Financial distress heterogeneity and capital structure adjustments during Covid-19: Evidence from Chinese listed firms

Abstract

This study examines the heterogeneous effects of the COVID-19 pandemic on corporate capital structure decisions among Chinese listed firms, with particular attention to how firms' pre-existing financial distress risk shapes their leverage responses. Using a difference-in-differences (DID) framework applied to 17,214 firm-year observations spanning 2017 to 2022, and employing both Altman's Z-Score and Ohlson's O-Score as complementary measures of financial distress, the paper documents a significant pandemic-driven increase in financial leverage across firms. Crucially, firms with low financial distress risk exhibit substantially larger leverage increases than their high-distress counterparts, with the differential concentrated in short-term debt. Further analysis confirms that this pattern reflects differential access to external credit: financially healthier firms obtained greater incremental borrowing during the pandemic due to their superior creditworthiness, consistent with pecking order theory and credit-rationing mechanisms. Robustness checks using tercile groupings corroborate the main findings. These results contribute novel firm-level evidence on the interaction between pandemic shocks, financial vulnerability, and capital structure dynamics in an emerging market context.