Excessive External Borrowing in China: Evidence from a Nonparametric Threshold Regression Model with Fixed Effects

We investigated the excessive external financing problem in Chinese industrial firms by examining the potential threshold effect of the leverage ratio on the total factor productivity of firms. We hypothesized the existence of a turning point in leverage ratio at which the productivity of these firms is maximized, and this point may vary by firm ownership type. To test our hypotheses, we proposed a nonparametric panel threshold regression model. From a modeling perspective, our approach contributes to the literature by allowing the threshold variable to be endogenous, accounting for unobserved firm heterogeneities, and imposing no restrictions on the functional form of regression. We employed a two-step estimation procedure, first estimating the threshold using an extreme kernel estimator and then conducting local linear regression based on the estimated threshold. We obtained standard errors via bootstrapping and demonstrated the favorable numerical performance of our estimator through simulation studies. Consistent with our hypotheses, we found that excessive leverage relative to the identified turning point significantly restrains productivity growth. Additionally, the estimated turning point varies by ownership type, particularly in state-owned enterprises (SOEs), where leverage exceeding the threshold negatively impacts productivity. Consequently, regions with a higher concentration of SOEs experience stagnant productivity growth. Our results were statistically supported by nonparametric tests and remained consistent when using leverage growth rate as an alternative measure of external financing.