False Hopes and Blind Beliefs: How Political Connections Affect China's Corporate Bond Market
73 Pages Posted: 21 Jul 2019 Last revised: 18 Nov 2020
Date Written: November 15, 2020
This paper explores whether and how political connections affect the market for corporate bonds issued by privately owned enterprises (POEs) in China. We test two competing theories – the zero-default myth and the borrower channel theory – that predict how political connections affect the likelihood of bond issuance, refinancing costs, the market reaction to a bond issue announcement, and firms’ post-issue performance. Using a sample of Chinese POEs from 2007 to 2016, we show that – in line with the zero-default myth theory – politically connected POEs are more likely to issue corporate bonds as a debt financing instrument than their non-connected counterparts. They also achieve lower coupon rates (i.e., lower refinancing costs), despite exhibiting lower overall performance after bond issuance. We find that investors react positively to corporate bond-issuing announcements if the issuing firm is politically connected. At the same time, our research indicates that politically connected bond-issuing POEs in China have weaker corporate governance and a surprisingly higher default probability than non-connected issuers.
Keywords: Bank Loans, China, Corporate Bonds, Emerging Markets, Political Connections
JEL Classification: G15, G18, G34
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