Does Expected Bond Liquidity Affect Financial Contracts?

Associate Professor at Department of Economics and Finance, City University of Hong Kong. Prof. Qi received her PhD at the Rutgers University in New Jersey, United States. Prior to joining the City University of Hong Kong, she was an Associate Professor at the Department of Finance, Concordia University, Canada.

This paper shows that bond market liquidity plays an important role in determining corporate debt contracts. We find that bonds with better expected market liquidity are issued with fewer restrictive covenants, longer maturities, and lower offering yield spreads. These results are robust to a quasi-natural experiment using the implementation of TRACE as an exogenous shock to bond market liquidity, and an instrumental variable regression controlling for the endogeneity of bond liquidity. Further investigation shows that the effect of liquidity is more pronounced in firms subject to more credit supply frictions, firms with poorer credit ratings and more rollover risk, and firms relying more on debt financing.