A Sovereign's Cost of Capital: Go Foreign or Stay Local

39 Pages Posted: 26 Oct 2015 Last revised: 24 Jun 2016

See all articles by Michael Bradley

Michael Bradley

Duke University - Fuqua School of Business

Irving De Lira Salvatierra

Duke University - Graduate School

G. Mitu Gulati

Duke University School of Law

Date Written: June 21, 2016

Abstract

A critical question faced by any sovereign seeking to raise funds in the bond market is whether to issue the debt under foreign or local parameters. This choice determines other key characteristics of any bond issue such as which banks, lawyers, and investors will be involved. Most important though, this decision involves a tradeoff between the sovereign retaining discretion in managing the issue and relinquishing control of the issue to third parties to prevent the sovereign from expropriating wealth from bondholders in the future. Based on a sample of 17,349 issuances by 117 sovereigns between 1990 and 2015, we investigate this question in the context of the initial pricing of government bonds. We examine the three key factors that bear on this decision; governing law, currency, and exchange listing. We find that highly-rated sovereigns, with strong domestic institutions that protect investors, almost always issue debt under domestic parameters. In contrast, low-rated sovereigns with weak domestic institutions tend to issue debt under foreign parameters. These findings suggest that low-quality sovereigns are forced to issue debt under foreign parameters to assure investors that the sovereign will not act opportunistically to expropriate their wealth once the debt is issued. Put differently, low-quality sovereigns that issue debt under domestic parameters face a higher cost of capital.

Keywords: bond pricing, financial economics, sovereign debt, contracts

JEL Classification: F3, F33, F34, K2, K22

Suggested Citation

Bradley, Michael and De Lira Salvatierra, Irving and Gulati, Gaurang Mitu, A Sovereign's Cost of Capital: Go Foreign or Stay Local (June 21, 2016). Duke Law School Public Law & Legal Theory Series No. 2015-50. Available at SSRN: https://ssrn.com/abstract=2679077 or http://dx.doi.org/10.2139/ssrn.2679077

Michael Bradley

Duke University - Fuqua School of Business ( email )

Box 90120
Durham, NC 27708-0120
United States
919-660-8006 (Phone)
919-660-7971 (Fax)

Irving De Lira Salvatierra

Duke University - Graduate School ( email )

Durham, NC 27708-0097
United States

Gaurang Mitu Gulati (Contact Author)

Duke University School of Law ( email )

210 Science Drive
Box 90362
Durham, NC 27708
United States

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