Bank Intermediation in Corporate Bond Issuance∗

This paper studies the frictions in the primary market for corporate bonds. Using a novel proprietary dataset about corporate bond issuance in the U.S. from 2010-2018, I find reduced form evidence that corporate issuers are heterogeneously exposed to global demand shocks based on their bank relationships. Specifically, I look at the ECB’s corporate bond buying program in June 2016. I find that firms that were more exposed to the Eurozone through their bank relationships faced higher demand for their bonds, achieved a lower cost of capital, and issued more bonds. This evidence suggests that there are bank-related frictions in primary markets that cause an uneven dispersion of demand shocks. I argue that these frictions are not due to balance sheet effects, but rather to search costs that banks incur when they act as matching agents between firms and investors in the primary corporate bond market. These costs vary based on the relative mass of investors and issuers. When there is more investor interest in US corporate bonds, banks have lower search costs, and encourage issuers to borrow more. ∗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, Tomasz Piskorski, Giorgia Piacentino, Tano Santos, Kairong Xiao, Neng Wang, and various seminar participants at Columbia Business School. †Kerry Siani is a PhD Candidate in Finance at Columbia Business School 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. Banks underwrite all of these bonds. Are there bank-related frictions in the primary market for corporate bonds? Understanding the role of the bank in this market is important, as it can help explain sources of growth in this market. Search-based frictions in secondary asset markets are well-documented. Primary markets for bonds and equities face frictions as well, due to information asymmetries and signaling effects. Primary markets for corporate bonds, however, are typically considered frictionless. This paper seeks to test the hypothesis of frictionless primary markets. If bond issuance were frictionless, then the bank relationship should not impact the firm’s capital raising decisions or outcomes. Using novel proprietary bond-issuance-level data, I find evidence that rejects the null hypothesis of frictionless markets. 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. The key mechanism behind this channel stems from the bank’s efforts to minimize its search costs on any given bond sale. Banks incur costs to search for investors to buy each firms’ new securities. The ECB’s QE program reduced search costs significantly, making each individual bond issuance more profitable for banks. Banks, working on commission, thus encouraged firms to issue more. In order to uncover these frictions, I rely on the observation that bank-firm relationships are persistent. I make the assumption that the geographic distribution of bank-investor relationships do not change in the short term. 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. 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 buyers and sellers. Banks have sticky relationships with firms. When issuing bonds, banks incur costs in their search for buyers of securities. When there are more buyers than sellers, the cost of underwriting a bond is lower. Banks will then look for more sellers of bonds, and share rents with the additional sellers by lowering underpricing on their securities. Issuers that have ongoing relationships with banks that have more buyers than sellers thus benefit from the demand shock. To formalize my hypothesis and these patterns in the data, I plan to adapt the model of Duffie Garleanu and Pedersen (2005), henceforth DGP. They build a dynamic asset-pricing model that captures the search-and-bargaining features of over-the-counter (OTC) markets for securities. Using this model, they derive equilibrium allocations, prices, and marketmaker bid-ask spreads, determine search intensities chosen