Investment Horizon of the Bond Investor Base and the Leverage of the Firm

Abstract

We examine the effect of the investor horizon of institutional bondholders (e.g., mutual bond funds and insurance companies) on the leverage of the firm using a novel dataset. Our main finding is that the investment horizon of the firm’s bond investor base (measured as functions of (i) the average portfolio turnover of investors holding the firm’s bonds, or (ii) the prevalence of mutual funds among the firm’s bondholders as opposed to insurance companies) has a positive and significant effect on the leverage of the firm. The investment horizon of the firm’s bond investor base also has a positive and significant effect on the firm’s probability of issuing bonds, and a negative and significant effect on the firm’s probability of issuing equity and borrowing from banks. The results are robust to controlling for potential endogeneity of the investor-firm matching using geography-based instruments. Our results highlight the vulnerability of companies that depend on short-horizon mutual funds as primary bond investors.

Keywords: institutional investors; corporate bonds; investment horizon; corporate finance; capital structure; leverage; clientele; investor base

JEL Classification: G1, G2