Excessive debt and priced risk exposure under systemic shock: Evidence from Chinese Listed Firms during COVID-19

Abstract

This study examines whether excessive debt, defined as a positive deviation from firm-specific target leverage, is associated with market-priced financial vulnerability during the COVID-19 shock. Using panel data for non-financial and non-utility Chinese A-share listed firms from 2017 to 2022, the study treats the pandemic as an exogenous systemic shock that increased cash-flow uncertainty, refinancing pressure, and capital-structure adjustment costs. Excessive debt (EXD) is measured as actual book leverage minus target leverage; positive values indicate that a firm operates above its sustainable leverage benchmark. Priced risk exposure is proxied by annual cumulative abnormal return (CAR) estimated from a market model. CAR is interpreted cautiously as a market-based measure of required compensation for firm-specific vulnerability rather than as a direct measure of operating performance. The empirical results show that COVID-19 is positively associated with risk-adjusted return, and excessive debt is positively related to CAR in the baseline model. More importantly, the interaction between EXD and COVID-19 is positive and significant, indicating that the pandemic strengthened the market pricing of leverage-related vulnerability. Robustness tests using alternative debt proxies and Altman's Z-score confirm that debt dependence weakens financial stability. Instrumental-variable tests and additional specifications reduce concerns that the findings are driven solely by reverse causality or omitted firm characteristics. The study contributes to crisis-period capital-structure research by showing that the distance from target leverage, not leverage level alone, is a relevant channel through which systemic shocks are transmitted into market-priced vulnerability. It also clarifies that higher abnormal returns among over-leveraged firms should not be interpreted as superior performance; rather, they are consistent with higher required returns demanded by investors for bearing leverage-related risk. The findings provide practical implications for managers, investors, and regulators by supporting early-warning systems based on leverage gaps, debt maturity pressure, cash-flow capacity, and industry-adjusted debt thresholds.