Global Demand Spillovers in Corporate Bond Issuance: The Effect of Underwriter Networks

This paper studies how monetary policy shocks propagate across borders through bond issuance networks of firms, underwriters and investors. Using a difference-in-differences strategy, I find that the European Central Bank’s quantitative easing program in 2016 spilled over to the U.S. corporate bond issuance market via an underwriting channel. U.S. firms connected to underwriters with more Eurozone investor clients faced greater orders for their bonds, achieved a lower cost of capital, and ended up issuing more bonds. The underlying mechanism is likely driven by costly search that underwriters face in locating potential investors, which incentivizes maintaining investor relationships for repeated business. As such, investor demand shocks transmitted through underwriters affect issuers heterogeneously based on preexisting issuer-underwriter-investor networks. ∗I am deeply grateful for the comments and suggestions of Simona Abis, Charles Calomiris, Kent Daniel, Olivier Darmouni, Xavier Giroud, Wei Jiang, Yiming Ma, Harry Mamaysky, Giorgia Piacentino, Tomasz Piskorski, Tano Santos, Kairong Xiao, Neng Wang, and various seminar participants at Columbia Business School. †Columbia Business School. Email: kfy2101@columbia.edu Since the financial crisis, the reliance of large corporations on external capital funded through capital markets has been increasing. U.S. corporations issued over $1.6 trillion in bonds in 2017, accounting for 61% of US corporate issuance for the year. This was a 44% increase since 2007. Bond issuance is conducted entirely through bank underwriters. This is a global network, where banks connect U.S. issuers with investors from around the world looking to buy USD securities. How do demand shocks propagate through these networks across country borders? What are the mechanisms and magnitudes of potential spillover effects? The prevalence of unconventional monetary easing tools employed by various central banks has made this a more pressing question. While it is well established that demand shocks transmit through bank networks via a balance sheet channel (see, for example, Chodorow-Reich (2014) and Darmouni and Rodnyansky (2017)), other mechanisms through which banks connect global markets are less clear. This paper explores how banks propagate demand shocks via the underwriting of corporate bonds. Isolating the impact of bank underwriting networks on new issue bonds is difficult for two primary reasons. One, there are many firm-specific characteristics that influence bond issuance outcomes. These characteristics may be observable to potential investors and to firms, but unobservable to the econometrician. Two, institutional relationships may be correlated with these firm characteristics, making it difficult to disentangle firm-specific effects vs. bank relationship-specific effects. I tackle the first problem by using a novel dataset that records the spread between primary and secondary market prices on a near-universe of corporate bonds issuances between 2010-2018. By studying exclusively the difference between primary and secondary markets, I effectively control for any firm characteristics that are observed by market participants and firm managers and unobserved by the econometrician. I tackle the second problem by identifying firms’ heterogeneous exposure to a foreign shock, the ECB’s increase in demand for corporate bonds. I run a series of robustness checks to SIFMA 2018; see Appendix for more aggregate data on this market. 2 ensure that a firm’s exposure to the shock is not correlated with firm characteristics. Given my novel dataset and identification strategy, I am able to identify the impact of bank networks on the corporate bond issuance market. Using novel proprietary bondissuance-level data, I find that firms respond to bank-specific demand shocks that are unrelated to firm fundamentals. Specifically, I look at how the ECB’s corporate bond buying program in June 2016 impacted US firms through the bank underwriting channel. I find that firms that have relationships with banks that are more exposed to the Euro area receive more orders and issue more bonds. I show that this is not related to firm fundamentals or geography. I interpret this as evidence that there are bank-related frictions in the bond issuance market. Banks act as a conduit through which demand shocks spread between countries. In order to uncover these frictions, I run a Difference-in-Difference analysis using the initiation of the ECB’s 2016 QE program as an exogenous shock. Banks are heterogeneously exposed to Europe based on their institutional investor relationships. Firms have heterogeneous relationships with banks. In my empirical methodology, firms are “treated” if they have more relationships with banks that have more investor clients in Europe. I estimate a Diff-in-Diff model with the firm’s exposure to Europe via its bank network as a continuous treatment variable. I find that following the start of the ECB’s corporate bond purchasing program (CSPP), more “treated” firms had more demand for their bonds, achieved lower costs of capital, and issued more debt. I run a series of robustness checks to ensure that results are not being driven by endogenous firm-bank choice. Why might demand shocks transmit globally through bank underwriting networks? Unlike the bank lending market, bond underwriting is not directly impacted by bank balance sheets. In the corporate bond underwriting market, banks act as match makers between