The Great Wall and Beyond: The Value of Implicit Government Guarantees for Corporate Bonds in Mainland China and its Northeast Regions

Abstract

This paper explores how implicit government guarantees affect the yield spreads of Chinese corporate bonds. We argue that quasi-municipal corporate bonds (“Chengtou” bonds), issued by local government financing vehicles (LGFVs), carry an implicit government guarantee. Using a sample of publicly traded corporate bonds between 2010 and 2017, we show that bond investors are significantly less sensitive to bond-specific risks for corporate bonds with an implicit government guarantee: the yield spreads of Chengtou bonds are significantly lower than those of corporate bonds issued by privately-owned enterprises (POEs) in China. We also find that corporate bonds from Northeast China are riskier than those issued by firms elsewhere in the country. Furthermore, we find that policy changes introduced by China’s central government, which were intended to regulate local governments’ debt financing activities, significantly reduced the gap in yield spreads between Chengtou bonds and bonds issued by POEs. Overall, our results suggest that implicit government guarantees play a crucial role in China’s corporate debt market and that China’s recent policy changes reduce the effectiveness of implicit government guarantees, making China’s corporate bond market more market-oriented.