Effect of Corporate Bond Issuance and Its Determinants

G11, G32, G14 KEy woRDS: JEL Classification: bond, equity market behavior, event study 1 INTI International University, Malaysia, 2Universiti Utara Malaysia, Malaysia Correspondence concerning this article should be addressed to: Nur Adiana Hiau Abdullah, School of Economics, Finance and Banking, College of Business Universiti Utara Malaysia, 06010 UUM Sintok, Kedah, MALAYSIA, e-mail: diana897@uum.edu. my Sze Kim Chin1 & Nur Adiana Hiau Abdullah2 Primary submission: 17.05. 2012 | Final acceptance: 01.08. 2012 6 Sze Kim Chin & Nur Adiana Hiau Abdullah 10.5709/ce.1897-9254.70 DOI: CONTEMPORARY ECONOMICS Vol. 7 Issue 1 5-18 2013 of 1986. This was the first step in developing the debt securities market in this country. The bond market in Malaysia further gained attention in 1990s, when conventional bank borrowing was found to be inadequate for funding long-term infrastructure and development projects by the private sector. The Malaysian government therefore increased its effort to develop corporate bond markets in order to offer the private sector an alternative source of financing and with the hope of helping to reduce funding mismatches (Ibrahim & Wong, 2005). The development of the bond market from an inactive to a developing market can be seen in Table 1, which shows that the bond market is becoming a larger source of borrowed funds than the banking system and the equity market. More than 50% of the funds in the capital markets and banking system were raised through the issuance of bonds, whereas less than 30% were raised from bank borrowings (except in 2004) and less than 20% were raised from equity issues. As the bond market becomes the major source of funds, there is a possibility that it could affect the equity market. As noted by Gebhardt, Hvidkjaer, and Swaminathan (2005), bonds and stocks have the same underlying operating cash flows and are affected by the same company fundamentals. Therefore, bonds cannot evolve independently of equities. Thus, some correlations between bonds and equity market behavior are expected. However, there is still little research in this area. The present study aims to address the impact of bonds on the equity returns of the issuing companies, which still an under-researched subject, especially in emerging markets such as Malaysia. Thus far, mixed results were found by those who have attempted to explore this subject matter, such as Kapoor and Pope (1997) and Lewis, Rogalski and Seward (2001) in the US market, Abhyankar and Dunning (1999) in the UK market, Schramade (2005) in the Dutch market, Carlsson, Holm, and Sello (2006) in the European markets, and Martel and Padron (2006) in the Spanish market. Hence, research analyzing the bond issuance effect on share price performance and examining the cross-sectional determinants of this effect for listed companies in Malaysia is needed. The following section presents a literature review of underlying theories and prior empirical evidence, followed by the research design in section three. The analysis of the results is subsequently presented in section four. Finally, section five concludes the study and suggests some possible future research areas. 2. Underlying theories and empirical evidence on the effect of bond issuance and its determinants According to Lewis et al. (1999), corporate events often lead to changes in the trading activities of a company’s common stock. Though Fama and French (1998) argue that a company’s financing decisions have no effect on its market value and thus that security holders are indifferent to debt versus equity financing, their argument relies entirely on the existence of a perfect capital market and assumes that companies Table 1. Funds raised in the capital markets and banking system Year New issues of Bonds (RM million) Borrowings from