Empirical Research On The Impact Of Liquidity Risk And Credit Risk On Covenants Design Of Protecting Bond Investors

After nearly thirty years of development, our country has developed a capital market which is formed of stocks, bonds, derivatives and so on. On the one hand, it provides enterprises the channels of financing, on the other hand, it also provides abundant financial products for people to invest. However, the development of China’s capital market is not balanced, which is not only reflected in the imbalance between direct financing and indirect financing, but also reflected in the imbalance among the direct financing channels. As a direct financing channel, the development of China’s bond market is insufficient, compared with the stock market. As china’s bond market development is late, many systems are not perfect, and the investor’s protection system is one of them. The research shows that insufficient design of the protection mechanism of the creditor will be a serious obstacle to the development of the bond market. Under the background of developing the bond market in China, researching the protection mechanism of bond investors is very important.In theory, the agency conflicts between creditors and shareholders are mainly embodied in the following two aspects:(1) the reverse selection existed before bond issuing (2) moral hazard existed after bond issuing. Asymmetric information will lead to the problem of adverse selection before bond issuing. And after the successful issuance of corporate bonds, agency by agreement will lead to moral hazard problems. Therefore, adding the protection of the investors in the bond contract can reduce the information asymmetry, and it can reduce the moral hazard.Based on the background above, this paper takes 442 corporate bonds issued from 2007 to 2014 as a sample, and uses the empirical research method to study whether liquidity risk and credit risk have impact on bond’s covenants of protecting investors.First, this paper examines the impact of liquidity risk and credit risk on bond’s covenants. In this paper, I classified the covenants into four categories:covenants of option, covenants of asset transferring restriction, covenants of investment restriction, and covenants of financing restriction. I researched the relationship between these four categories of covenants and the risks of liquidity and credit respectively. It is found that the liquidity risk has no effect on bond’s covenants of protecting investors, and the credit risk has an effect on bond’s covenants of protecting investors.Second, considering the great impact of the U.S. subprime mortgage crisis on the global market, this paper studied the change of relationship between the credit risk and the bond covenants. It is found that the ratio of containing covenants of option has no significant change after the financial crisis, but the ratio of containing covenants of financing restriction become larger.At last, this paper also examines the impact of bank loans on the relationship between credit risk and bond’s covenants.This paper finds that as a company financing channel, bank loans play completely different roles during financial crisis and after financial crisis. During the financial crisis, as bank loans have a prior right of being payed, therefore, bond investors require more covenants to protect themselves. And after the financial crisis, as bank loan can play a role of signal transmission, company reduces the use of covenants of option which can generate a greater uncertainty for the company and reserves covenants of financing restriction.The main contribution of this paper are as follows.First.collecting all the covenants by handwork, including general covenants and covenants protecting investors.Second,it studies the impacts of liquidity risk and credit risk on bond’s covenants. Third, the impacts of financial crisis and bank loans on the relationship between credit risk and bond’s covenants are also studied. The author hopes that the conclusions of the study has a certain reference value in the designing of the bond covenants when companies issue bonds, and has a certain reference value for the bond investors, regulators and other relevant entities of the bond market.