Professor of Finance
The Effects of Bond Supply Uncertainty on the Leverage of the Firm
Authors: Massa Massimo, Zhang Lei
The authors examine the effects of institutional investors' credit supply uncertainty (CSU) in the corporate bond markets on the capital structure of the firm. The authors measure CSU as the bondholders' investment horizon, based on the idea that the shorter the investment horizon of investors, the higher the issuer's refinancing risk, i.e., the risk of not being able to roll over its maturing debt due to investors' credit supply uncertainty.The authors find that high CSU leads to lower leverage and lower probability of issuing bonds in the next period. High CSU, on the other hand, increases the firm's probability of issuing equity and borrowing from banks in the next period.Moreover, these effects are concentrated in firms whose bond investor base is more prone to credit supply imbalances, as measured by investor geographical concentration, herding propensity, and local bond preference.These findings suggest that the financial fragility arising from supply-based (as opposed to demand-based) factors have significant effects on the capital structure of the firm. While the positive effect of CSU on bank borrowing implies that issuers can substitute away from bonds into bank loans in times of high CSU, this substitution occurs only for firms whose bank relationships are nonexclusive.In contrast, CSU does not affect bank borrowing decisions of firms with exclusive bank relationships. Together, our findings suggest that investors' bond supply uncertainty and segmentation of the credit markets (bonds vs. bank loans) are important drivers of corporate financing policy and capital structure even for established firms with access to public bond markets.