Study On The Motivation And The Credit Enhancement Effect Of Issuing Guaranteed Bonds

Bond guarantee is an important way of enhancing credit and a mechanism to resolve information asymmetry problems between investors and bond issuers.Since the regulation issued by China Banking Regulatory Commission on October 12 th,2007,the commercial banks have stopped providing guarantees to corporate bonds.Since then,a variety of guarantee types emerged in China's credit bond market.In current times,there are two main kinds of guarantee types in the bond market,the external guarantee and the internal guarantee.The external guarantee is an irrevocable guarantee by a third party to pay bondholders' coupon and principal payments in the event of issuer default.According to the nature of the third party,it can be divided into guarantees provided by professional guarantee corporations and guarantees provided by the third-party enterprises.The internal guarantee refers to collateral or pledge that gives investors a specific claim on an asset without reducing general claim against the bond issuers in the event of default.After the outbreak of the default event of “11ChaoRi Debt” on March 4th,2014,a series of default cases broke out in China's bond market.As one of the important mechanisms to tackle with the default case and reduce the loss,bond guarantee is increasingly valued by the market.In this paper,firstly,based on the theory of adverse selection and moral hazard theory,I analyze the motive of issuing bond.Secondly,I analyze the effect of guarantee bond on credit rating and issuance costs based on the mechanism of credit enhancement effect of internal and external guarantee.Finally,using a sample of corporate bonds and enterprise bonds during the period 2008-2015,I conduct a empirical research on the motivation and effect of bond guarantee.The results indicate that,firstly,guarantee is negatively correlated with issuer's credit rating.The higher the risk of issuers,the lower the credit rating,the more likely issuers are to get guarantees.Secondly,among the bonds with the same bond ratings,guaranteed bonds suffer higher issue spreads.This suggests that bond guarantee solves the information asymmetry problems in the bond market.But it mainly alleviates the ex-post moral hazard rather than solves the ex-ante adverse selection.Thirdly,bond guarantee can significantly improve the bond ratings.Among the three types,guarantee provided by professional guarantee corporations can improve the bond rating by about 1.2,which has the most significant effect;collateral and pledge can improve the credit rating by about 0.7;guarantee provided by the third-party enterprise can only improve the bond rating by about 0.5.Fourthly,only guarantee corporation can significantly reduce the issuing cost.The spread of bonds guaranteed by guarantee corporation is lower by 20.5BP than that of unsecured bonds between the bonds with the same issuer rating.This conclusion is consistent with the improvement of credit rating.Bonds guaranteed by the guarantee corporation receive more recognitions in bond market,which can not only significantly improve the bond credit rating,but also significantly reduce the issuing cost,while the effects of collateral,pledge and the third-party-enterprise guarantee are not significant.This paper indicates that guarantee can alleviate the information asymmetry and restrain the behavior of the issuers after issuing.Bond guarantee is complementary to signaling role of credit ratings in the market.Although all the three guarantees can significantly improve the bond credit rating,the effect of reducing the bond spreads are not satisfactory.This indicates that rating agency may exaggerate the safety of the bond,of which the credit ratings are not accepted by the market.There may exist the phenomenon of distortion of credit rating.What's more,the way of guarantee that the majority of enterprises adopt are not approved neither.Based on the current situation of bond market and the conclusions drawn from this paper,we make some suggestions from the aspects of strengthening the credibility of credit ratings,improving the credit enhancement system and improve the regulations of bond guarantees.Finally,the limitations of this study and prospects for future research are pointed out.