Capital Misallocation and Financial Distress: Social Implications for Chinese Firms

Abstract

Inefficient allocation of financial capital can increase the vulnerability of companies, limiting their financial stability and creating social consequences for stakeholders. The aim of this study is to examine how capital misallocation affects corporate financial distress among Chinese listed companies from 2010 to 2023 and to explore the underlying mechanisms of this relationship. The empirical analysis is based on panel data from Chinese companies whose shares are traded on the A-shares market for 2010-2023. The source data is obtained from the CSMAR database. Regression models with individual and temporary fixed effects and robust standard errors were used to evaluate the relationships. The results show that inefficient capital allocation significantly increases the risk of financial insolvency. The stability of the result is confirmed by using the O-score (0.0410), including the regional financial development indicator (-0.1189) and excluding observations for 2019-2020. An analysis of the mechanisms shows that inefficient capital allocation reduces the operating profitability of companies (-0.0094) and at the same time increases the degree of manipulation of financial leverage (0.0423). Inefficient capital allocation increases the risk of financial distress among non-labor-intensive companies (-0.1379) and companies in competitive industries (-0.1196). The results show that improving the efficiency of financial resource allocation and limiting excessive debt burden can help reduce the risk of financial insolvency and strengthen the sustainability of companies.