Wednesday, October 28, 2020 | 2:00pm - 3:30pm | ZOOM, Room 339

Abstract

This paper examines how perceived government support for state-owned enterprises, SOEs, can shut out non-SOE firms in China’s credit market, causing severe segmentation in credit pricing. Since 2018Q2, amid government-led credit tightening, the SOE premium the difference in credit spreads between non-SOE and SOE issuers of the same rating, exploded from a stable level of 20 bps to well over 100 bps. Using issuer- level information on governments’ equity ownership, we find that this sharp increase in SOE premium was driven not by the SOE label, but the richer information on the extent of government support. Examining the impact of this severe segmentation on price discovery, we find that, amid heightened concern for credit risk, non-SOE bonds became significantly more informative of credit quality, while SOE bonds became sensitive to government support. Overall, our results find a market of improved price efficiency, and, paradoxically, worsening segmentation as government support emerges as an important factor in credit pricing. We further document the negative impact of this severe credit misallocation on non-SOE firms in China.