Do Foreign Institutional Investors Affect International Contracting? Evidence from Bond Covenants

Abstract

We examine the impact of foreign institutional investors on the prevalence of restrictive bond covenants using a sample of 959 Yankee bonds from 29 countries over the period 2001–2019. We find a significantly negative relation between foreign institutional ownership and debt cov-enants. This inverse relation is strongest for U.S. institutional ownership of foreign-issued Yan-kee bonds, and for covenants designed to mitigate such opportunistic behavior as claims dilu-tion and wealth transfers. We also show that the inverse relation between U.S. institutional ownership and restrictive debt covenants is moderated by country- and firm-level variables re-lated to corporate governance, information asymmetry, and agency costs of debt. Additional analyses show that U.S. institutional ownership has a significant pricing effect on Yankee bond investors by lowering the issuer’s cost of borrowing.