The Real Effect Of Financial Reform: Evidence From Bond Market In China

Motivation: There has been rich literature on the relationship between equity market liberalization or overall financial development and economic growth, however, very few studies focus on the private bond market. It is difficult to identify the causal effect of liberalization on the real economy because of the potential endogeneity problem. This paper provides new insights by explaining the real effect of financial reform on the private bond market, i.e., the corporate bond market, and tackling the endogeneity problems.Premise: This study aims to examine the real effect of China's bond issuance reform in 2015 on the cost of debt and debt choices. We use this reform to address endogeneity concerns because this policy shock only targets on the corporate bond market, not on the enterprise bond market.Approach: We employ a difference-in-difference method to investigate the effects of liberalization of the private bond market on the cost of debt and debt structure from both the bond-level and listed-firm level. The bond-level dataset covers 689 enterprise bonds and 1,295 corporate bonds issued from 2007 to 2016. The listed firm-level dataset covers almost all the public firms on China A-share market from 2013 to 2016, including 2,500 firms across 17 industries.Results: The bond-level results show that the reform reduces the cost of bond financing in terms of bond yield spread by approximately 29.4 percent and enhances the bond issuance volume by approximately 1.7 percent. At the listed-firm level, the reform reduces the cost of total debt by around 7.4 percent, enhances the public debt issuance instead of the private debt, and shortens the debt maturity. Additional robustness tests show that the above results are more pronounced for state-owned companies.Conclusion: The liberalization of the private bond market reduces the cost of debt and alleviates financial constraints. Furthermore, with less frictions in the public debt market, firms issue more public debt, i.e., bond, instead of private debt, i.e., bank loan. The effect is more significant for politically connected firms with more concentrated ownership, indicating that they may use it as a way to insulate from bank monitoring.Consistency: This research provides important implications on the role of financial reform for the private bond market. Liberalization of the private bond market reduces the cost of debt and further raises the public debt over bank loans, which may help reduce the exposure to liquidity shock during economic downturns. The paper sheds light for policy makers who aim to alleviate financial constraints and improve real growth through liberalizing capital markets.