Working Paper: CEPR ID: DP17032
Authors: Viral Acharya; Ryan Banerjee; Matteo Crosignani; Tim Eisert; Rene Spigt
Abstract: We document capital misallocation in the U.S. investment-grade (IG) corporate bond market, driven by quantitative easing (QE). Prospective fallen angels---risky firms just above the IG cutoff---enjoyed subsidized bond financing in 2009-19. This effect is driven by prolonged cumulative Fed purchases of securities inducing long-duration IG-focused investors to rebalance their portfolios towards higher-yielding IG bonds. The benefiting firms (i) exploited the sluggish downward adjustment of credit ratings after M&A to finance risky acquisitions with bond issuances, (ii) increased market share affecting competitors' employment and investment, but (iii) suffered severe downgrades at the onset of the pandemic.
Keywords: capital misallocation; corporate bond market; investment-grade bonds; BBB rating; large-scale asset purchases; LSAP; credit ratings
JEL Codes: E31; E44; G21
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Prolonged purchases of securities by the Fed (E58) | Demand for higher-yielding BBB-rated bonds (E43) |
| Demand for higher-yielding BBB-rated bonds (E43) | Lower bond spreads for these firms compared to other investment-grade bonds (G24) |
| Lower bond spreads for these firms compared to other investment-grade bonds (G24) | Prospective fallen angels issue bonds to finance risky acquisitions (G24) |
| Prospective fallen angels issue bonds to finance risky acquisitions (G24) | Delay in downgrades that would increase their borrowing costs (G32) |
| Sluggishness of credit rating agencies to downgrade these firms (G33) | Maintain investment-grade status longer (G33) |
| Concentration of prospective fallen angels in industries (G24) | Lower employment growth and investment levels in those industries (O49) |