Corporate Debt Market Research Articles

IndiGrid: Creating India's First Power Transmission InvIT (A)1

The case describes the structure of Infrastructure Investment Trusts (InvITs) created and launched in Indian markets in 2017. Besides introducing InvITs and their potential role in relaxing the financing constraint created by the lack of an active corporate debt market in India, the case can help in analysing why the market is discounting the IndiGrid unit price relative to its issue price. It also offers an opportunity to value IndiGrid's Patran acquisition.

Accounting Information Completeness and Firm Default Risk

Corporate debt market is crucial to raise capital for businesses and to maintain steady economic growth. Disclosure with more complete accounting information provides more informative signals for investors to assess a firm’s risk of defaulting on its debt, which is the fundamental mechanism of the seminal theory by Duffie and Lando [2001, Term Structures of Credit Spreads with Incomplete Accounting Information, Econometrica 69(3), 633–664]. Using a disclosure quality measure that captures the completeness of accounting information in the income statement and balance sheet, we show that a firm’s default risk is significantly and negatively associated with the completeness of its accounting information. We further show that the negative relation is mainly driven by the information completeness of the balance sheet, relative to that of the income statement. In addition, the information completeness of the long-term liabilities on the balance sheet better explains a firm’s default risk, compared to the current liabilities. Overall, our findings provide new evidence on the importance of accounting information completeness for both firms and investors in the debt market.

Analysis of Yields and Their Determinants in the European Corporate Green Bond Market

The green bond market helps to mobilize financial sources toward sustainable investments. Green bonds are similar to conventional bonds but are specifically designed to raise money to finance environmental projects. The feature of green bonds is the existence of greenium, or the lower yield compared to “conventional” bonds of the same risk. The relevance of the paper is underpinned by the mixed evidence on the existence of ‘greenium’, especially in corporate green bond markets; there has been limited research on the topic and a narrow focus on global, US, or Chinese green bond markets. Instead, the greenium in European debt markets remains underexplored. The objective of this study is to investigate the existence of greenium and its key determinants in European corporate debt capital markets, including the local markets of the United Kingdom (UK), France, Netherlands, and Germany. The sample included 3851 corporate bonds, both green and conventional ones, between 2007 and 2021 from 33 European countries. Linear regression was applied for the analysis. The results show that the climate corporate bonds in Europe are priced at a discount to the same-risk conventional corporate bonds. The magnitude of greenium is around 3 bps. Determinants of greenium include the presence of an ESG rating and belonging to the utility and financial industry. The remaining drivers of bond yields in the European corporate debt market are the credit quality (expressed by the level of credit rating), the coupon size, the bond tenor, the market liquidity, and macroeconomic variables (growth of gross domestic product and consumer price index). For the local corporate debt markets, our results are controversial. In all markets under consideration except for the UK and the Netherlands, we did not find sustainable evidence of greenium. The results of the research lead to a better understanding of the green bond market for investors, researchers, regulators, and potential issuing companies.

The intra-regional spillover effects of bond defaults: Evidence from the Chinese corporate debt market

Taking the first bond defaults in each province in China as credit events, we adopt a staggered difference-in-difference model and find that credit spreads of other corporate bonds in the same province increase by 15 basis points, suggesting spillover effects. The spillover effects are stronger on local state-owned enterprises (LSOEs) and non-state-owned enterprises (Non-SOEs) than on central state-owned enterprises (CSOEs). Moreover, the defaults of LSOEs trigger the greatest spillover effects among all types of defaults. Provinces with higher guarantee capability experience fewer spillover effects. Our findings suggest intra-regional spillover effects from investors' shaken beliefs on implicit government guarantees.

The Intra-Regional Spillover Effect of Bond Defaults: Evidence from the Chinese Corporate Debt Market

The Intra-Regional Spillover Effect of Bond Defaults: Evidence from the Chinese Corporate Debt Market

The performance of corporate bond issuers in times of financial crisis: empirical evidence from Latin America

Purpose – The fundamental theory of Modigliani and Miller (1958) states that a firm’s financing decisions are independent from the firm’s value. Nevertheless, several empirical studies as well as theoretical approaches from the past decade impugn this relation for real markets with their immanent inefficiencies. However, these questions are rather than academic in nature: Especially the influence of macroeconomic conditions on the market perception of debt issues is from high economic importance, since the need for new liquidity usually becomes even more urgent when the economic conditions worsen. Design/methodology/approach – This paper analyzes the reaction of shareholders to the issue of debt by Latin American firms under special consideration of the macroeconomic sentiment. To do so, a sample of debt issued by Latin American companies between 2003 and 2010 is empirically examined through an event study. Findings – The authors empirically demonstrate that specifically in Latin America, debt issuing companies show a significant underperformance during recessionary periods and an overperformance during nonrecessionary periods. These findings differ from previous results for mature capital markets. The authors conclude that not only the overall economic conditions matter to explain stock market reactions on bond issues but also the maturity of the corporate debt market plays an important role. Originality/value – The authors provide first evidence that the previously described changes in the returns on specific stocks depending on the economic sentiment (Baker and Wurgler, 2006) are under certain conditions also present in the market for corporate debt. Keywords – Emerging markets, Debt issue, Sentiment, Event study, Corporate debt, Financing decisions, Firm value Paper type – Research paper

The performance of corporate bond issuers in times of financial crisis: empirical evidence from Latin America

PurposeThe fundamental theory of Modigliani and Miller (1958) states that a firm's financing decisions are independent from the firm's value. Nevertheless, several empirical studies as well as theoretical approaches from the past decade impugn this relation for real markets with their immanent inefficiencies. However, these questions are rather than academic in nature: Especially the influence of macroeconomic conditions on the market perception of debt issues is from high economic importance, since the need for new liquidity usually becomes even more urgent when the economic conditions worsen.Design/methodology/approachThis paper analyzes the reaction of shareholders to the issue of debt by Latin American firms under special consideration of the macroeconomic sentiment. To do so, a sample of debt issued by Latin American companies between 2003 and 2010 is empirically examined through an event study.FindingsThe authors empirically demonstrate that specifically in Latin America, debt issuing companies show a significant underperformance during recessionary periods and an overperformance during nonrecessionary periods. These findings differ from previous results for mature capital markets. The authors conclude that not only the overall economic conditions matter to explain stock market reactions on bond issues but also the maturity of the corporate debt market plays an important role.Originality/valueThe authors provide first evidence that the previously described changes in the returns on specific stocks depending on the economic sentiment (Baker and Wurgler, 2006) are under certain conditions also present in the market for corporate debt.

The Emerging Asia Pacific Capital Markets: Sri Lanka

The capital market of Sri Lanka consists of government securities, stocks, and corporate bonds. All financial instruments have a combined value of about USD 66.3 billion as of July 2020. Government securities contribute the most, with about 63% of the economy. Government securities are issued in both Sri Lankan rupee (LKR) and foreign currency denominated securities. The current stock market formed in 1985 and was later renamed the Colombo Stock Exchange (CSE). The CSE currently has two indices, and the main securities traded include ordinary and preferred shares, close-ended funds (unit trusts), and corporate debentures. Currently 287 entities are listed on the CSE, with stocks contributing 16% of the economy. The corporate bond market became active in 2013, with the introduction of incentives from the government, including the exemption of interest income received from listed debt from income and withholding taxes. The market capitalization of the listed corporate debt market reached LKR 257.9 billion in July 2020. The Securities and Exchange Commission (SEC) and the CSE have focused on expanding the contributions made by corporate debt in the capital market. The CSE faces many challenges, including the need to increase corporate listings, liquidity, and foreign investor participation as well as to broaden the depth of financial instruments. A master plan has been developed with the SEC to develop the Sri Lankan capital market to be on par with global exchanges, beginning with the South Asia region. Importance has been placed on attracting global investors and developing new financial instruments. Development of capital market–related infrastructure has included measures to set up and implement a risk management system, a delivery versus payment settlement method, and a central counterparty clearing house. The SEC has also facilitated the introduction of real estate investment trusts (REITs), as a forward-looking step in its market development strategy.

Role of Institutional Investors: Evidence from the Foreign Rule-144A Debt Market

We examine the unique role played by institutional investors in the private corporate debt market for Rule 144A debt. We use the recent global financial crisis as a quasi-natural experiment to study how qualified institutional buyers (QIBs) facilitated funding to the foreign debt issuers in U.S. Using an exhaustive sample of foreign bond issuances in the U.S. from over 65 countries between 1990 and 2013, we examine (a) corporate decisions involving debt choice and market timing, and (b) determination of offer spreads. Our findings collectively support the notion that QIBs enabled funding in the foreign 144A debt market despite the financial crisis.

Discharging the Discharge for Value Defense

Despite its massive size, the corporate debt market is often considered a sleepy refuge for the risk-averse. Yet, corporate debt contracts are often mind-numbingly detailed. That complexity—when coupled with the financial stakes in play—can be a recipe for calamity. And in late 2020, calamity struck in the form of an accidental $1 billion payoff sent to Revlon Inc.’s distressed creditors—not by Revlon itself but rather by Citibank, the administrative agent for the loan. When several lenders refused to return the cash, Citibank commenced what many reckoned would be a successful (if embarrassing) lawsuit to claw it back. But in a dramatic 2021 opinion, a New York federal court sided with the creditors, applying an obscure equitable doctrine known as the “Discharge for Value” defense. The lenders could keep their wayward windfall, and Citibank got stuck with a sizeable write-down. Regardless of how it comes out on appeal, the case seems destined to feature prominently in contracts classes and textbooks for years to come. Against this backdrop, this Article makes three contributions: First, it spotlights several doctrinal and logical irregularities in the District Court’s opinion. Second, it builds on these inconsistencies to critique the opinion from an economic policy perspective. Third (and most substantially), it presents novel empirical data to analyze how market participants have reacted to the opinion. Consistent with the policy critique, I document a rapid, precipitous trend towards writing and/or amending debt contracts to nullify the Citibank opinion in its entirety, manifested in a variety of “Revlon blocker” provisions that have appeared in hundreds of publicly disclosed contracts. The firms that adopt Revlon blockers are systematically the largest and most sophisticated companies in the public markets, and their rejection of Citibank appears to have met with general market approval. Beyond demonstrating how legal theory and empirical evidence can helpfully interact, this analysis underscores the critical role that default rules play in contract law and policy, and the high stakes involved in getting them right.

Effect of Interest Rates on Private Sector Debt in Kenya

This study sought to examine the effect of interest rates on domestic private sector debt in Kenya over the 30 year period from 1990 to 2019. The dependent variable was private sector domestic debt, the independent variable was commercial bank weighted average lending rate while the control variables were annual GDP growth, extended broad money (M3) and annual USD-KES exchange rate. Using the Prais-Winstein estimator model, the regression model findings were commercial bank lending rate had an insignificant relationship with domestic debt at 95% confidence level but significant at 90% level while money supply had a negative and significant relationship with domestic debt. The study noted predominance of the banking sector in the financial sector and identified the need of a well-developed corporate debt market.

Does Firm Size Influence Leverage? Evidence from India

This study aims to investigate the size–leverage relationship in the context of India—one of the important emerging economies. Most of the studies that have tested the relationship between firm size and leverage have been conducted in the developed economies. For testing the much-discussed size–leverage relationship, we employ a large sample of firms for the study over a time span of 17 years from 2002 to 2018. Our findings support the negative size–leverage relationship, confirming the propositions of the pecking order theory. The study has implications for policymakers regarding the development of corporate debt market in India.

Five Facts About Direct Lending to Middle-Market Buyouts

Using a proprietary data set of private credit agreements, I document five facts about a previously unexplored segment of the US corporate debt market: nonbank direct lending to private equity (PE) middle-market buyouts. First, PE-backed middle-market firms have high cash flow, low liquidation value of tangible assets, and exhibit strong (weak) dependence of debt capacity to cash flow (liquidation value). Second, these features are stronger for those borrowing using direct loans despite their being smaller in size. Third, direct loans face markedly higher annual borrowing costs that are over 300 basis points higher than on comparable bank loans. Fourth, direct loans instead have a much more borrower-friendly covenant structure. Fifth, borrowers of direct loans find covenant violation costly, for it may constrain future borrowing. These findings suggest that small firms are not limited to asset-based bank debt and can rely heavily on cash flow-based debt. Further, direct lenders can provide more flexible solutions to PE sponsors in exchange for greater cash flow rights without compromising ex-post enforcement of contractual rights. Overall, this paper raises important questions for research in the growing literature on shadow banking.

COVID-19 And The Credit Cycle

The COVID-19 health crisis has dramatically affected just about every aspect of the economy, including the transition from the record long benign credit cycle to a stressed one, with still uncertain dimensions. This paper seeks to assess the credit climate from just before the unexpected global health crisis catalyst to its immediate and extended impact and the performance of several key indicators of the nature of credit cycles - - default and recovery rates on high yield bonds that we expect to default over the next 12 months, and beyond, yield spreads and distress ratios, and liquidity. Our focus is primarily on the non-financial corporate debt market in the U.S. which reached a record percentage of GDP at the end of 2019 as firms increased their debt to take advantage of record low interest rates and investor appetite grew for higher promised yields on risky fixed income assets. We also examine the leverage loan and CLO markets as well as the increasingly large and important BBB tranche of the corporate bond market. Specifically, the latter’s vulnerability to downgrades over the expected downturn in the real economy and this vulnerability’s potential impact on expected default rates by “crowding-out” other firms’ very low quality firm debt, some of them “zombies”. Using Z-Scores for a sample of BBB companies between 2007 and 2019, we analyze this largest component of the corporate bond market to provide some evidence on the controversial debate as to whether there has been rating-inflation or perhaps, persistent over-valuation of the non-financial corporate debt market since the last financial crisis.

Harvesting Islamic risk premium with long–short strategies: A time scale decomposition using the wavelet theory

AbstractThe impact of the Islamic screening on the performance of stock and sukuk investments is subject of a serious debate. The aim of this paper is to contribute to the ongoing studies on Islamic markets by giving new insights about characteristics of the Islamic risk premium. To attempt this objective, we adopt a risk premia methodology using long–short strategies and a time scale decomposition to find out the scale and the intensity degree of this effect over time. Furthermore, we consider the Islamic risk premium as a market factor. Wavelet analysis results in Malaysia highlight the presence of the Islamic effect at low frequency bands and a higher intensity among the corporate debt market. However, this approach's effectiveness is conditioned to the existence of Islamic and conventional benchmarks.

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

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.

Predicting Probability of Debt Default: A Study of Corporate Debt Market in India and other Countries

Default by corporate is problem of concern for banking and financial services industry along with economy. Timely prediction of default is imperative for the bankers and regulators to devise and take preventive actions. There has been large numbers of studies across the world and in India too few studies conducted for Indian data. An extensive review of literature reveals that the subject of default prediction has not explored much in India. In India along with rest of the world, the numbers of defaults have been increasing every year. This creates scope for further studies. A comparative study has been conducted on the data of three countries, namely India, the US and the UK using four methods; MDA, logit, reduced form and structural models. The study for the Indian sample has developed 24 models for three methods; MDA, logit and reduced form model for two sample periods large sample period and small sample period on a sample of 2450 case over ten years from 1st April 2004 to 31st March 2014 and on two years data from 1st April 2014 to 31st March 2016, the developed models have been validated for the forward period as well as for the out of sample firms. Structural model has been tested on Indian data. The study for the American sample has developed three models for the three methods; MDA, logit and reduced form model. Structural model has been tested on American data. The study for the British sample has developed three models for the three methods; MDA, logit and reduced form model. Structural model has been tested on British data. So in this study total 30 models have been developed. The study uses multiple discriminant analysis and logistic regression analysis to calculate composite scores which are used to predict default. The structural model uses option mathematics to give probability of default with help of market value of assets, book value of debt and asset drift rate. Reduced form model uses Poisson regression to estimate intensity of default which is transformed into probability of default. The findings of the study for Indian sample suggest that logit model yields the highest classification accuracy of 97.7% and reduced form model yields the lowest classification accuracy of 82.3%. The models for small sample period are robust but classification accuracies for the models for large sample period are higher for different methods. The classification accuracies of 24 developed models for Indian sample has higher than many studies conducted in India and other countries. The findings of the study on American sample suggest that logit model yields the highest classification accuracy of 95% and structural model yields the lowest classification accuracy of 85.9% and classification accuracies of developed models higher than many studies. The findings of the study on British sample suggest that structural model yields the highest classification accuracy of 81.6% and reduced form model yields the lowest classification accuracy of 67.9%. The findings on variables suggest that all the three types of variables namely accounting, market and economic variables are significant for all the three samples from India, the US and the UK. In case of India, it is observed that all the variables which are significant for large sample period are significant for small sample period indicating the in long run firms tend to follow a certain pattern and default can be predicted with the help of a set of certain variables as far as default predict is concerned. However in short run market variables seem play minor role in default prediction. From the analysis of variables it is evident that total book value of debt with respect to total assets is the most important variable among all the variables with debt component. The biggest limitation of this study is that the models for small sample period are more robust while the models for large sample period have higher classification accuracy. The whole study is facing the problem of sample and selection biases.

Liquidity Risk and Corporate Risk-Taking

We construct a theoretical framework to investigate the impact of liquidity risk, in the secondary corporate debt market, on corporate risk-taking preferences. Using closed-form solutions, our model shows that equity holders choose to adopt high-risk projects upon the arrival of illiquidity shocks. This effect is more pronounced for firms with weaker fundamentals. Empirically, we confirm the positive relationship between liquidity risk and corporate risk-taking. We also document that the impact of liquidity risk on corporate risk-taking preferences is more pronounced for smaller firms and firms with lower profits and higher rollover risk. In addition, we use the introduction of the Trade Reporting and Compliance Engine (TRACE) as a natural exogenous liquidity shock and find a decrease of firms’ risk-taking preferences after the TRACE is implemented. Our findings shed light on the managerial behavior literature, which shows that the frictions of the secondary bond market have a real impact on firms’ risk-taking behaviors.

Corporate governance and debt securities issued in Brazil and India: A multi-case study

The corporate debt market tends to provide a funding alternative, but requires improvements in regulation and self-regulation. Therefore, corporate governance arises as a central element for reducing agency conflicts, and private debt market development. We analyze the corporate governance structure of debt issuers from Brazil and India through an index of Economic Commission for Latin America and the Caribbean (ECLAC). The results showed that the non-defaulted companies had higher scores and the corporate governance quality of the issuer tends to contribute to the fulfillment of its obligations.

Negotiated Bank Finance, Earning Quality and Firm Characteristics: Indian Evidence

Based on ‘ agency theory’ the present study argues that in a negotiated and collateral security based debt financing system where the need for debt financing of the firms is largely met by the banks in absence of active and liquid corporate debt market , there should be a two way relationship between debt and earning quality. More specifically, we argue that banks, in the interest of better credit risk management, should extend finance to firms with reliable earning quality, and as the debt monitors the managerial behavior of the firms, earning quality of the firms should also get impacted by debt through closer scrutiny by lenders. To our knowledge no prior study has covered the relation between debt and earning quality from this angle so extensively in a bank dominated finance system of an emerging market. Lending policy is set by banks on the basis of overall Reserve Bank of India’s ( the central Bank) circulars and directives. In this framework earning quality may not appear to play any direct role in granting and enhancing credit limit, though the asset quality of banks is contingent upon ‘true and fair’ reflection of earning and cash flow generation of the borrowing firms. The empirical evidence seems to suggest that the firms might report ‘abnormal accrual’ to enjoy higher credit limit. Consistent with the result we find that tangible assets as ‘collateral security’ plays a more decisive role in mitigating credit risk rather than earning quality (being essentially a qualitative attribute).