Abstract
When a sovereign faces the risk of debt default, it may be tempted to expropriate the private sector. This may be one reason why international investment in private companies has to take into account the sovereign risk. But the likelihood of sovereign risk transferring to corporates and increasing their risk of default may be mitigated by legal institutions that provide strong property rights protection. Using a novel credit default swaps (CDS) data set covering government and corporate entities across thirty countries, we study both the average strength of the transfer risks and the role of institutions in mitigating such risks. We find that 1) sovereign risk on average has a statistically and economically significant influence on corporate credit risks (all else equal, a 100 basis point increase in the sovereign CDS spread leads to an increase in corporate CDS spreads of 71 basis points); 2) the sovereign-corporate relation varies across corporations, with state-owned companies exhibiting a stronger relation with the sovereign; and 3) the presence of strong property rights institutions, however, tends to weaken the connection. In contrast, contracting institutions (offering protection of creditor rights or minority shareholder rights) do not appear to matter much in this context.
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