The Spillover Effect Of Default Of Local State-owned Enterprise Bonds

The 20 th National Congress of the Communist Party of China report has highlighted the importance of improving the function of the capital market and increasing the proportion of direct financing as a crucial task for the reform and development of the capital market in China under the new normal.Bonds,as a vital tool of direct financing,have witnessed rapid growth over the past decade,with the financing scale of the bond market exceeding that of the stock market.However,the bond market’s rigid payment and implicit guarantee from local governments have resulted in a limited number of financing subjects,low liquidity,and inadequate depth in serving the real economy compared to the stock market.Since the first default of state-owned enterprise bonds in 2015,defaults of stateowned enterprise bonds have gradually become commonplace.On the one hand,as an important pillar of regional economic development,state-owned enterprises are naturally related to local government credit,and the frequent defaults of state-owned enterprise bonds are likely to alter the market’s risk expectations gradually.Particularly in the current situation,where multiple risks such as geopolitical conflicts,changes in the international monetary environment,and the uncertainty of the COVID-19 pandemic have emerged,China’s economy is facing downward pressure.The frequent defaults of state-owned enterprise bonds are likely to trigger regional and systemic financial risks,which are not conducive to pursuing progress while ensuring stability,and achieving high-quality economic development.On the other hand,China’s ongoing reform has reached a critical juncture,and the reform of state-owned enterprises is closely linked to the capital market reform.Bond rigid payment is a product of the current era,and bond default is a normal phenomenon of asset pricing in the capital market under market mechanisms.The marketization of bond defaults is the necessity to promote the healthy development of the capital market.Therefore,in the current situation where the rigid payment of state-owned enterprise bonds is gradually being dismantled,but the corresponding mechanisms,capacities and awareness of market participants are not yet perfect,it is crucial for regulatory authorities and market participants to have a correct and objective understanding of the spillover effects of state-owned enterprise bond defaults and their underlying implications.This will enable them to address financial risks and stabilize the “pain period” of reform.However,academic research on the bond market is limited.Existing research on the bond market mainly focus on the agency problem and information problem,with a particular emphasis on the antecedents of bond credit spread.There is a scarcity of research on the theoretical and practical effects of bond default risk spillover.In addition,while bond default is an inevitable outcome of market operation,existing studies on bond default risk spillover primarily examine the negative effects at the micro-level,and fail to objectively and comprehensively evaluate and understand the spillover effects of bond default risk.Against this backdrop,this paper investigates the risk spillover path and economic consequences of bond defaults under the same actual controller of state-owned enterprises,taking the current reality of preventing systemic financial risks and promoting capital market reforms into account.Specifically,the paper starts from the bond default events of state-owned enterprises to explore whether bond default risk is controllable and whether bond defaults can drive the optimization of resource allocation.This paper aims to use the default of state-owned enterprise bonds to represent the weakening of implicit guarantees of local governments.As such,the state-owned enterprise bond defaults examined in this paper are those of state-owned enterprises directly or indirectly controlled(not exceeding two control levels)by the Local State-owned Assets Supervision and Administration Commission(SASAC).Specifically,from the perspective of bond market and stock market,at both the macro-level and micro-level,based on the risk spillover theory in the network effect,incomplete contract theory and resource allocation theory,combined with the literature of local government implicit guarantee in political economy,this paper theoretically analyzes and empirically tests the risk spillover effect of local stateowned enterprise bond default.The finding indicate that local state-owned enterprise bond defaults have a two-sided nature.On the one hand,the default of state-owned enterprise bonds leads to risk spillover,which hinders the financing of enterprises in both the bond market and stock market.On the other hand,the release of bond default risk causes the financing gap between state-owned enterprises and private enterprises in the region to narrow,thereby promoting the marketization of risk asset pricing.The main research conclusion of this paper is as follows:First,this study addresses the question of whether the risk spillover effect of defaulted state-owned enterprise(SOE)bonds through the same actual controller is real in Chapter 4,based on three research sets.Firstly,based on the issuance situation in the bond primary market,this chapter finds that when a SOE controlled by a local State-owned Assets Supervision and Administration Commission(SASAC)defaults for the first time,the quarterly scale and number of bond issues postponed or cancelled by other non-financial enterprises controlled by the same SASAC(“associated companies”)in the bond primary market increases significantly.Secondly,based on the market reaction of the stock market,this chapter finds that the default risk of SOE bonds spills over to the stocks of other listed companies controlled by the same SASAC(“associated companies”),with the cumulative abnormal stock return of associated companies significantly decreasing on the default day of bonds,and being unable to be completely reversed within a short period of time.Finally,in light of the information contagion effect that accompanies bond defaults,this chapter examines the influence of SOE bond default risk on the public opinion of associated companies.Based on the stagger difference-indifferences model,using A-share listed companies controlled by local SASACs as the research sample,it is found that after the occurrence of SOE bond default events,the number and proportion of negative media reports related to associated companies increases significantly.According to the cross-sectional tests based on bond default events,it is found that when the local SASAC that the defaulted SOE belongs to is located in an area with a lower level of marketization index,or when the default scale of bond default events is larger,the media coverage of associated companies increases significantly.However,whether the bond issuer’s credit rating plays a warning role has no significant difference in the degree of risk spillover effect of associated companies.According to the cross-sectional tests based on the characteristic of associated companies,it is found that when the operating risk of associated companies is higher,or when the agency problem is more serious,the risk spillover effect is greater.Based on these three sets,this chapter verifies the path of risk spillover of local SOE bond default through the same actual controller,indicating that local SOE bond defaults weaken the implicit guarantee of the local government.Second,the contagion of local state-owned enterprise(SOE)bond default risks spillover to associated firms and increases their borrowing costs from banks.After confirming the existence of the spillover path via the same ultimate state owner,Chapter 5 further examines whether the borrowing costs of associated firms change.Using a sample of non-financial A-share listed firms controlled by the local SASACs,a stagger difference-in-difference model is used to empirically test following questions.First,the gradual occurrence of local SOE bond default events leads to a significantly higher borrowing cost of associated firms.Second,in the cross-sectional test,the borrowing costs of associated firms increase to a greater extent in regions with a lower degree of marketization and larger default scales of bond defaults.However,whether the credit rating plays a warning role has no significant difference in the degree of borrowing cost of associated companies.The cross-sectional tests also confirm the existence of a contagion effect formed by an ultimate state owner.Third,based on the risk characteristics of associated firms,it is found that the increase in borrowing costs is greater when the credit risk and operating risk of associated firms are higher.Finally,when the company in an industry with a lower level of competition or the local policies are more preferential,the higher the increase in the cost of bank loans due to the bond default spillover effect.Furthermore,this chapter examines the credit spread of associated firms’ bond issues after bond default events,and finds that the issuance costs of associated firms’ bonds also increase significantly.In addition,this chapter finds that after the implicit guarantee expectations of the local government are weakened,the loan scale of associated firms has not been significantly reduced.Third,the financing gap between private enterprises and state-owned enterprises within the region decreased due to the increase of defaults risk of local state-owned enterprise bonds.Building upon the empirical results presented in Chapter 5,Chapter 6 delves deeper into whether the allocation of resources within regions where state-owned enterprise bonds defaulted became more equitable.Using a triple difference(DDD)model and A-share non-financial listed companies,this chapter examines the changes in the financing gap between private and stateowned enterprises in regions where state-owned enterprise bonds defaulted compared to those in regions where they did not.The findings suggest that,compared to regions where state-owned enterprise bonds not defaulted,in regions where state-owned enterprise bonds defaulted,the gap between bank loan costs for private and state-owned enterprises decreased,and the gap between trade credit supply for private and state-owned enterprises narrowed.Cross-sectional tests based on the characteristics of state-owned enterprise bond defaults revealed that when the marketization degree in the region where state-owned enterprise bonds defaulted was lower or the credit rating prior to the bond default failed to act as a warning,the gap between bank loan cost for private and state-owned enterprises and the gap between trade credit supply for private and state-owned enterprises decreased more obviously.Cross-sectional tests based on the local government’s information environment and financial resources of provinces found that when the local government’s information environment was poorer or the available financial resources were fewer,the decrease in the gap between bank loan cost for private and state-owned enterprises and the gap between trade credit supply for private and state-owned enterprises in the associated regions was more significant.Based on further tests,this chapter found that the gap between bank loan cost for private and state-owned enterprises within the region was mainly due to the relative increase in bank loan cost for local state-owned enterprises in the region,while the bank loan cost for private enterprises was not relatively reduced.However,this chapter found that the decrease in the gap between the trade credit supply for private and stateowned enterprises within the region was mainly due to the relative decrease in the trade credit supply for private enterprises in the region compared to other regions.This paper makes the following research contribution to the study of credit risk spillover effects of bond default events in China:First,this paper contributes to the study of credit risk spillover effects of bond default events in China and provides empirical evidence for the theory of risk spillover between real economy entities.While existing literature has explored the spillover effects of bond default events in China at the industry and regional levels on credit spread and information quality,research related to the default risk spillover path through the same actual controller remains scarce.In addition,few studies have differentiated between state-owned enterprise(SOE)bond defaults and private enterprise bond defaults and examined the spillover effects of SOE bond defaults on bond issuance spreads or investment efficiency across regions.The theoretical logic of this paper establishes the same actual controller as the risk spillover path,providing evidence that SOE bond defaults weaken the implicit guarantee of the local government in the region,and considers the impact of bond default risk spillover on formal financing and informal financing from the perspective of bond and stock markets.Second,this paper documents two sides of default of state-owned enterprise bonds.The existing literature on bond default risk focuses on the negative consequences of bond default on micro-company individuals,such as increased corporate earnings management and bond issuance rates,etc.,failing to jump out of the micro level and examine the social benefits of state-owned enterprise bond default from the macro level.This paper offers a more comprehensive,systematic and objective perspective that proves a new path of state-owned enterprise bond default risk and its underlying logic.This paper highlights that the default of stateowned enterprise bonds is beneficial in improving the imbalance of resource allocation structure between state-owned enterprises and private enterprises,forcing resource optimization and allocation,expanding the new connotation of state-owned enterprise bond default,and providing empirical evidence for promoting the marketization mechanism of bond default.Third,this paper expands the research on the antecedents of corporate financing.Previous literature mainly focused on the financing demand side,exploring how changes in corporate governance features,information quality,property nature and other characteristics affect a company’s access to credit resources or trade credit.In contrast,this paper starts from the supply side of financing,breaking through the event with the rigid payment of state-owned bonds,and examines how the credit suppliers’ willingness to provide credit affects the level and cost of credit to firms after the macro credit risk environment changes,thus more completely and objectively understanding the driving factors of corporate debt financing decision.Fourth,this paper enriches the research of capital market resource allocation efficiency.Previous literature mainly discussed the negative impact of company characteristics such as property nature,agency costs,information quality on capital market resource allocation efficiency,or focused on how local governments intervene in corporate financing costs,credit supply and investment efficiency,pointing out that local governments distorted the allocation of credit resources.This paper starts from the context of China’s financial deleveraging system and through the investigation of the impact of the rigid redemption of local state-owned enterprise bonds on the resource allocation structure of state-owned and private enterprises during the transition period of reform,it points out the important role of internal adjustment rather than external macro-industry policy in the efficiency of capital market resource allocation.