Distress risk, product market competition, and corporate bond yield spreads
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Distress risk, product market competition, and corporate bond yield spreads Han‑Hsing Lee1
© Springer Science+Business Media, LLC, part of Springer Nature 2020
Abstract The purpose of this paper is to examine whether industry-level risk affects corporate bond yield spreads. We use three types of industry risk variables in our empirical analysis: distress exposure measure, industry condition, and product market competition. After controlling for common bond-level, firm-level, and macroeconomic variables, the empirical results reveal significant relationships between these industry-level risk measures and bond yield spreads. Our evidence supports that industry-related risk does play an important role in explaining bond yield spreads. Keywords Distress exposure measure · Distress risk · Product market competition · Industry risk · Exposure CoVaR JEL Classification G12 · G32 · G33
1 Introduction Do industry-level risks play a role in corporate bond markets similar to the one they exhibit in equity markets? Previous research has shown that bond characteristics, credit quality of the firms, and macroeconomic conditions explain much of the variation in credit spreads on corporate bonds. However, while extensively studied in equity markets, the impact of industrylevel risks has rarely been investigated for corporate bond markets. In addition to macro and firm-specific risks, previous literature has indicated that industry attributes can affect security returns and how credit risks propagate (Hou and Robinson 2006; Acharya et al. 2007). Practitioners such as KMV have also incorporated industry risk in their three-layer factor structure model for asset return correlations (Crouhy et al. 2000). Therefore, this study approaches this issue by investigating the impact of industry-related risk on corporate bond yield spreads. Industry-related risk impacts a firm in many ways. It can arise from the industry structure, expected future performance of the industry, and the prospects of the industry. It affects not only a firm’s operating performance, but also its real value. Some research studies regarding industry risks have investigated the effects of asset specificity and * Han‑Hsing Lee [email protected] 1
Institute of Finance, National Chiao Tung University, 1001 University Road, Hsinchu, Taiwan
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industry-wide distress on recovery rates. Acharya et al. (2007) examined a broad cross section of industries and found that recoveries are significantly lower when the industry of the defaulting firm is also in distress. They further found that the effect of industry distress on recovery values is greatest for those industries relying heavily on assets that are not easily redeployed. This is consistent with the fire sale hypotheses of Shleifer and Vishny (1992), whereby many assets are specialized and thus cannot be easily redeployed to industry outsiders without a substantial loss in value. Accordingly, for many assets, the highest valued users are other firms within the same industry, a
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