Private Ownership and the Cost of Public Debt: Evidence from the Bond Market

Abstract

A number of studies have examined the effect of public and private ownership on the cost of debt and concluded that the cost of debt of privately owned firms is higher, driven mainly by the poorer information environment in which these firms operate. We extend this strand of research in two ways. First, we identify and empirically establish the mechanisms that bring about a higher cost of debt to privately owned firms—namely, the limited access that these firms have to the equity capital market, their high rate of management and private-equity ownership, and their less conservative reporting. Second, we improve the reliability of the estimates of the effect of ownership type on the cost of debt by controlling for the different information environments in which privately and publicly owned firms operate. This is accomplished through the use of a sample consisting of publicly owned and privately owned firms that have public debt and are therefore subject to identical reporting and disclosure requirements. Certain data and design features allow us to better control for other factors that might lead to the observed difference in the cost of debt between the two groups of firms. The results contribute to our understanding of the role of ownership type on the cost of capital. This paper was accepted by Suraj Srinivasan, accounting.

Corporate Governance Practices and Audit Quality: Do They Matter for the Cost of Debt?

“…Furthermore, Badertscher et al [27] show that companies with more independent board structure and more effective board approach have more market liquidity compared to other companies. In fact, companies with higher score in terms of corporate governance quality experience lower ask-bid spread and higher different share supplied and demanded.…”

“…Furthermore, the theoretical and empirical studies about corporate governance have suggested that the ownership structure is a crucial determinant of the governance practices effectiveness [28] and [27]. According to Shleifer and Vishny [28], ownership concentration increases control over managers.…”

“…Accordingly, higher management's equity ownership leads to an alignment effect of interest, maximizing thus the corporate value. Moreover, Badertscher et al [27] argue that when equity ownership and corporate decision-making are concentrated in just a small number of decision-makers, these owner-managers will likely be more risk averse and thus less willing to invest in risky projects.…”

“…We consider also the managerial shareholders (MANAG) which represents the percentage of managers owning shares in the company, participate in strategy pattern and decision-making and who are almost present in the management board. This measure has been used previously by [27] and [34]. Finally, the presence of an institutional shareholder (INSTIT) is captured by the percentage of directors who represent the State and the financial institutions and their shareholding [32].…”

Fixed Income Conference Calls.

“…On the other hand, information from rating agencies could lead to increased investor demand for information from management because investors are trying to better interpret the rating agency disclosures or perhaps predict the rating itself.Our tests control for whether a firm is private, which means it lacks publicly-traded equity.In this test, as we restrict this sample to firms with available data in Compustat North America, our private firms of interest do issue public debt, which requires them to file typical SEC disclosures, like 10-Ks and 10-Qs (the source of Compustat's information). These private firms have been the focus of some studies, such asKatz (2009) andBadertscher et al (2019). Even though they file with the SEC, this sample of private firms continue to have weaker information environments than typical public firms because they may have less media and sell-side analyst coverage, and by definition they don't have a public stock price that aggregates value relevant information.…”