Title: On the effect of bond liquidity on financial contracts
Authors: Yuan Wang - Concordia University (Canada) [presenting]
Abstract: The aim is to examine whether and how the bond market liquidity affect the contractual terms of newly issued public bonds. We find firms with better bond market liquidity issue bonds with lower cost of debt, fewer restrictive covenant and longer maturity. These results hold after we control for firm fixed effects, various bond and firm characteristics, use alternative proxies of bond liquidity, and employ an instrument variable regression to deal with the endogeneity of bond liquidity. To identify the causal effect of bond liquidity on debt contracts, we conduct a quasi-natural experiment study by using the implementation of TRACE as an exogenous shock to bond market liquidity. We find that the improvement of bond liquidity due to the introduction of TRACE indeed affects debt contracts as expected. Further investigation shows that the impact of bond liquidity is more pronounced in firms with poorer credit rating and more short-term debt. These findings are consistent with the notion that improvement of bond market liquidity reduces firms rollover and credit risk so that firms can issue bonds with more favorable contractual terms.