Ginka Borisova

1. Government Ownership and the Cost of Debt: Evidence from Government Investments in Publicly Traded Firms GinkaBorisova Iowa State University Kate Holland The University of Oklahoma Sovereign Investment Laboratory Bocconi University VeljkoFotak The University of Oklahoma Sovereign Investment Laboratory Bocconi University Bill Megginson The University of Oklahoma Sovereign Investment Laboratory Bocconi University

2. Introduction • 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?

3. Possible Impact Of Government Stock Ownership On Cost Of debt • 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: • By increasing moral hazard due to the implicit government guarantee; • By reducing incentives for management and external monitors; • By hampering the profitability of the firm through the imposition of social and political goals.

4. Literature Supporting Lower Cost Of Debt from Government Ownership 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

5. Literature Supporting Higher 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

6. 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:

7. Hypotheses • 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.

8. 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

9. 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: • 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

10. 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:

11. 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 years • 43 countries ; between 1990-2010

12. 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

13. 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)

14. Mean Difference Tests and Univariate Analysis • Banks with gov. ownership have lower avg. spreads than non-banks, regardless of the time period • Without gov. ownership, banks vs. non-banks:

15. 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 • Ratingisregressed 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.

16. 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

17. 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

18. 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

19. Government Entities

20. Government Entities (Categories)

21. 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

22. 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.

23. The Contribution MAIN FINDING: • Domestic govt ownership reduces cost of debt during times of distress • Govt ownership associated with higher cost of debt outside distress CONTRIBUTIONS: • 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

24. Thank You William L. Megginson wmegginson@ou.edu http://faculty-staff.ou.edu/M/William.L.Megginson-1/