Corporate bond market clientele

Abstract

This thesis consists of two essays that explore research questions related to corporate bond market clientele. In the first essay, I examine the investment behaviour of corporate bond mutual funds, the fastest-growing clientele for corporate bonds in recent times. Specifically, I study the extent to which the funds’ investment decisions are driven by their investment mandates. In the second essay, I draw on anecdotal and empirical evidence that shows that clientele in corporate bond markets are fundamentally different from clientele in equity markets. I apply these insights to examine how corporate policy is affected by differences between corporate bond and equity investors’ pricing of risk. Theoretical and anecdotal evidence suggests that mandates are a key determinant of mutual fund investment behaviour. However, other evidence reveals that mandates are not legally binding, and funds may have incentives to deviate. In the first essay, I compare the investment expenditure of funds with different mandates within segments of the corporate bond market. The segments categorize bonds according to maturity or credit rating. I find that, in each segment, the funds that spend relatively more (less) are those whose mandates imply that they should invest more (less) in that segment. For example, if a fund states that it targets a longer portfolio maturity, the fund invests significantly more in long-term bonds, on average, relative to funds that target shorter portfolio maturities. These results apply not only to average investment expenditure, but also to how each incremental unit of flow is allocated across segments. Results hold in subsamples of secondary market bonds, as well as new issues, regardless of whether the issuer of a new bond is a firm in which the fund already invests. Overall, my findings suggest that the investment behaviour of corporate bond mutual funds is consistent with the funds’ mandates. In the second essay, I use a dynamic investment and financing model that accounts for differences between equity and corporate bond holders’ pricing of macroeconomic risk. In line with empirical and anecdotal evidence, I calibrate the bond investor’s price of risk to be unconditionally higher than the equity investor’s, as well as volatile and independent of the macroeconomy. Relative to a counterfactual scenario in which both investors price risk identically, average market (book) leverage is 2.8 (3.3) percentage points lower. These results reveal a new quantitatively significant channel to address the under-leverage puzzle. Also, in the scenario with heterogeneous risk pricing, firms issue equity more frequently as they substitute away from debt financing. Overall, relative to the scenario with homogenous risk pricing, firms exhibit a similar, albeit slightly lower, average rate of investment.