Summary:
As the world's second-largest onshore credit market, China's corporate bond market has become increasingly important in the global financial system. With an escalating number of bond defaults, debt renegotiation has emerged as a prevailing practice in the bond market. Debt renegotiation refers to shareholders bargaining with creditors to renegotiate debt contracts when a company is in financial distress. Although the literature on debt renegotiation examines its implications for expected stock returns and corporate yield spreads, it has remained silent on how the heterogeneity of firms' debt structures affects their incentives to negotiate strategic debt servicing. In this paper, we aim to fill this gap and examine the role of firms' debt rollover frequency in shaping the pricing implications of debt renegotiation. When a firm is exposed to rollover maturing debt, its overall rollover costs depend on its fundamentals as well as its debt structure. Structural models that embed rollover risk typically focus on the interaction with bond market illiquidity but overlook the impact on the pricing effect of shareholders' strategic actions. By incorporating rollover risk into a structural model of strategic debt servicing, we propose a novel channel through which a firm's debt structure influences its financing costs. Given the theoretical finding that shareholders' strategic behavior directly affects corporate bond spreads by means of liquidation costs and bargaining power, the new insight offered by our model is that the rollover channel amplifies the effect of debt renegotiation on credit spreads: a higher rollover frequency forces equity holders to absorb a greater rollover loss per unit of time and, in turn, the increased cost of complying with debt obligations motivates firms to strategically service their debt at a higher fundamental threshold. It follows that bondholders increase the credit spread ex ante as compensation for the increased probability of strategic debt service. Using the theoretical implications derived from our model, we empirically test these hypotheses using a data sample of over-the-counter market transactions of corporate bonds issued by Chinese public firms from May 2014 to December 2020. In the baseline regression analysis, we consider two proxies for liquidation costs—the concentration of an issuer's industry and the degree of tangibility of its assets—and measure shareholders' bargaining power by the fractions of equity owned by the firm's CEO as well as the proportion of public debt to its total debt financing. We find that credit spreads widen as the liquidation costs and bargaining power of shareholders increase, regardless of the empirical proxies used. This finding identifies debt renegotiation as an important determinant of corporate yield spreads in China. Furthermore, we find evidence that rollover risk is an accelerator in the pricing impact of debt renegotiation. Specifically, the effect of debt renegotiation on credit spreads is more pronounced for bond issuers with a higher (vs. lower) proportion of long-term debt maturing within a year, which we use as a proxy for rollover risk exposure. This accelerator effect is statistically and economically significant after controlling for other well-documented determinants of corporate bond spreads. In addition, our heterogeneity analysis shows that the impact of rollover risk on the renegotiation effect is stronger for bonds with a short time to maturity, small firms, and firms in financial distress than for other firms. Moreover, our results remain robust to alternative measures of credit spreads, alternative proxies for debt renegotiation risk and rollover exposure, and the exclusion of bonds with option-like features. Finally, we introduce instruments with respect to our strategic proxies and confirm that our main results are unlikely to be driven by potential endogeneity effects associated with these proxies. This paper makes three contributions to the literature. First, we extend the strategic debt service model by incorporating firms' exposure to rollover risk. As such, our study lays a solid theoretical foundation for subsequent research. Second, this paper enriches the literature on the determinants of credit spreads by testing the effect of liquidation costs and bargaining power in the Chinese corporate bond market. Our empirical results contrast with findings obtained from developed credit markets. Finally, we empirically test the marginal effect of debt renegotiation through a rollover risk channel. Our findings demonstrate the role of rollover risk in shaping credit spreads above and beyond its interaction with debt illiquidity.
叶彦艺, 刘碧波, 施展. 债务协商、再融资风险与信用债定价 ——来自中国债券市场的证据[J]. 金融研究, 2023, 521(10): 104-124.
YE Yanyi, LIU Bibo, SHI Zhan. Debt Renegotiation, Rollover Risk, and Credit Spreads: Evidence from the Chinese Bond Market. Journal of Financial Research, 2023, 521(10): 104-124.
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