Downstream Credit Shock and Construction Firm Debt Burden: A Dynamic Capabilities Perspective

Abstract

Successive global financial and geopolitical shocks have intensified credit market tightness, heightening uncertainty in developer financing, which in turn exposes construction firms reliant on these downstream payments to acute credit shocks. However, this issue has not been sufficiently examined in the existing literature. To address this gap, this study examines the impact of downstream credit shocks on the debt burden of construction firms. Using China’s “Three Red Lines” policy as a quasi-natural experiment and a Difference-in-Differences approach with financial data from listed construction firms, we find that downstream credit shocks significantly increase firms’ debt burdens. Exposed construction firms experience a 13.2% rise in debt-to-asset ratios and an increase of 15.18 billion yuan in debt obligations on average. Drawing on the dynamic capabilities perspective, we show that digital transformation and business diversification mitigate these effects, whereas regulatory violations exacerbate financial distress. Theoretically, this study extends the dynamic capabilities perspective by demonstrating how firm-level organizational conditions shape the effectiveness of firms’ responses to downstream credit shocks. Practically, we suggest that construction firms strategically invest in digital technology, diversify their business portfolios, and maintain strong regulatory compliance to better buffer against the financial contagion along the supply chain.