Firm Leverage and Stock Price Crash Risk: The Chinese Real Estate Market and Three-Red-Lines Policy

Xiaoling Chu (), Yongheng Deng () and Desmond Tsang ()
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Xiaoling Chu: Chinese University of Hong Kong
Yongheng Deng: University of Wisconsin-Madison
Desmond Tsang: Chinese University of Hong Kong

The Journal of Real Estate Finance and Economics, 2025, vol. 70, issue 3, No 6, 544-582

Abstract: Abstract This study examines the relationship between firm leverage and stock price crash risk, where extant literature shows mixed findings on the impact of leverage on stock price crashes. Utilizing the Chinese real estate industry setting with high debt financing, we show that leverage is significantly positively associated with stock price crash risk. We further examine how the relationship between leverage and stock price crash risk is attributed to the unique Chinese institutional and economic environment. We show that the effect of leverage on stock price crash risk is concentrated in regions of low social trust, low marketization, and low economic growth. We next consider China’s new guidance of the “three red lines” that governs firms’ debt financing policies, and we find that, among the three-red-line debt measures, the liability-to-asset ratio is the most significant determinant of crash risk. We also examine the implementation of the guidance in August 2020 with a difference-in-difference research design, and we show that the new guidance has significantly reduced stock price crash risk for high-leverage firms. Overall, our results show consistent evidence of stock price crash risk increases for Chinese real estate firms that have shown overreliance on debt financing. Our study highlights the vital role of firm leverage on stock price crash risk that pertains specifically to highly-levered firms.

Keywords: Firm leverage; Stock price crash risk; Chinese real estate; Three-red-lines (search for similar items in EconPapers)
JEL-codes: G32 G38 R38 (search for similar items in EconPapers)
Date: 2025
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DOI: 10.1007/s11146-023-09953-0

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