The Help that May Hurt: On the Link between Institutional Ownership and Cost of Debt Capital

Abstract

Recent literature has documented a link between institutional equity ownership (IO) to cost of debt capital, and interpreted it as a corporate governance effect. However, separate literature has also interpreted IO as information asymmetry proxy. Given the heterogeneity among IO and their different association with corporate governance and information asymmetry effects, here we look at equity ownership by various types of institutional investors, which allows us to distinguish between the two effects. Based on a most update-to-date and comprehensive bond pricing data spanning the past 20 years, we find that yield spreads narrow (widen) with an increase in the equity institutional group that is more (less) sensitive to information asymmetry and is least (most) expected to help improve corporate governance. The contrasting patterns between yield spreads and various IO persist after controlling for potential endogeneity and other information asymmetry measures. Overall, our findings provide strong support for information asymmetry effect on cost of debt, and highlight the importance of distinguishing various types of institutional investors.

Keywords: Cost of Debt, Institutional Equity Ownership, Information Asymmetry

JEL Classification: G12, G32