Why do firms issue guaranteed bonds?

Moral Hazard Effects of Corporate Bond Guarantee Purchases: Empirical Evidence from China

“…As for studies of bond markets, John et al (2003) construct an agency cost model and reveal that the interest rates of collateral debts are significantly higher than that of unsecured bonds. Chen et al (2015) also show that US companies issue guaranteed bonds for credit enhancement and easing the agency problem.…”

“…Financially constrained firms have difficulty in accessing capital because of their low creditworthiness. Thus, issuers with a higher level of financial constraints are more likely to purchase a guarantee (Chen et al, 2015). High levels of ROE indicate firms that are financially healthy and are likely to produce a low yield spread (Campbell & Taksler, 2003).…”

“…Long-Term Debt Ratio: An issuer's long-term debt to total assets at issuance. Issuers with more debt overhang are more likely to use guarantees to mitigate underinvestment (Kolasinski, 2009;Chen et al, 2015). An issuer with a high long-term debt ratio indicates that the issuer is highly leveraged with a high yield spread (Campbell & Taksler, 2003).…”

“…A bond guarantee is issued by a third party on the instruction of the bond issuer and used as an insurance policy when the bond issuer fails to fulfil a contractual commitment. According to Chen et al (2015), the portion of newly issued bonds with guarantees measured by par value increased significantly from 1.4% in 1993 to over 18% in 2012 and peaked.…”

“…Studying corporate guaranteed bonds issued in Japan, Pagano et al (2015) find evidence of self-selection where issuers with unrated bank-guaranteed bonds have higher levels of information asymmetry and poorer firm quality, and bond investors are willing to accept lower yields for guaranteed bonds than rated ones because of the perceived value of a guarantee to the bond issuer. Chen et al (2015) provide evidence that rating enhancement is not the only driver for corporations to issue guaranteed bonds and the role of agency problem and debt overhang can also play a significant part for issuing firms to purchase a bond guarantee. Two broad strands of theoretical arguments emerge to explain guarantees as arising from the existence of either ex-ante private information or ex-post incentive problems between bond issuers and investors.…”