China's local government debt financing has been expanded aggressively to support infrastructure investment, especially since the enactment of four‐trillion‐yuan stimulus plan to stimulate the economy post global financial crisis. At the same time, the rapid increase of firm‐level leverage ratio of state‐owned enterprises (SOEs) and the decline of leverage ratio of non‐SOEs jointly deteriorated China's credit misallocation problem. In this study, we empirically test the effect of local government debton firm leverage in China. We find that an expansion of local government debt significantly crowded out the leverage of non‐SOEs, while crowded in that of SOEs. Moreover, the effect differed across industries and sectors.