Public Debt Issues Research Articles

What Does the Yield on Subordinated Bank Debt Measure?

We provide evidence that the yield spread on banks’ subordinated debt is not a good measure of bank risk. First, we use a model with heterogeneous investors in which subordinated debt is primarily held by investors with superior knowledge (i.e., the“informed investor hypothesis”). Subordinated debt, by definition, coexists with non-subordinated, or “senior,” debt. The yield spread on subordinated debt thus must not only compensate investors for expected risk (i.e., to satisfy their participation constraint), but also offer an “incentive premium” above a “fair” return to induce informed investors to prefer it to senior debt (i.e., to satisfy an incentive constraint). Second, we test the model using data we collected on the timing and pricing of public debt issues made by large U.S. banking organizations in the 1986-1999 period. Findings with respect to issuance decisions lend strong support for the informed investor hypothesis. But rival explanations for the use of subordinated debt, such as differences in investor risk aversion or such as the signaling of earnings prospects by the bank, are rejected. A sample selection model on observed issuance spreads provides evidence for the existence of the postulated subordinated incentive premium. In line with predictions from the model, the influence of sophisticated investors’ information on the subordinated yield spread became weaker after the introduction of prompt corrective actions and depositor preference regulatory reforms, while the infl uence of public risk perception grew stronger. Finally, our model explains some results from the empirical literature on subordinated debt spreads and from market interviews — such as limited spread sensitivity to bank specific-risk or of the “ballooning” of spreads in bad times.

The Term Structure of Interest Rates and the Public Debt Issuance Policy: A Note

Abstract We estimate, using a previously unexploited set of data for the Italian public debt, quarterly yield curves over the period 1970-1996 to test the main implications of the expectations hypothesis theory (EH). Our empirical results show that short-term interest rates move according to the prediction of the EH, though the same cannot be found for long-term interest rates. In addition, using a probit model, we investigate the public debt issuance policy. We find and interpret a signi ficant relationship between the slope of the yield curve and the probability of an increase in the aggregate duration of the outstanding debt. JEL classification: H63, E44, E58, E61. Keywords: term structure of interest rates, expectations hypothesis, public debt management. ∗ Acknowledgments: The authors thank Abhay Abhyankar, Mark de Broeck, Alessandro Missale, Lucio Sarno and Stefano Scalera for their helpful comments on a previous draft of this paper. The usual disclaimer applies, meaning that the authors alone are responsible for any errors that may remain.

World Markets for Raising New Capital

Financial markets are increasingly integrated globally. We examine the extent to which firms from countries around the world rely on different sources of capital, the locations where they raise capital, and the factors that affect these choices during the 1990-2001 period. International security issuances are widespread, totaling about $4.6 trillion. International debt issuances are substantially more common than equity issues, accounting for over 90% of the international security issues, and about 20% of all public debt issues. In contrast, international equity issues account for about 4.4% of all international security issues, and about 6% of all equity issues during the our sample period. Market timing considerations appear to be very important in security issuance decisions. Firms all around the world are more likely to issue equity prior to periods of low market returns. Most of the cross-border equity is issued in the U.S. and the U.K., and these issues tend to occur in hot markets, and prior to relatively low market returns. Finally, firms issue more debt when interest rates are lower, and issue debt overseas when interest rates in the place of issue are lower than they are at home.

What Does the Yield on Subordinated Bank Debt Measure?

We provide evidence that a bank's subordinated debt yield spread is not, by itself, a sufficient measure of default risk. We use a model in which subordinated debt is held by investors with superior knowledge ("informed investor hypothesis"). First, we show that in theory the yield spread on subordinated debt must compensate investors for expected loss plus give them an incentive not to prefer senior debt. Second we present strong empirical evidence in favor of the informed investor hypothesis and of the existence of the incentive premium predicted by the model. Using data on the timing and pricing of public debt issues made by large U.S. banking organizations during the 1985-2002 period, we find that banks issue relatively more subordinated debt in good times, i.e. when informed investors have good news. Spreads at issuance (corrected for sample selection bias) react to (superior) private and to public information, in line with the comparative statics of the postulated incentive premium. Interestingly, as the model predicts, the influence of sophisticated investors' information on the subordinated yield spread became weaker after the introduction of prompt corrective action and depositor preference reforms, while the influence of public risk perception grew stronger. Finally, our model explains anomalies from the empirical literature on subordinated debt spreads and from market interviews (e.g. limited sensitivity to bank-specific risk and the "ballooning" of spreads in bad times). We conclude that a bank's subordinated yield spread conveys important information if interpreted together with its senior spread and with other banks' subordinated yield spreads.

Do banks time bond issuance to trigger disclosure, due diligence, and investor scrutiny?

This paper tests a new hypothesis that bank managers issue public debt, at least in part, to convey positive, private information and refrain from issuance to hide negative, private information. This “positive selection” hypothesis is tested against the traditional “adverse selection” hypothesis. We find evidence for “positive selection,” using ratings migrations, equity returns, bond issuance, and balance sheet data for US bank holding companies. The results add to our understanding of “market discipline” in monitoring bank holding companies and also inform upon how proposed regulatory requirements that banking organizations frequently issue public debt might augment “market discipline.”

Multiple versus Single Banking Relationships in an Emerging Market: Some Taiwanese Evidence

This study examines the relationship between how firms borrow from banks and various corporate financial characteristics in an emerging economy. Using Taiwanese listed firms over the 1990-2002 period, we find, on the one hand, that older firms tend to maintain a close relationship with a single bank without private information disclosure (i.e. without public debt), in order to benefit from efficient monitoring and avoid information leakage. Larger firms, on the other hand, tend to maintain multiple relationships with banks (requiring duplicate or inefficient monitoring and higher agency costs) with public debt (i.e. private information disclosure). Furthermore, older firms seem to exhibit higher profitability than larger firms. Firms with multiple banking relationships appear to have higher leverage, lower performance (Tobin's Q), higher bank debt ratios, lower fixed assets ratios, and higher collateral requirements than those firms with close single banking relationships. Firms with single banking relationships seem to have stronger financial structures and better loan terms than firms with multiple banking relationships. When firms choose to issue public debt, those with single banking relationships will suffer as a result of severely unfavorable loan terms such as higher collateral required and higher earnings volatility. However, on the other hand, they will exhibit a better financial structure, such as a higher Tobin's Q, lower financial risk (leverage) and lower bank debt ratios among all of the sub-groups. Hence, efficient monitoring associated with private information disclosure to the public will lead to better financial characteristics of firms. However, once this close relationship is broken due to the issue of public debt, unfavorable collateral requirements will follow. Interestingly, when firms that maintain multiple banking relationships choose to issue public debt, this sub-group will appear to have the worst financial structure, such as the lowest Tobin's Q, highest financial risk (leverage) and highest bank debt ratios among all the sub-groups. Hence, inefficient monitoring associated with the disclosure of private information to competitors will result in the worst financial characteristics of firms.

The Costs, Wealth Effects, and Determinants of International Capital Raising: Evidence from Public Yankee Bonds

This paper examines the costs, wealth effects, and determinants of international capital raising for a sample of 260 public debt issues made by non-U.S. firms in the Yankee bond market. We find that investors demand economically significant premiums on bonds issued by firms that are located in countries that do not protect investors' rights and do not have a prior history of ongoing disclosure. The results provide support for the literature that suggests better legal protections and more detailed information disclosure increases the price investors will pay for financial assets. Journal of Economic Literature Classification Numbers: F3, G1.

Decentralization and Fiscal Discipline in Subnational Governments:The Bailout Problem in Uruguay

This paper analyzes the reasons behind Central Government (CG) bailouts of Subnational Governments (SNGs) in the case of Uruguay. We argued that Uruguay represents a good example of the risks of fiscal decentralization, in the context of adjustment policies, and when SNGs` responsibilities and resources have not been carefully defined. We show that, in unitary countries where SNGs lack the opportunities to misbehave that they have in federal countries (e. g. , public debt issuance, international borrowing), SNG officials find ways to finance deficits through non-compliance with politically contestable obligations. In particular, SNGs in Uruguay finance their deficits by accumulating debts with other government agencies and obtaining discretionary transfers from the CG. Through statistical analyses we show that debts and deficits are mainly related to vertical fiscal imbalances and economic conditions in the SN jurisdictions. Yet, the analysis of recent bailout episodes suggests that institutions and political factors play a role (i. e. , they are important ex-post factors). This implies that bailouts have been more than simple compensations for structural imbalances, thus creating opportunities for strategic behavior on the part of SNG authorities (partly confirmed by the disparate fiscal performance of Montevideo vis-a-vis the rest of the country).

Are maturity and debt type decisions interrelated? Evidence from Australian firms in international capital markets

This paper models the interrelationship between maturity and debt type decisions that arise from agency and flotation cost hypotheses. Private debt and short-term debt are substitutes for resolving agency conflicts, whereas large public debt issues and lengthening maturity are alternative mechanisms for mitigating large fixed transaction costs. Using a sample of international bonds and syndicated loans of Australian firms, we find evidence that maturity has a strong direct effect on debt choice, but weak evidence that debt choice affects maturity. However, a direct simultaneous relationship is found when Eurobonds are excluded from the sample or treated as private debt.

Bank Debt and Market Debt: An Empirical Analysis for Spanish Firms

This paper examines the effect on the firm's banking cost of the issue of debt securities. We argue over the existence of a positive relationship between the issue of market debt and the reduction of firm's banking cost. This idea relies on three main arguments: i) banks can delegate to investors the supervision task, a feature that makes bank supervision less costly; ii) The issue of public debt increases firms' bargaining power in front of the banks, as the former can get funds through non-bank financing channels; iii) Banks with no prior information on the issuing firm may interpret the issue of debt securities as a positive signal of firm's quality. Additionally, we argue that the previous effects are less important for non-first issues and are sensible to the maturity of the bond issued. We empirically test these and other related theoretical results making use of a database of non-financial Spanish firms during the 1993-1998 period. We find empirical support for our theoretical contentions.

Are Bank Loans Special? Evidence on the Post-Announcement Performance of Bank Borrowers.

Unlike equity offerings or public debt offerings, bank loan financing elicits a significantly positive announcement return, which has led financial economists to characterize bank loans as special or somehow different from other types of external finance. Here, we find that firms announcing bank loan financing suffer negative abnormal stock returns during the three-year post-announcement period. In the long run, therefore, it appears that bank loans are no different from seasoned equity offerings or public debt issuance. We also find that bank borrowers had operating performance below their peers' a year before their loan announcement, and that their performance does not improve in the subsequent three years. Finally, we document a reduction in earnings transparency following bank loan announcements. These findings are inconsistent with the notion that bank loans mitigate asymmetric information problems of the borrower.

Do Crime-Related Expenditures Crowd out Higher Education Expenditures?

Fears about insufficient public education spending are often expressed in the area of higher education, whereby it is often argued that increases in expenditures on crime-related programs crowd out expenditures on higher education. This view suggests that higher education and crime-related programs directly compete for government expenditures so that what one program gains the other must lose as in a zero-sum game. A competing hypothesis is that higher crime-related spending leads to higher taxes or public debt issuance or to lower spending on programs other than higher education. We estimate a three-equation model of spending on crime-related programs, spending on higher education, and the crime rate from which we directly test whether spending on crime-related programs and higher education influence each other. Our empirical analysis provides weak evidence that crime-related programs have crowded out spending on higher education.

A Non-Parametric Examination of Stability in the Euro

Stage three of the introduction programme for the Euro began on January 1, 1999. This in many ways signalled the true beginning of the currency as thereafter the Euro was allowed for trade in foreign exchange markets and also in the issuance of new public debt. However it is already clear that this new currency will become a serious competitor of the Dollar in international usage. To illustrate, forecasts under a number of economic headings suggest that the Euro will be a closer competitor to the Dollar than having the Deutsche Mark as a vehicle currency (Portes and Rey, 1998; and McCauley, 1997). For example, in terms of all foreign exchange transactions, the Euro will be represented 50 to 60% (Dollar - 92%) of the time and the Euro will account for 25% (Dollar - 59%) of world trade invoices (McCauley, 1997). Other forecasts are even more optimistic suggesting equal status for these two currencies (Portes and Rey, 1998). Thus, the Euro is a very important currency for the fundamental welfare of the global economy and any concern over its stability is paramount. The backdrop for this analysis is that participating national currencies of the Euro were previously part of the Exchange Rate Mechanism that unfortunately suffered considerably from currency traders' speculative attack on a number of occasions. These attacks reached their zenith during the 1992/1993 crises leading to a radical revamping of the currency system. Generally, exchange rate fluctuations are measured unconditionally through an average standard deviation value, or conditionally using a GARCH related specification. However, the objective of this paper is to provide a plethora of information on the specific issue of whether speculative activity would unhinge participating governments' confidence in the currency. To achieve this, the paper concentrates on possible large scale exchange rate movements by applying a methodology specifically set-up to provide accurate measures of values located at the tail of the distribution, namely Extreme Value Theory. The findings are mainly encouraging. In many ways, the Euro shows similar characteristics to exchange rate series in general. For instance, the unconditional distribution of the Euro conclusively rejects the assumption of normality as well as having a unit root property and exhibiting volatility clustering. In terms of its stability, this paper finds there is no reason for concern regarding speculative pressure on the Euro. In fact, for a spectrum of probability and quantile measures, it consistently shows less volatility than the Yen. Moreover, the Euro follows a similar risk pattern to the Deutsche Mark, the currency that it is essentially replacing.

The Costs, Wealth Effects and Determinants of International Capital Raising: Evidence from Public Yankee Bonds

This paper examines the costs, wealth effects, and determinants of international capital raising for a sample of 260 public debt issues made by non-U.S. firms in the U.S. (Yankee) market. We find that investors demand economically significant premiums on bonds issued by firms that are located in countries that do not protect investors' rights and do not have a prior history of on-going disclosure. The results provide support for the literature that suggests better legal protections and more detailed information disclosure increases the price investors will pay for financial assets. We also find that the average stock price reaction to Yankee bond offerings is significantly positive and that abnormal returns are largest for first-time Yankee bond issuers. In addition, we show that foreign firms tend to issue in the Yankee market when the relative interest cost is low, indicating that potential differences in borrowing costs influence where firms choose to sell bonds.

DO BANK RELATIONSHIPS MATTER IN PUBLIC DEBT OFFERINGS?

Finance theorists have argued that banks have a comparative advantage over public debtholders and other suppliers of debt both in gathering information about and in monitoring corporate borrowers. Although underwriters of public debt issues and private placements have access to inside information when executing specific transactions, commercial bankers have ongoing relationships with their corporate borrowers that have often been built up over years. Perhaps more important, banks are also often in a better position and have stronger incentives than a dispersed collection of bondholders to keep tabs on what the borrowers do after receiving the capital.This theoretical argument received striking empirical support from a study by Chris James published in 1987 in the Journal of Financial Economics. Entitled “Some Evidence on the Uniqueness of Bank Loans,” the study documented that announcements of new bank lending aggreements by public firms are received positively, on average (and in a large majority of cases) by the stock market. This finding offered a pointed contrast to the neutral to sharply negative stock‐price responses that accompany announcements of almost all other kinds of securities offerings, including private placements of debt and public offerings of straight debt.In this article, the authors discuss their own recently published study that provides another piece of evidence of the value added by banking relationships. Specifically, the authors report that the first public debt offerings of companies with bank relationships carry spreads that are 85 basis points less than the spreads of initial debt issues by comparable firms without bank relationships. As the authors interpret their findings, a banking relationship not only helps to “certify” the value of corporate borrowers to their stockholders, but also provides other lenders with valuable “cross‐monitoring” benefits that are reflected in lower borrowing costs.

Notes on Optimal Debt Management

(1999). Notes on Optimal Debt Management. Journal of Applied Economics: Vol. 2, No. 2, pp. 281-289.

Dualism and Macroeconomic Volatility

This paper develops a simple macroeconomic model that shows that combining capital market imperfections together with unequal access to investment opportunities across individuals can generate endogenous and permanent euctuations in aggregate GDP, investment, and interest rates. Reducing inequality of access may be a necessary condition for macroeconomic stabilization. Moreover, countercyclical escal policies have a role to play: in our model savings are underutilized in slumps because of the limited debt capacity of potential investors. Therefore, the government should issue public debt during recessions in order to absorb those idle savings and enance investment subsidies or tax cuts for investors. The most important single fact about saving and investment activities is that in our industrial society they are generally done by different people and for different reasons. (. . .) For years there might tend to be too little investment, leading to deeation, losses, excess capacity and unemployment. For other years, there might tend to be too much investment, leading to periods of chronic ineation—unless prudent and proper public policies in the escal and monetary eelds are followed [Paul A. Samuelson, Economics 8th edition, 1970, pp. 196‐198].

Discussion of The Performance of Long‐run Stock Returns Following Issues of Public and Private Debt

<i>Discussion</i> of The Performance of Long‐run Stock Returns Following Issues of Public and Private Debt

The Performance of Long‐run Stock Returns Following Issues of Public and Private Debt

This study uses a balance sheet‐based method to identify both public and private debt issues. This feature is important because there have been no studies of the information content of private debt issues, while private debt is substantially more prevalent than public debt. We find no abnormal returns following straight debt issues. However, convertible debt issuers under‐perform the market on the order of 50 to 70 percent in the following five years. In pursuit of explanations, we find that convertible debt issues signal a deterioration of future profitability, which accounts for at least part of the stock price underperformance.

Do law enforcement expenditures crowd-out public education expenditures?

As state and local governments have devoted a rising share of their resources to crime-related programmes, concerns have arisen that spending on other programmes such as education will fall. Coupled with growing public concerns over performance of the public education system, and expectations that prison populations will rise as states pass and enforce more stringent sentencing laws, it is not surprising that some view the expansion of crime-related programmes as troublesome. One hypothesis is that education and crime-related programmes directly compete for government expenditures so that what one programme gains the other must lose as in a fixed-pie situation. A competing hypothesis is that spending on these two public programmes are unrelated and therefore higher crime-related spending may also lead to higher taxes or public debt issuance, or to reduction in spending on programmes other than education. We estimate a three equation model of spending on crime-related programmes, spending on education, and the crime rate from which we directly test whether spending on crime and education influence each other.