Government Ownership and the Cost of Debt: Evidence from Government Investments in Publicly Traded Firms

Abstract

We investigate the effect of government share ownership on the cost of corporate debt. Government ownership could carry an implicit debt guarantee reducing the chance of default and leading to a lower cost of debt. On the other hand, government ownership could lead to a higher cost of debt if this guarantee increases moral hazard for managers and if state owners impose social and political goals that reduce corporate profitability. Using a sample of 5,048 bond credit spreads from 43 countries over 1991-2010, we find that government ownership is associated with a higher cost of debt in non-crisis years (61 basis points (bp)) but with a lower cost of debt during the recent financial crisis (18 bp) and other banking crises (9 bp). We further show that the cost of debt associated with government ownership generally decreases as the size of the government stake increases. The impact of government ownership is stronger for non-investment-grade bonds and for bonds associated with highly-levered firms. Additionally, we document that the effect of government ownership differs by type of government entity; for instance, lower spreads are more often associated with central governments, and higher spreads with sovereign wealth funds. Finally, domestic government ownership is linked to a decrease in debt pricing, while foreign government ownership is tied to an increase. Our results indicate that government ownership generally leads to a higher cost of debt, consistent with investment distortion fostered by state influence, but in times of economic recession or firm distress, the dominant effect is a reduction in perceived default risk due to implicit government guarantees.

Keywords: Privatization, Government Ownership, Bonds, Cost of Debt

JEL Classification: G32, G34, H11, H81