Government Ownership and the Cost of Debt: Evidence from Government Investments in

Publicly Traded FirmsGinka Borisova

Iowa State University

Bill Megginson

Kate HollandThe University of Oklahoma

Veljko Fotak

Sovereign Investment LaboratoryBocconi University

The University of OklahomaSovereign Investment Laboratory

Bocconi University

The University of OklahomaSovereign Investment Laboratory

Bocconi University

Rise in government ownership around the world◦ Since 2000, US$ 969 billion from SDC

Sovereign wealth funds (SWFs) Bailouts

Privatization (the opposite process)◦ Since 2000, US$ 725 billion from SDC

Broad impact on all aspects of investment targets◦ Corporate governance◦ Profitability

Prevalent use of debt by companies Unexplored question: cost of debt?

Introduction

Government ownership might carry an implicit debt guarantee that increases the probability of repayment, thus lowering the cost of debt.

Government ownership might lead to a higher cost of debt through three channels: 1. By increasing moral hazard due to the implicit

government guarantee; 2. By reducing incentives for management and external

monitors; 3. By hampering the profitability of the firm through the

imposition of social and political goals.

Possible Impact Of Government Stock Ownership On Cost Of debt

Lower probability of default for government firms Lower Cost Debt :

Faccio, Masulis, and McConnell (2006) find that politically connected firms are more likely to be recipients of government bailouts

Brown and Dinç (2009) present evidence that defaults of government-owned banks are less common than defaults of privately-owned banks

Borisova and Megginson (2011) at high stakes, credit spreads lower

Literature Supporting Lower Cost Of Debt from Government Ownership

Implicit government guarantee and moral hazard Higher Cost Debt :

Stiglitz, Jaramillo-Vallejo, and Park (1993) Borisova and Megginson (2011): BH-SH conflict

Impaired monitoring Higher Cost of Debt : OECD (1998): less incentives for bondholders to monitor Eckel and Vermaelen (1986): government presence

decreases the threat of a takeover Bortolotti, Fotak, and Megginson (2010): monitoring gap

Literature Supporting Higher Cost Of Debt from Government Ownership

Governments have other goals Higher Cost of Debt : Shleifer (1998) Megginson et al (1994) and other privatization literature –

government presence and goals lead to inefficiencies Jensen (2002) – value destruction effect of conflicting goals Kahan and Rock (2010) – governments can impose their

own goals more easily than private shareholders Implicit guarantees can lower probability of default and the

cost of debt But the last 3 channels point to an increase in the

probability of distress and hence in the cost of debt The net effect is a matter of empirical investigation. We

simply hypothesize:

Literature Supporting Higher Cost Of Debt from Government Ownership

• H1: Government ownership impacts the cost of debt of investment targets.

• H2: The impact of government ownership on the cost of debt of investment targets differs during recessions and periods of market-wide financial distress.

– Importance of government guarantees during distress counters greater probability of default

• H3: The impact of government ownership on the cost of debt of investment targets differs during periods of firm-specific distress.

Hypotheses

Hypotheses• H4: The impact of government ownership on the cost of

debt of investment targets differs according to the type of government investment vehicle.

• Activism by different branches:– Central Government (national, treasury, ministries)– Local Government (city, state, region)– SOE

• Full• Mixed

– Government Financial Institutions (central and development banks and other financial institutions)

– Pensions Funds– SWF

Protectors

Investors

Hypotheses• H5: The impact of government ownership on the cost of

debt of investment targets will differ for domestic firms.

Lower cost of debt for domestic targets:1. Geographic proximity and lower information asymmetry• Almazan, deMotta, Titman, Uysal (2010)• Baik, Kang, Kim (2010)2. Foreign governments are passive investors• Bortolotti, Fotak, Megginson (2010)

• “Constrained Foreign Government Investor Hypothesis”• Worry about public opposition

Lower cost of debt for foreign targets:1. Foreign investors are better monitors • Ferreira, Matos (2008)• Djankov, Murrell (2002)• Brown, Earle, Telegdy (2006, 2010)2. Foreign governments less likely to impose social and political goals on targets

Data• Collect government purchases in publically traded firms

from SDC M&A 1980-2010 (2,517 transactions with DS code by 1,953 unique targets)

• SDC New Issues to look for ‘plain vanilla’ bonds 1990-2010 (7,804 bonds from 388 unique issuers)– Find ISINs (2,977 bonds have ISIN from SDC + 945 additional bond ISINs

are found in Datastream)• 3,922 bonds TOTAL

• Collect yearly bond data from Datastream (3d November Wednesday) :

– Yield (spread to benchmark) 10,124 bond year spreads– Rating (S&P) 6,854 bond years with spread & rating 1,554

bonds by 278 firms– Get collateral and instrument type from Bloomberg:

Data• WorldScope accounting data• Find government ownership in each target 1990-2010

– Thomson One Banker ownership module + annual reports, websites, press releases, EDGAR, CEDAR, Privatizations Barometer, World Bank, Lexis-Nexis.

• FINAL SAMPLE:214 firms 289 transactions (government

purchases) 1,278 bonds; 5,124 bond years43 countries ; between 1990-2010

Controls• Bond-level:

– Quality control

• Credit rating: lower probability of default; negative throughout the models

– Liquidity controls

• Maturity: (+)

• Firm-level:– Leverage: increases probability of default– Profitability: Negative effect (ROE)– Size and M_B: Negative effect

Descriptive Statistics• Greatest total value of acquisitions: by U.K. govt, followed

by Singapore• Greatest total value of investments: in U.K., followed by U.S.• Top target industry (value) is finance and real estate (SIC 6),

then transportation, communication, and electric (SIC 4)

Continuous Variables Count Mean Median Standard deviation

Credit spread 5,126 214.39 133.90 236.63 Government Variables Govt ownership 5,126 13.67 2.29 22.47 Govt ownership > 0 3,148 22.26 10.74 25.12

Mean Difference Tests and Univariate Analysis

Variable Full sample Govt presence No govt presence p-value Count

Credit spread 214.39 225.14 197.27 0.359 5,126

Credit spread (1990-2007) 146.07 167.25 117.94 0.017 3,292 Credit spread (2008-2010) 337.02 310.76 396.15 0.084 1,834 Credit spread (2008-2010, without bailouts)

356.95 340.68 399.33 0.358 1,530

Variable All firms of

variable category Banks Non-banks p-value Count

Credit spread (1990-2007, without govt presence)

117.94 79.93 130.87 0.005 1,414

Credit spread (2008-2010, without govt presence)

396.15 391.56 398.33 0.927 564

Banks with gov. ownership have lower avg. spreads than non-banks, regardless of the time period

Without gov. ownership, banks vs. non-banks:

Panel Regressions Panel data with year, bond collateral/instrument type,

bond currency, and issuer country fixed effects◦ issuer-clustered errors (Petersen, 2009)◦ lagged ownership

Datta et al. (1999) residual transformation for rating◦ To address the a priori effects of government ownership on credit

rating determination◦ Rating is regressed on all other explanatory variables◦ Residuals are saved, used in the main model to replace original values

Bailouts are excluded from models using observations from the 2008 Financial Crisis (9% of total sample)

The dependent variable – credit spread (yit)– the difference between the corporate bond’s current yield to

maturity and that of government bond closest matched maturity– proxies for the cost of debt.

Government Ownership and the Cost of Debt

• Government ownership is linked to a higher cost of debt• Non-linear – at higher level of government ownership guarantees

lead to a lower cost of debt

All observations   Bailouts removed    

Presence Stake Both   Presence Stake Both   2nd Stage

 Model 1 Model 2 Model 3   Model 4 Model 5 Model 6   Model 7

Govt presence29.21**   36.46***   27.73*   37.07**   44.98***

 2.226   2.677   1.928   2.522   3.247

Govt stake %  -0.267 -0.569**     -0.569** -0.839***    

   -1.000 -2.025     -1.997 -2.855    

Constant264.5*** 275.9*** 269.0***   219.8*** 242.1*** 232.0***   367.0***

 4.121 4.244 4.170   3.400 3.618 3.559   3.228

Observations5124 5124 5124   4645 4645 4645   5124

R-squared0.55 0.547 0.55   0.556 0.554 0.557    

Wald χ2

                8656

Government Ownership, Financial Crises and the Cost of Debt

• Government ownership is linked to a higher cost of debt (59 bp)• Government ownership is linked to a lower cost of debt during crises (23 bp)• Similar for banking crises: government ownership outside crises is linked with higher cost of

debt (39 bp) but with a lower cost of debt (14 bp) during the crises

Financial Crisis Banking Crises

All observations Bailouts removed 2nd Stage All Observations 2nd Stage

  Presence Stake Presence Stake Presence Presence Presence

  Model 1 Model 2 Model 3 Model 4 Model 5 Model 6 Model 7

Govt ownership 58.94*** 0.325 49.91*** -0.106 66.36*** 39.01*** 27.85*

  4.142 0.893 3.269 0.291 4.689 3.119 1.865

Govt ownership * Fin. crisis

-82.28*** -1.272** -70.50** -1.079* -81.73***    

-2.976 -2.369 -2.044 -1.831 -7.98

Fin. crisis 439.9*** 446.2*** 127.2*** 130.6*** 152.1    

14.107 15.579 3.697 6.34 1.422    

Govt ownership * Banking crisis

          -53.15* -53.60***

          -1.924 -5.176

Banking crisis           65.40*** 68.66***

          2.771 6.299

Constant 268.9*** 273.6*** 226.4*** 241.7*** 379.5*** 261.4*** 393.9***

4.261 4.194 3.515 3.594 3.356 4.152 3.476

Observations 5124 5124 4645 4645 5124 5124 5124

R-squared 0.554 0.549 0.56 0.555   0.555  

Wald χ2         8879.1   8863.6

Government Ownership and Firm-Specific Distress

• Government presence is linked to a higher cost of debt for non-investment grade firms• Greater stake owned by state yields lower spreads for non-investment grade firms and high

leverage firms• Government presence is linked to a lower cost of debt for non-investment grade firms and

high leverage firms during the crisis

Model 1 Model 2 Model 3 Model 4 Model 5 Model 6

1990-2010 1990-2010 1990-2007 1990-2007 2008-2010 2008-2010

Presence Stake % Presence Stake % Presence Stake %

72.81** -1.760*** 103.6*** 0.933 -43.72 -6.293***

-2.177 -2.942 -2.709 -0.914 -0.769 -5.965

Constant 1624*** 1503*** 755.6*** 801.8*** 2731*** 2320***

8.846 8.881 3.151 3.088 4.182 3.900

Observations 699 699 449 449 254 254

R-squared 0.455 0.454 0.425 0.41 0.435 0.467

14.78 -1.153** 48.18** -0.322 -104.8* -0.95

0.578 -2.315 2.380 -0.519 -1.883 -1.182

Constant 290.4*** 323.7*** 395.4*** 407.7*** -174.2 -3.515

3.445 3.868 5.721 5.701 -0.805 -0.016

Observations 2108 2108 1567 1567 548 548

R-squared 0.61 0.611 0.545 0.542 0.533 0.523

Junk Bonds

High LeverageGovt ownership

Govt ownership

Government Entities

Model 1 Model 2 Model 3 Model 4 Model 5 Model 61990-2010 1990-2010 1990-2007 1990-2007 2008-2010 2008-2010Presence Stake % Presence Stake % Presence Stake %

-26.12 -1.094* -7.609 -0.689 -67.54** -1.088**-0.985 -1.866 -0.283 -1.113 -1.998 -2.10919.92 0.023 9.541 -0.189 -34.93 -0.3130.840 0.048 0.347 -0.317 -1.150 -0.585-7.087 -2.216*** 19.06 0.977 20.06 -2.422**-0.446 -2.741 1.094 0.891 0.945 -1.99414.25 -1.017** 36.37** -0.0416 -87.04*** -2.199**0.755 -2.138 2.272 -0.092 -2.622 -2.460

Govt bank 39.22 12.76*** 90.41 9.108* 84.16** 16.63***1.262 4.091 1.644 1.915 2.326 3.204

SWF 41.4 3.064** 71.67 4.111 31.46 1.4341.590 2.048 1.378 1.586 1.406 0.605

Pension fund 61.48*** 2.534 22.15 -6.470* 56.31 4.766***3.893 1.031 1.276 -1.854 1.602 2.995

Constant 241.9*** 270.2*** 298.0*** 298.6*** 378.2** 346.3*3.506 3.910 4.831 5.530 2.106 1.877

Observations 4645 4645 3291 3291 1361 1361R-squared 0.559 0.56 0.454 0.448 0.536 0.537

-195.5*** -4.177*** -239.3*** -5.222*** -339.0* -8.843***-5.141 -5.388 -4.015 -3.679 -1.911 -3.697

-157.1*** -3.845*** -90.73 -18.31 -485.5*** -7.887***-3.409 -3.936 -0.530 -0.776 -4.009 -5.11127.75 -2.473* 39.14 2.731* -12.38 -5.431*0.521 -1.944 0.647 1.964 -0.108 -1.77162.43* 1.372 49.95* 1.372 38.06 -0.4991.925 1.273 1.760 1.432 0.431 -0.145254.0* -0.593 268.2* -1.909 -1.5781.940 -0.337 1.945 -0.278 -0.699

163.6** 2.148 442.4*** 84.64** 6.837 -102.173 0.782 5.467 2.340 0.071 -1.343

86.96** 26.4 115.6*** 41.12** 162.8 120.0***2.558 1.352 2.838 2.332 1.505 4.164

1510*** 1501*** 503.6** 530.7** 1612* 552.28.264 8.952 2.630 2.451 1.878 0.897

Observations 699 699 449 449 254 254R-squared 0.487 0.468 0.515 0.466 0.449 0.476

Constant

Junk Bonds

All Observations (Bailouts Removed)

SWF

Pension fund

Central govt

Local/regional govtSOE full

SOE mixed

Govt bank

Central govt

Local/regional govtSOE full

SOE mixed

Government Entities (Categories)Model 1 Model 2 Model 3 Model 4 Model 5 Model 6

1990-2010 1990-2010 1990-2007 1990-2007 2008-2010 2008-2010Presence Stake % Presence Stake % Presence Stake %

-2.518 -0.896*** 45.28*** -0.0548 -78.46** -1.424***-0.151 -2.859 -2.646 -0.136 -2.443 -3.465

55.32*** 3.092** 42.3 0.135 49.18** 3.132**3.590 2.558 1.641 0.088 2.430 2.291

248.4*** 260.6*** 278.9*** 268.3*** 361.2** 375.8**3.749 3.831 5.529 5.193 2.055 2.077

Observations 4645 4645 3291 3291 1361 1361R-squared 0.558 0.556 0.454 0.442 0.531 0.529

Constant

Govt protector

Govt investor

Domestic and Foreign Government Ownership

• Domestic government ownership is linked to lower cost of debt during the crisis• Foreign government ownership is linked to a higher cost of debt outside of crisis• Even more pronounced for non-investment grade firms

Model 1 Model 2 Model 3 Model 4 Model 5 Model 61990-2010 1990-2010 1990-2007 1990-2007 2008-2010 2008-2010Presence Stake % Presence Stake % Presence Stake %

-2.27 -0.832** 3.977 -0.262 -52.81* -1.095**-0.153 -2.302 0.429 -0.643 -1.902 -2.48133.22* 0.567 36.82 1.177* 18.72 -0.791.920 0.695 1.563 1.666 0.927 -0.930

247.5*** 247.6*** 280.1*** 265.7*** 356.8** 308.8*3.730 3.758 5.457 5.353 2.121 1.737

Observations 4645 4645 3291 3291 1361 1361R-squared 0.555 0.555 0.445 0.444 0.531 0.529

-49.07 -2.363*** -42.81 0.141 -94.91* -7.040***-1.425 -3.132 -1.083 0.133 -1.760 -5.912

140.9*** 0.718 208.6*** 4.324** 125.4** -4.338*2.915 0.590 3.585 2.167 2.235 1.945

1692*** 1544*** 855.6*** 789.9*** 2245*** 1101**9.049 8.963 3.803 3.102 3.574 2.369

Observations 699 699 449 449 254 254R-squared 0.468 0.458 0.447 0.418 0.442 0.468

Constant

Junk Bonds

All Observations (Bailouts Removed)

Domestic govtForeign govt

Constant

Domestic govtForeign govt

Conclusions• State ownership leads to a LOWER cost of debt:

– During the recent financial crisis

– During various banking crises

– For highly-levered firms

– For high-yield bonds

• Overall, results indicate the impact is an implicit debt guarantee, more valuable in times of distress and specific to domestic state ownership.

• But outside of the above, government ownership is associated with a HIGHER cost of debt.

The ContributionMAIN FINDING: • Domestic govt ownership reduces cost of debt during times of distress• Govt ownership associated with higher cost of debt outside distressCONTRIBUTIONS:• To the literature on state ownership:

– Documenting the impact of government ownership on cost of debt– Showing that not all government entities have the same impact– Providing evidence of an implicit government guarantee being priced

• To literature on bond pricing:– Providing evidence that identity, or at least type, of major

shareholders a priced factor• To literature on cross-border investments:

– Providing evidence indicating that cross-border investments by governments do not provide an implicit debt guarantee as do domestic government investments

Thank You

William L. Megginsonwmegginson@ou.edu

http://faculty-staff.ou.edu/M/William.L.Megginson-1/