ThispaperexaminestheeffectofgovernmentpoliciesonthefinancingdecisionsoffirmsinChina.Arealoptionsmodelisdevelopedtounderstandhowfiscalandmonetarypoliciesaffectcorporateleverage.Themodelpredictionswillbetestedwithacomprehensivepaneldatasetspanningfrom2002to2011.Thisworkdocumentsrobustevidencethatshowthepositiveassociationofbothtaxandrisk-freeratewithfirmleverage:increaseintaxrateandriskfreeratebyonestandarddeviationresultsintheincreaseincorporateleveragesby0.61to1.06percentand2.54to3.68percent,respectively.Inaddition,theproductionsofthefirmsarenotaffectedbythetaxrateintheshortrun,andthefirmsareoperatingintheiroptimalmarketleverage.Theimpliedtaxrateandriskfreeratearesolvedbyassumingthatthefirmsachievetheiroptimalleverages.Theimpliedtaxratedeclineswiththesize,whereastheoppositegoesforimpliedrisk-freerate.
