False hopes and blind beliefs: How political connections affect China's corporate bond market

Abstract

This paper explores whether and how political connections affect the market for corporate bonds issued by privately owned enterprises (POEs) in China. We test two competing theories – the zero-default myth and the borrower channel theory – that offer alternative explanations for the effect of political connections on the likelihood of bond issuance, the costs of refinancing, the market reaction to a bond issue announcement, and the performance of the firm after the bond has been issued. Using a sample of Chinese POEs from 2007 to 2016, we show that – in line with the zero-default myth theory – politically connected POEs are more likely to issue corporate bonds as a debt financing instrument than their non-connected counterparts. They also achieve lower coupon rates (i.e., lower refinancing costs), despite exhibiting lower overall performance after bond issuance. We find that investors react positively to corporate bond-issuing announcements if the issuing firm is politically connected. At the same time, our research indicates that politically connected bond-issuing POEs in China have weaker corporate governance and a surprisingly higher default probability than non-connected issuers.