Information Asymmetry and Bank Regulation: Can the Spread of Debt Contracts be Explained by Recovery Rates?

Posted: 3 Nov 2011

See all articles by Wenchien Liu

Wenchien Liu

Chung Yuan Christian University - Department of Finance

Peter Miu

McMaster University - DeGroote School of Business

Yuanchen Chang

National Chengchi University - College of Commerce

Bogie Ozdemir

Standard & Poor's

Date Written: November 3, 2011

Abstract

We investigate whether the spread of corporate debt contacts can be explained by their ultimate recovery rates. Using the actual realized recovery rates of defaulted debt instruments issued in the U.S. from 1962 to 2007, we find that recovery rate is reflected in the spread at issuance, and that this relationship has become more significant since commercial banks were allowed to underwrite corporate securities. Our further investigation indicates that the enhanced informativeness of recovery rate can be attributed to the lowering of information asymmetry of individual firms. Besides, the relation between the spread at issuance and the recovery rate is stronger for weak corporate governance and non-investment grade issuers. Our conclusions are found to be robust to endogeneity issues, potentially omitted variables and alternative model specifications.

Keywords: Recovery rate, Information asymmetry, Bank regulation, Corporate governance, Credit rating, Glass-Steagall Act, Financial Modernization Act

JEL Classification: G10, G11, G12, G13, C5

Suggested Citation

Liu, Wenchien and Miu, Peter and Chang, Yuanchen and Ozdemir, Bogie, Information Asymmetry and Bank Regulation: Can the Spread of Debt Contracts be Explained by Recovery Rates? (November 3, 2011). Journal of Financial Intermediation, Forthcoming, Available at SSRN: https://ssrn.com/abstract=1953901

Wenchien Liu

Chung Yuan Christian University - Department of Finance ( email )

200 Chung Pei Rd
Chung Li City, 32023
Taiwan

Peter Miu

McMaster University - DeGroote School of Business ( email )

1280 Main Street West
Hamilton, Ontario L8S 4M4
Canada
905-525-9140 ext 23981 (Phone)

Yuanchen Chang (Contact Author)

National Chengchi University - College of Commerce ( email )

Taiwan
886229393091-81102 (Phone)
886229393394 (Fax)

Bogie Ozdemir

Standard & Poor's ( email )

130 King Street West
Suite 1100, PO Box 486
Toronto, Ontario M5X 1E5
Canada

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