of the research, so as to clarify the research questions and tasks of this paper. In the literature review section, the domestic and international literature on financialization and corporate performance is reviewed to understand the recent research status and shortcomings of scholars on related research issues; in the research hypothesis formulation section, the paper composes and analyzes related issues based on different research perspectives, so as to propose specific research hypotheses. This method has been used by researchers like Klinge et al., (2021) and Safieddine and Titman (1999) as one of their research methods on their topics.

2. Empirical Analysis Method

The empirical research method is an econometric analysis of historical data relevant to the study of this research to test the validity of the hypotheses. This paper focuses on quantitative arguments for the core questions of this paper through nonlinear and multiple linear regression models. The explanatory variables include percentage of financial income and percentage of financial assets, which are two primary measurement indicators of corporate financialization (Klinge et al., 2021). In this research, the percentage of financial assets is used to reflect the financialization level of enterprises. The monetary funds, trading financial assets, derivative financial assets, net available-for-sale financial assets, net held-to-maturity investment assets and net investment properties held by enterprises are classified as financial assets accounts. Single and composite measures are the primary measures of company performance. Compared with single measures, composite measures provides a more comprehensive and systematic view of corporate performance, but it is not easy to manipulate and data is more difficult to obtain. The common forms of single measures are accounting indicators and market value indicators.  Return on total assets (roa) and return on net assets (roe) have strong data reliability and availability, and both are common indicators to reveal the performance status of enterprises in China (Jin et al., 2022).

Therefore, this paper uses percentage of financial income and percentage of financial assets as independent variables, roa and roe as dependent variables to reveal the corporate performance. The moderating variable is leverage ratio. The measurement model will be adapted from the model presented by Xu and Guo (2021).

4. Research Plan

PROJECT TIMESCALES
Activity	Week Start	Duration in weeks	Month
Data gathering and Literature Review	1	3	June-July
Analysis and Methodology	4	2	July
Discussion of Results and Conclusion	6	2	July-August
Introduction, Abstract	8	1	August
Review of Literature Review and Editing	9	1	August
Proof Reading and Submission	10	1	August

5. References

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