Do political connections matter to bondholders? Evidence from China

Abstract

This article examines the association between political connections and the pricing of bonds in China. Political connections are associated with higher at-issue spreads on corporate bonds, implying that political connections do not ensure the alignment of interests between managers and bondholders. The adverse effects of political connections on borrowing costs are eliminated when the chairman and the CEO are politically connected. Evidence suggests that bondholders price new debt issuances by using the information about the political backgrounds of top managers. Moreover, the costs and benefits of political connections for bondholders vary with the extent of the connectedness of a firm.

Keywords:

• political connections
• bond spreads
• China
• bondholders

JEL Classification:

• G12
• G32

Notes

¹ Accounting standards have a critical role in corporate governance by informing investors and by making contracts more verifiable (La Porta et al., 2000).

² Political connections have a crucial role in corporate financing in Chinese firms (Fan et al., 2007; Li et al., 2008).

³ Both the chairman and the CEO (general manager) are crucial top managers in Chinese corporations. See Wu et al. (2012) for detailed discussion.

⁴ We exclude the company bonds issuing by the state-owned enterprises because they are guaranteed by the largest commercial banks in China. For comparison, we collect data of 24 enterprise bonds from 2004 to 2009 and find that the at-issue spreads of the 24 enterprise bonds range from −3.54 to 2.95 with a median of −2.77, which confirms the intuition from the overall institutional infrastructure that the spreads of enterprise bonds are relatively low. To avoid ambiguity, we focus on the bonds issued by listed private companies.

⁵ From the sample, 26% of the company bonds are issued with a put option. Theoretically, the put option provides bondholders the right to sell bonds back to the firm, which reduces the required rate of interest.