Implicit Government Guarantees Research Articles

Local government financing vehicle restructuring, implicit government guarantees and debt financing costs: Evidence from the Chinese municipal corporate bond market

Local government financing vehicle restructuring, implicit government guarantees and debt financing costs: Evidence from the Chinese municipal corporate bond market

Implicit government guarantees, media tone and bond pricing

AbstractBy exploiting the first public bond default event in China—the Chaori bond default in 2014—we examine how implicit government guarantees shape the role of media information in bond pricing. We find an insignificant association between preissuance media tones and bond issuances’ yield spreads before the event; however, the association becomes negative and significant after the event. The role of media tone in bond pricing is more pronounced for regions with greater information demand for default risk and for media outlets with stronger information provisions toward implicit government guarantees after the event. Mechanism analyses suggest increased bond investors’ risk awareness, rather than strengthened information provisions in media tones, as the force behind the more pronounced role of media tone in bond pricing. Finally, lower yield spreads driven by more positive media tone do not suggest bond overpricing. Our study reveals the role of media tone in bond pricing and displays the evolution of the media tone's role in bond pricing due to changing institutions.

Bond Issuance as Reputational Signal: Debunking the Negative Perception of Additional Liability

This paper examines the determinants of bond issuance in the Chinese market and the influence of capital structure—in particular direct debt finance—on firm performance and the cost of debt. The results reveal that institutional factors in the Chinese market, in particular the involvement of the financial authority permission process during bond issuance, enhance the credibility of firms that are able to successfully issue bonds. Empirical analysis of Chinese listed manufacturing firms over the period from 2010 to 2021 demonstrates that firms with higher outstanding levels of bonds perform better and face lower costs of both bond and nonbond direct finance. We interpret this as bond issuance approval serving as a signal to markets of an implicit government guarantee on firms that are approved to issue bonds. The agency problem is analyzed using propensity-score matching and Logit analysis, revealing a trade-off between the principal–agent conflict and conflicts of interest among different shareholders when power is very concentrated through CEO duality: the CEO simultaneously serves as the chairman of the board. In large firms, as measured by total assets, the cost-reducing effect of the principal–agent problem being mitigated by CEO duality outweighs the agency costs arising from conflicts of interest between large and small shareholders, leading to an increased likelihood of successful bond issuance. However, in large firms, as measured by market capitalization, where share ownership is likely more diversified, this effect diminishes. In conclusion, this paper posits that policymakers ought to investigate strategies for granting preferential treatment to high-growth, small to mid-sized enterprises, enabling them to secure funding through direct debt financing.

Does environmental regulation caused by air pollution reduce shadow banking for non-financial companies? Based on the exit perspective of implicit government guarantee.

As China's economy enters the stage of high-quality development, the sustainability of development becomes increasingly important. Therefore, this study takes air quality index as the explanatory variable, the level of shadow banking as the explained variable, and environmental regulation as the intermediary variable to empirically study whether environmental regulation caused by air pollution will affect the shadow banking of non-financial enterprises. The findings suggest that air pollution is likely to strengthen environmental regulation, thereby reducing the level of shadow banking, as air pollution strengthens environmental regulation, leading to the reduction of implicit government guarantees, while enterprises tend to abandon or minimize reliance on these guarantees and reduce leverage. The mechanism test shows that the ESG performance of non-financial firms weakens the process by which air pollution reduces the degree of shadow banking of non-financial firms, while the short-sightedness of management enhances this process. Heterogeneity analysis shows that this process is more significant under the effect of market-driven environmental regulation and in private enterprises and enterprises in regions with large industrial scale. Therefore, the policy implication is that government should continue to strengthen environmental law enforcement in future supervision, as this can not only reduce pollution levels but also reduce systemic financial risks. Enterprises should also increase their sense of social responsibility.

State ownership and credit rationing: Evidence From China

We investigate the impact of a firm’s ownership on credit rationing. We find that state-owned enterprises (SOEs) are less likely to be credit rationed than non-state-owned enterprises (non-SOEs). After controlling for a large set of control variables, we find that SOEs are 12.22 percent less likely to experience credit rationing in comparison to non-SOEs. This finding is robust to different definitions of SOEs and other regression methods accounting for omitted variables bias and endogeneity problems. Furthermore, the effects of state ownership on credit rationing are heterogeneous among different cities. Specifically, SOEs are less likely to be credit rationed in cities with low financial development and high government intervention. This may reflect the fact that implicit government guarantees of SOEs are more effective in these cities.

The Influence of Implicit Guarantee on the Yield Spread of China’s Quasi-municipal Bond

Local government debts are an important part of the bond market. This paper mainly investigates the risk that the implicit guarantee brings to the market of quasi-municipal bonds. The implicit guarantee comes from local government financing vehicles (LGFVs), which are the finance entities for the local government, issue quasi-municipal bonds. Because people are potentially thought these bonds are guaranteed by the local government, the funding cost of quasi-municipal bonds is lower than other bonds. However, some local government's ability to pay back the investors' money is weak which causes some high-rated quasi-municipal bonds to default and triggers many defaults, which, along with the local government's mounting debt, may make investors more concerned about its capacity to repay the loan in the event of default. Therefore, China's central government then issues some policies to reduce the effectiveness of implicit government guarantees, trying to make the quasi-municipal bonds turn to become more marketize and contain less guarantee. In this paper, the author initially tries to demonstrate that the implicit guarantee reduces the yield spread of quasi-municipal bonds. Then, the author argues that the issue of relevant policies lessens the implicit guarantee and increases the marketability of quasi-municipal corporate bonds. Lastly, the author tries to show that different administrative levels of LGFVs will affect the yield spread of the bond.

Government's implicit guarantee and the credit spread of the quasi-municipal bonds

Breaking the rigid repayment of municipal investment bonds (MIBs) is essentially releasing the implicit guarantee of local governments. We analyze the effects of implicit government guarantees on MIBs’ credit spreads and find that regional economic strength, local government's financial strength, and fiscal balance have significant effects on the credit spreads of MIBs; the effects of implicit government guarantee on the credit spreads of MIBs depend on the regional economic development status; the effects of implicit government guarantee on the credit spreads are significant across different MIBs issued by public welfare institutions, quasi-public welfare institutions, and comprehensive municipal investment companies.

Trade policy uncertainty and corporate innovation: evidence from resource dependence perspective

ABSTRACT Corporate innovation activities under uncertain environment have attracted growing academic attention, yet didn’t reach a consistent result, and the mechanism of firms’ interdependence with other organisations is not well explored. This paper is committed to uncover the latent mechanism from a resource-dependence perspective behind the environment–innovation relationship. Adopting an unbalanced dataset of Chinese public listed firms from 2006 to 2020, this study testifies the positive association between trade policy uncertainty (TPU) and corporate innovation, based on the two-way fixed empirical model. Furthermore, levels of buyer companies’ dependence on major suppliers and implicit government guarantee reinforce the strength of TPU’s prompting effect on innovation output. Our conclusions are robust to a series of sensitivity tests and two-stage least squares (2SLS) instrumental variable method. Heterogeneous analysis shows that the buyer dependence mechanism is exclusively prominent in high-technology firms, and the implicit government guarantee mechanism is more significant among non-high-tech firms.

Deposit insurance system, risk-adjusted premium and bank systemic risk: Evidence from China

In this paper, we investigate whether and how the Deposit Insurance (DI) system and its Risk-adjusted Premium (RAP) scheme affect the systemic risk of Chinese banks. Based on bank-level panel data from 2007 to 2020 and the difference-in-differences (DID) method, we find that the establishment of the explicit DI system in China increases bank systemic risk, while the implementation of RAP alleviates this negative impact by reducing systemic risk. We further find the mechanism behind this phenomenon that bank profit acts as a mediator. We also find evidence for international heterogeneity using cross-country data and show that, as China has a longstanding implicit government guarantee, the establishment of explicit DI actually reduces the extent to which banks are protected, thus increasing bank systemic risk. Our study highlights the specificity of Chinese DI system, offers important policy implications for the design of financial safety nets in China and worldwide.

The flight to safety during credit recovery: The role of implicit government guarantees

This paper examines the investor flight-to-safety phenomenon during the credit recovery period following corporate bond defaults. We find that implicit government guarantee (IGG) bonds crowd out non-implicit government guarantee (non-IGG) bonds in the Chinese corporate bond market at the provincial level. The crowding-out effect is stronger in a province with scarce bank credit resources. In contrast, the crowding-out effect disappears when the bonds are explicitly guaranteed by a third-party or if the default event is triggered by a state-owned enterprise (SOE). This finding is robust to various maturity terms, alternative samples, propensity score matching and placebo tests. Our evidence highlights the significant role of implicit government guarantees in the crowding-out effect during the credit recovery period.

Implicit Government Guarantees and Continuous Innovation in Manufacturing Firms: Incentives or Disincentives? --Micro evidence from A-share listed companies

This paper explores the impact of implicit government guarantees on the continuous innovation of manufacturing enterprises using A-share listed companies from 2008 to 2017 as the research sample. It is found that the higher the implicit government guarantee is, the more it inhibits the continuous innovation of enterprises, and the mechanism of excessive indebtedness, inefficient investment, rent-seeking cost, and zombie enterprises is further found.

When Expectations of Implicit Government Guarantees Diminished, Do Retail Stock Investors Run Away?

When Expectations of Implicit Government Guarantees Diminished, Do Retail Stock Investors Run Away?

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.

Political connections and short sellers

This study finds that politically connected firms, comparing with their non–connected peers, are less likely to be targeted by short sellers, especially during the periods of market turmoil. Short sellers’ avoidance of politically connected firms can be attributed to the implicit government guarantee, which significantly increases the target firms’ information complexity and decreases short sellers’ expected risk–adjusted profits. The absence of short sellers consequently results in less negative stock returns for politically connected firms as compared to their non–connected peers. Our findings extend Boehmer et al.(2010) by showing that the absence of short sellers may not necessarily indicate good news but can be attributed to the presence of political connections. This study sheds some light on the sources of market value of political connections.

The Real Effects of Implicit Government Guarantee: Evidence from Chinese State-Owned Enterprise Defaults

We study the effects of implicit government guarantee (IGG) on Chinese state-owned enterprises (SOEs). We find that SOEs reduce their investments by 2.4% of book assets, on average, relative to matched non-SOEs after the first SOE default in China’s onshore bond markets in 2015. The investment reduction concentrates among SOEs that are financially constrained, yet SOEs financed by large state banks are hardly affected. Bondholders require more stringent default protection in newly issued SOE bonds. We also find that the investment reduction is more pronounced for SOEs with severe agency problems and that SOEs experienced more positive market reactions to acquisition announcements after 2015. Our results suggest that the reduction in IGG has confounding effects on Chinese firms. Although the weakening of IGG may help mitigate overinvestment, it exacerbates financial constraints of those with limited access to alternative sources of financing. This paper was accepted by Lucas Schmid, finance. Funding: Z. Zhang acknowledges the funding support by Research Grants Council of Hong Kong [Project 11503318]. Supplemental Material: The data files and online appendix are available at https://doi.org/10.1287/mnsc.2022.4483 .

Implicit Government Guarantee and Corporate Investment: Evidence from China’s Belt and Road Initiative

ABSTRACT Implicit government guarantee results in financing convenience and distorting corporate investment. The effects on MCB’s credit spread and corporate investment are studied in this paper based on China’s bond market from 2010 to 2020. The implicit government guarantee lies in MCBs whose financing costs are significantly lower than those of POEs. The inefficiency of corporate investment also exists in MCBs with investment reductions. But this inefficiency has been corrected by China’s recent major national strategy, the Belt and Road Initiative. We provide direct evidence from three perspectives, provinces along BRI routes, city-level features of China-Europe Railway Express and bond-level funding purposes. This paper reveals that implicit government guarantee could only reduce the funding cost, while major national strategy is helpful to promote corporate investment.

Bankruptcy courts and the marketization of bond issuance

PurposeThis paper aims to study the effect of the establishment of bankruptcy courts on bond issuance market. This paper helps to predict that the introduction of bankruptcy courts in China can mitigate price distortions caused by the implicit government guarantees and promote the development of the high-risk bond market.Design/methodology/approachThis paper exploits the staggered introduction of bankruptcy courts across cities to implement a differences-in-differences strategy on bond issuance data. Using bonds issued in China between 2018 and 2020, the impact of bankruptcy courts on the bond issuance market can be analyzed.FindingsThis paper reveals that bond issuance credit spreads increase and is more sensitive to firm size, profitability and downside risk of issuance entity after the introduction of bankruptcy courts. It also reveals a substantive increase in bond issuance quantity and a decrease in issuer credit ratings following the establishment of bankruptcy courts. In addition, the increase of credit spreads is more prominent for publicly traded bonds, those whose issuers located in provinces with lower judicial confidence, bonds issued by SOEs and bonds with stronger government guarantees. Finally, the role of bankruptcy courts is more pronounced in regions with higher marketization.Originality/valueThis paper relates to previous studies that investigate the impact of laws and institutions on external financing. It helps provide new evidence to this literature on how improvements of efficiency and quality in bankruptcy enforcements relate to the marketization of bond issuance. The results provide further evidence on legal institutions and bond financing.

Implicit government guarantees and bank risk

We develop a model on bank risk and implicit government guarantees. This model concerns the willingness and capacity of implicit government guarantees. Using the Option Pricing Theory, we derive a mathematical formulation of maximizing the bank’s net present value (NPV) with implicit government guarantees. Unlike previous work, both the loan portfolio and the bank’s NPV are regarded as a combination of options underlying the risky project. We conduct comparative static analyses and numerical examples to examine how implicit government guarantees and capital control affect bank risk and its asset scale. The main insight of our analysis is that implicit government guarantees have some unintended consequences: (a) Inefficient and excessive risk taking (including bank’s asset and overall risk); (b) Inefficient investment if there is no binding capacity constraint. We show that it is mainly due to the bank's excessive reliance on contingent assets. In addition, we demonstrate the ineffectiveness of capital constraint on risk control under certain circumstances. Therefore, we suggest that the gradual withdrawal of implicit government guarantees should be accompanied by multiple combinations of regulatory measures and proper institutional reform to avoid risk surges.

The economics of banking regulation in Europe: does the post-GFC bail-in regime effectively eliminate implicit government guarantees?

This paper assesses the market effects of regulatory events associated with the implementation of a bail-in regime for failing European banks. The bail-in regime was designed to make banks efficiently resolvable in order to abolish Implicit Government Guarantees (IGGs). We use a seemingly-unrelated-regressions framework to estimate the effects on Credit Default Swap (CDS) spreads and equity returns of key events associated with the two cornerstones of the European bail-in regime, the Bank Recovery & Resolution Directive (BRRD) and the Single Resolution Mechanism Regulation (SRM-R), and other relevant events. Contrary to the regulations’ objectives, we find that regulatory events associated with the implementation of BRRD and SRM-R led to tighter CDS spreads and higher equity returns over the 2009–2017 period. The pattern varies with bank heterogeneity and is particularly pronounced for global systemically important banks (G-SIBs), i.e. banks whose systemic risk profile is deemed to be of such importance that the bank's failure would trigger a wider financial crisis and threaten the global economy, suggesting that the regime does not effectively solve the systemic problem of bailout expectations in the European banking sector.

Regional Happiness and Corporate Green Innovation: A Financing Constraints Perspective

In China’s period of economic transition, enterprises often find it difficult to obtain the support of formal institutions and the capital market, so informal institutions such as value and social networks are particularly important resources. Regional happiness can influence corporate green innovation by shaping the external environment. This study takes a sample of Chinese A-listed companies and empirically tests the impact of regional happiness on corporate green innovation by constructing happiness data at a city level. The empirical results show that in cities with high levels of happiness, the green innovation level of listed companies is higher. This is manifested by a higher number of green patents and green invention patent applications. To test for reliability, a series of robustness tests were carried out. First, we performed 2SLS regression using the instrumental variable method in consideration of the possibility of a reverse generation of endogenous problems. Second, we remeasured corporate green innovation using a green patent authorization considering the rationality and applicability of the measurement method of core variables, and then remeasured the regional happiness based on a text analysis of social media content. Both tests showed that the conclusions are robust. Mechanism analysis revealed that regional happiness has an impact on corporate green innovation through financing constraints, namely, that it can either alleviate enterprises’ financing constraints, or substitute for regional financial development to promote corporate green innovation. Further analysis showed that, for enterprises lacking political connections, regional happiness plays a significant role in promoting green innovation. This indicates that, in the absence of financing convenience, the resource effect brought by regional happiness acts as a substitute for an implicit government guarantee. This study provides new insights into the determinants of corporate green innovation and the value of informal institutions in environmental sustainability.