Institutional Equity Investment, Asymmetric Information and Credit Spreads

Abstract

Theoretical work suggests that information risk affects corporate bond pricing. This paper empirically examines the relation between information asymmetry, a specific aspect of information risk, and bond yield spreads. Using equity holdings by different institutions following distinct investment and trading styles, we find that yield spreads narrow (widen) with an increase in equity holdings by institutional groups that are more (less) sensitive to information asymmetry. This relation is strongest for bonds with short maturities, lower ratings, higher leverage, and higher equity return volatilities. The relation between yield spreads and different institutional equity holdings is not subsumed by other information risk measures, including probability of informed trading, bid-ask spread, analyst forecast dispersion, and accounting disclosure rankings. It also survives adjustments for the equity style of the issuing company. Moreover, the relation holds for both the level and changes in bond yield spreads.