Controlling shareholders’ portfolio composition and firm leverage

Controlling shareholders influence the leverage decisions of firms they control by assessing the investment risks posed to their overall portfolio. Our theoretical model formalizes this intuition by showing that when a firm constitutes a larger share of a controlling shareholder's portfolio (i.e., has higher “stock importance”), the shareholder prefers the firm to adopt lower leverage to reduce overall portfolio risk. This relationship strengthens when firms face lower credit quality. Using a comprehensive sample of Chinese listed firms, we provide strong empirical support for these theoretical predictions. The negative relationship between stock importance and leverage is most pronounced among firms facing financial constraints, higher default risks, or weaker governance structures. These findings remain robust across various endogeneity tests and alternative specifications. Our study reveals a novel determinant of capital structure decisions by showing how controlling shareholders' portfolio composition significantly influences corporate leverage choices. • We model how controlling shareholders' portfolio composition affects the leverage choices of the firms they control. • Firms with higher portfolio weight in controlling shareholders' holdings adopt lower leverage to mitigate risk. • This negative relationship is stronger when firms facing financial constraints, higher default risks, or weaker governance structures.