Ultimate Ownership Structure,Institutional Environment,and Corporate Bond Contract Terms

In August 2007,the “Measures for Pilot Corporate Bond Issuance” promulgated by the China Securities Regulatory Commission marked the official launch of the issuance of corporate bonds in China.Subsequently,the Chinese corporate bond market developed rapidly.The Shanghai and Shenzhen Stock Exchanges issued 1,708 general corporate bonds with 2.5 trillion RMB in total amount by the end of 2016.Along with the booming development of bond market,the rational design of bond contract terms has become increasingly important.The agency conflict between bondholders and shareholders will lead the managers,who are acting in the shareholders’ interests,have incentives to take actions in ways which harm the interests of the bondholders.Rational bondholders recognize the incentive behaviors by the shareholders and managers.They require reasonable bond contract terms to mitigate the agency problem.The agency conflict between the ultimate controlling shareholders and bondholders,as one of the main problems of our internal governance,will affects the design of the corporate bond contract terms.At the same time,the regional disparities in institutions caused by differences in resource endowments,geographical locations and policies will influence the bondholders’ confidence,resulting in affecting the design of bond contract terms.Therefore,based on the review of literature on the factors which affect the bond contract terms,this paper theoretical analyses and empirical investigates the effect of ultimate ownership structure and institutional environment on corporate bond contract terms,and how the institutional environment affects the relation between the ultimate ownership structure and corporate bond contract terms.Based upon the research sample of corporate bonds issued by Chinese listed firms from 2008 to 2016,this paper adopts univariate T-test,OLS and Poisson models to examine the effect of ultimate ownership structure,the institutional environment,and their interaction on corporate bond contract terms in China.The main conclusions of this paper are as follows:Firstly,combined with the incomplete contract theory and principal-agent theory,this paper examines the relationship between the ultimate ownership structure(including the cash flow rights,the separation between cash flow and control rights,and the type of ultimate controlling shareholders)and the corporate bond contract terms(including bond issuance spreads,maturity and covenants).The results show that:(1)the higher the cash flow rights of the ultimate controlling shareholders,the stronger the motivation for pursuing the maximization of firm’s value.At this time,the agency conflicts and information asymmetry between insiders and bondholders are mitigated.Hence,higher cash flow rights foster bondholders’ confidence,resulting in firms’ access to bond market at favorable conditions.(2)the separation between the control and cash flow rights of ultimate controlling shareholders represents their motivations of predatory behaviors and information manipulation.The higher the separation between two rights,the more information asymmetry and agency problem between insiders and bondholders get.At this time,bondholders face higher investment risk,and require stricter bond contract terms.(3)the state-owned property of the ultimate controlling shareholders will foster bondholders’ confidence,thereby reducing their requirements for bonds risk compensation.Thus it will reduce bondholders’ requirements on strictness of bond contract terms.Secondly,the optimization of institutional environment can significantly alleviate the financing constraints of corporations in capital market.Based upon the research sample of corporate bonds issued by Chinese listed firms from 2008 to 2016,this paper examines the effect of institutional environment(including legal environment sub-environment,financial development sub-environment,government quality sub-environment,social trust sub-environment)on corporate bond contract terms(including bond issuance spreads,maturity and covenants).We find that when firms operating in regions with better legal environment,more developed financial system,better government quality,stronger social trust,face with better bondholders’ protection,which foster bondholders’ confidence,thereby reducing their requirements for strictness of bond contract terms.In such an environment,the bond issuance contract terms will become looser(i.e.lower bond spreads,longer bond maturity,and fewer bond covenants).Finally,a sound system as an effective mechanism for corporate external governance can mitigate the predatory behaviors of the ultimate controlling shareholders,and thus alleviate the agency problem and information asymmetry between insiders and bondholders.Based on the consideration of the impact of the ultimate ownership structure and institutional environment on the bond contract terms,this paper further theoretically analyzes and empirically tests the effect of the interaction between the institutional environment and the ultimate ownership structure on the bond contract terms.The empirical results show that,the negative association between the cash flow rights,the state-owned property of ultimate controlling shareholders and bond issuance spreads,and the positive association between the separation between cash flow and control rights of ultimate controlling shareholders and bond issuance spreads,covenants are weakened in regions with better institutions.