Are banks misled by leverage misestimate of Chinese listed companies?

Abstract

Purpose

The authors point out that the existing research confuses the operational liabilities formed based on the “transaction” relationship with the financial liabilities formed based on the “investment” relationship, which not only exaggerates the value of leverage but also underestimates the level of protection that companies provide for creditors alone. That is, the confusion of concepts not only triggers the problem of leverage misestimate but also triggers the short-term financial risk misestimate. The performance of “nominal leverage” and “nominal short-term solvency” based on total assets calculation cannot reflect the real leverage level and the real short-term financial risk of enterprises.

Design/methodology/approach

To distinguish the concepts of “assets” and “capital” and rationalize the relationship between “transactions” and “investments”, authors systematically design the “real leverage” indicators and “real short-term solvency” indicators, and measure the degree of misestimate of leverage and short-term financial risk indicators by traditional research. On this basis, this paper describes and analyses the trends of leveraged misestimate and short-term financial risk misestimate of listed companies in China and analyses which companies have more serious leverage misestimate. And it helps readers to form an objective understanding of the leveraged misestimate and short-term financial risk misestimate of listed companies in China.

Findings

Firstly, the overall high level of leverage of listed companies in China in the traditional sense is largely because of the misestimate of indicators. And this kind of misestimate is more serious among firms that have advantages in trading, such as state-owned enterprises and firms with higher market shares. Secondly, for most firms with normal solvency, traditional research systematically overestimated the negative impact of “nominal leverage” on financial risk indicators (represented by short-term solvency). The overestimation is significant in firms with serious leverage misestimate. Thirdly, indicators’ misestimate of the traditional research makes the banks cannot make effective credit decisions according to the firm's “real leverage” and “real short-term solvency”.

Originality/value

Firstly, clarify the differences between the concepts of “assets” and “capital”, and clarify the level of “real leverage” of listed companies in China, which is conducive to the process of “de-leveraging”. Secondly, revise the problem of misestimate of related indicators, so that financial institutions can clearly identify the true profitability and real risk level of the entity domain, and thus improve the effectiveness of credit decisions.

Citation

Wang, Z., Wang, Z. and Su, X. (2020), "Are banks misled by leverage misestimate of Chinese listed companies?", Nankai Business Review International, Vol. 11 No. 4, pp. 507-535. https://doi.org/10.1108/NBRI-12-2019-0067